Business Breakdowns
· Matt Reustle
[00:00:00] S0: This is Matt Reustle and today we are breaking down the recent WaterBridge IPO. I was joined by James Davolos from Horizon Kinetics and this one was a long time in the making. As you will hear in the episode, HK has a long history in these unique capital-light, high cash flow potential businesses, most notoriously with TPL, Texas Pacific Land Trust. And I had been in pursuit of getting HK as guests, but it wasn't until friendly listener Chris Polk made the connection that this all came to life. So we start the episode with a bit about HK's history with, again, these very unique businesses that are off the radar for many with TPL, LandBridge and now WaterBridge. And then we get into the weeds and nuances about what this business actually does, why this disposal water and this service that they're providing is so incredibly important, particularly with US Shale and where they are in the Permian Basin. So this is an interesting one from all different angles and it's a timely one which is always special. So please enjoy this breakdown of WaterBridge. All right, James, I am excited to have you here. It's a timely business breakdown. We're here to talk WaterBridge. I think we're going to get into a bit about LandBridge as well, the overall space and what these businesses kind of represent in the market. Maybe you could just start us off with a simple introduction—how you would describe WaterBridge, maybe even LandBridge as well, to a broader audience to get them familiar with what's going on at these businesses?
· James Davolos
[00:00:00] S1: Sure. First, I want to say thanks for having me. I've been a big fan of the podcast and everything at Colossus for a long time now. I think let's start with WaterBridge. So WaterBridge came public yesterday and WaterBridge is the leading water infrastructure company in Texas. And so unlike traditional water infrastructure you might be familiar with, which are utilities that generally treat, dispose and move water around in residential and commercial systems for consumption, this is actually a waste byproduct that is part of the oil and gas extraction industry. I think a lot of the listeners will be surprised to learn that in the Delaware Basin, which is the largest and fastest growing part of U.S. oil production, about four barrels of this water are produced for every barrel of oil and gas. It's a lot. Suffice it to say, LandBridge is actually already public. Came public a little over a year ago. And the way I think about it is they are the land company with basically triple net leases that facilitate the activities of WaterBridge and other infrastructure companies operating in that Texas ecosystem. So while the core business is driven by water, there's definitely some next-gen things in power generation, transmission, maybe some data centers, etc.
· Matt Reustle
[00:00:00] S0: It's a very helpful overview. And these are unique businesses. I would almost say they're a class of business—not quite an asset class, but they're a class of business. And I know you have history, Horizon Kinetics has history in this space. So can you talk a little bit about the history that would result in these coming onto your radar and a little bit about that background?
· James Davolos
[00:00:00] S1: Absolutely. And can't take any credit for it because you're going back to 1995 when the firm was founded and I was 11 or 12 years old, but Murray Stahl, our chairman, came across this funky liquidating land trust in Texas that was listed on the NYSE called Texas Pacific Land Corporation. And the original thesis was very simple. We actually have a research report that he issued publicly back then. And it was essentially this: company was created through the bankruptcy of the Texas and Pacific Railway in the late 1880s. The idea was to connect Texas to Southern California. People that remember history of that era and the robber barons and railroads and the leverage are pretty familiar. That didn't end well. They got land grants for every mile of railroad that was built in the state of Texas. Impossible to sell off a couple million acres, certainly in 1888, probably no less so today. And so they listed it on the NYSE and it was a liquidating trust. So basically they would take their proceeds, much of it was from grazing land, later some small oil and gas royalties, and then buy back stock or pay dividends. But if you bought back stock at a lower value, you're effectively buying back acreage at a lower implied price. So if you're buying back stock at an implied price of $10 an acre and acres on the fair market were 100, it was the most accretive compounding machine you've ever seen. So that was the thesis. And then obviously things have changed dramatically with fracking, the development of water, the development of the Permian Basin. But our history with that company, which is now a corporation, and Murray is on the board of directors, was one of the earlier windows that we had into this large, nascent water infrastructure industry within the larger U.S. energy complex.
· Matt Reustle
[00:00:00] S0: Yeah, it's the fascinating background and the railroad story and them getting those grants. It's something that came up on our Union Pacific Railroad episode where their assets, they eventually sold to Anadarko for 4 billion 25 years ago. So it's interesting to see how these assets, these grants, all preserve some interesting value over the years. So how would you define this group or this concept of investing, if you could, in a snapshot—how do you frame it or approach it? Just in general terms.
· James Davolos
[00:00:00] S1: You can look at the broader energy industry. And most people in energy look at three different business models and there's nuance to each. So you've got your companies that are primarily E&P, so exploration and production—they drill and they make their money basically drilling for hydrocarbons. Then some of those companies then can be integrated where they're fully upstream, which is drilling. The second set is midstream, which would be transporting those hydrocarbons. The third would be downstream, which would be your refining and then your retail petroleum station. So those are the three traditional verticals. You can add a slight adjacency being oil field services. So the companies that Schlumberger, Halliburton, maybe some of the offshore companies that do services that are ancillary but part of oil field energy extraction, those businesses tend to be very capital intensive and very cyclical. Some of them have more stable cash flows, but generally they're all somewhat cyclical relative to the volume and the pricing of oil and gas markets. We prefer to look at companies that have lower capital intensity and less cyclicality. Now, you can't remove all of that. But so our protracted history now investing in Texas Pacific and then other companies within the ecosystem is we came to the conclusion that land. And land in Texas, there's really two different types. There's surface acreage and then there's the mineral estate. In some cases they are one and the same. But land is the preeminent asset because it's essentially a pure margin business that's perpetual with optionality. So within land, there are minerals or royalties. There's a variety of royalty companies that are public now. But if you were to think, okay, Chevron, Exxon, ConocoPhillips, they're spending hundreds of millions, if not billions, developing their U.S. energy position. The royalty holder is literally earning a percentage of the oil and gas that they produce off the top. So you participate in no OPEX and no CAPEX. In Texas parlance, they call this mailbox money. Because if you're so lucky as to have a ranch and ConocoPhillips is operating that lease, you just go out to your mailbox and you pick up your check every month. It's a pretty good gig if you can get it.