Business Breakdowns
· James Davolos
[00:00:00] S1: Yep. So for the produced water, which is really that basic business of you take the water from the wellbore, transport it and dispose of it, they're getting about 78 cents a barrel right now on a run-rate, pro forma basis for handling that water. And that includes a little bit of skim oil. But about 85% of their pro forma revenue is just handling the water. 8% is skim. The remaining is mostly this water solutions business, which is cleaning it up for refracs. But again, 78 cents with an adjusted margin, an operating margin per barrel of about $0.44. So call it about a 56% operating margin on a per barrel basis. The consolidated EBITDA margin of the business on a run-rate where they're just shy of about a $400 million run-rate of EBITDA that's running around 51%. So fairly high-margin business. But to your point, okay, I was referencing dollar rates. And so one of their newer projects is getting water from New Mexico east over the state line on a new pipeline called Speedway into Texas. And this is important because New Mexico is far more stringent in their permitting in some cases, again notwithstanding the newer crackdown on permits. But you could get a Texas well permitted in weeks, if not a month or two. The average permitting time in New Mexico was over two years. Wow. And a lot of people don't realize a huge part of the Permian Basin is in New Mexico. Lea County, Eddy County are juggernauts of U.S. energy growth. So it's easier to build a long-haul pipeline to get that out of New Mexico into Texas. So the big gold mine has been that lower state line. So the southern border of New Mexico Speedway is going to take water east over the eastern border into the panhandle of Texas. So yes, there is a higher incremental capital investment because you're building a long-haul pipeline to get it over that border. But one of the interesting things when talking to them is they've identified about $3.5 billion of capex, which should contribute about a billion of EBITDA on a fully utilized basis. So call it around a 30% unlevered return on incremental invested capital. And as you start having higher pricing power and you start having higher utilization, I would expect these numbers to drift higher.
· James Davolos, Matt Reustle
And so the reason that you can have such extraordinary returns on an incremental invested capital is the ability to control the land and then scale the business. And so it's not the same as how difficult it's going to be to capture if you're going to try to expand oil and gas pipelines. And I think that's another nuance is that the returns here and then the ability to get these systems online and then capture market share is just a completely different universe. I'd say superior to midstream. [00:00:00] S0: Yeah, I mean midstream, especially once we're talking about some of the state lines that they try to cross, is a totally different ball game. The $3.5 billion of capex, is that spread out over a long time period or is that all going to come quickly?
· James Davolos
[00:00:00] S1: So that's just what they've identified in a theoretical standpoint. I don't want to represent that as being guidance, but as an indicative case study of what hypothetically could happen if this really comes to fruition. But to the extent that that does come, I'd say probably five to 10 years that would be spread out over depending on how quickly some of these developments come to bear. But actually something else just popped in my head that I feel we should touch on that I forgot is... So going back to my comments earlier about... So in Texas you have the surface estate, which is the surface, just your fee simple ownership in your house. Then there's the mineral estate, which is the oil and gas. There's essentially eminent domain for the mineral holder where the surface owner cannot prevent you under reasonable circumstances from extracting your oil and gas. And so they can't say no, you can't get a wellbore easement, no, you can't get a frac pad, no, you can't get an easement for a pipeline. There's different university land systems that publish systems around the rates for these things. But in essence there's eminent domain for the oil and gas holder to extract their minerals. Water is not protected by eminent domain, even though it could shut in oil and gas. So a rancher could literally just say, no, you cannot cross my land, hard stop. Or they could ask for some extravagant amount of money. When I say it's getting harder and harder to compete with the incumbent systems, go back to that checkerboard I mentioned of these 640-acre square miles. If you have to go 50 miles and deal with 50 different landholders asking you different rates, I mean that just shows you how difficult it is because there's no protection around giving you egress to get rid of that water, even though it could very literally shut in your operations.
· Matt Reustle
[00:00:00] S0: Yeah, it's interesting just in terms of the nuances of that legal domain and legal rights. So yes, NIMBY rules everywhere when it's allowed to. I wanted to close on one last point just on the capex because again, the 50ish percent EBITDA margins, I understand that capex spend for growth opportunities is spread out. When it comes to maintenance capex, which I know is a dirty word in this midstream infrastructure space, do you have some sense of just the maintenance costs associated with keeping obviously infrastructure that's dealing with very intense saltwater that would I'm sure corrode? Is that a heavy burden on the business?
· James Davolos
[00:00:00] S1: Yeah. So you definitely have maintenance of the pumps and the pipes and it's a newer nascent industry. But we're looking, depending on the different types of equipment you have, anywhere from seven up to 28 years of useful lives. But we look at it as saying, okay, 10 to 15% of undepreciated PP&E just as a heuristic, probably on the high side. But again there's, once they build out the growth, there's really, really high free cash flow conversion to this business. And then something else going back to the growth that I think is worth mentioning. And I mentioned earlier, Five Point had an asset called Northwind. And Northwind is more of a traditional midstream business, but they specialize in AGI injection wells. So acid gas injection, the other AGI. Yeah. So this is sour gas. So if you look at the Delaware Basin, that Eastern shelf is what's called sour gas. And it's sour because it has very high hydrogen sulfide. And hydrogen sulfide in high levels is extremely dangerous. Deadly. And it's that really sulfuric egg smell. But then at high doses you don't smell it at all. And it can be life threatening. But it's very difficult and expensive to deal with. So you've seen a lot of operators just ignore that sour gas window. But Northwind, when Five Point funded went out and said if we build these AGIs, basically you're setting the infrastructure for people to come up there and start really drilling in earnest. And so MPLX recognized that they bought them and what I've heard was a very aggressive, hotly contested bidding war for Northwind because people see all that growth around sour gas. WaterBridge obviously working as a Five Point portfolio company is, well if this growth really comes into this Eastern shelf, we want to be in a position. So not only do they acquire a lot of surface at LandBridge, but they're developing a lot of infrastructure so they're ready to go once those drill bits come, whether it's going to be Devon, Oxy, Coterra. And so I don't want to call it de-risked, but I think there's a lot of visible growth simply from that sour gas window starting to get developed. That again something very few people are talking about, but that's also probably a significant portion of that incremental capex and growth that I referred to earlier.
· Matt Reustle
[00:00:00] S0: Yeah, there seems to be just some interesting non-obvious growth angles that wouldn't have stood out to me. I guess if we just transition to how you frame a business like this, thinking about any type of valuation approach that you would use, how would you go about that? And if you want to use what you've seen in the market or anything else, I'm always curious as this midstreamish, not quite linked to oil prices, linked to the production, but with a very unique profile in terms of the durability of some of this stuff. So putting that all together, how do you go about framing valuation?