Business Breakdowns
· 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?
· James Davolos
[00:00:00] S1: We ultimately build everything bottom up. We look at our volume pricing margin, discount it back using a fairly conservative discount rate. However, ultimately I think it's more discernible to look at okay, what are comps and what are multiples on a static rate and then reconcile that with your DCF. So today you're gathering and processing peer groups. So mostly natural gas, Western and MPLX, ONEOK, et cetera. They tend to trade around 9 times 4 forward EBITDA. The IPO process targeted a peer set to GNPs with a one turn discount to incentivize the IPO book build. I think it did so and then more so. It priced at the top end of the range and they were able to upsize. I think that pricing at a GNP multiple, while I think it's necessary because it's such a nuanced, idiosyncratic business, you have to use something the market has familiarity with. We think the business can grow on a fairly organic basis for 15% or better for three to five years. So that's expanding Kraken, that's expanding Speedway, that's isolating the sour gas window. You can also bolt on some M&A assets. So Pilot, which is owned by Berkshire is up for sale. They have a very interesting Midland Basin business that is legacy Diamondback which could be bolted on. But forgetting those more aggressive bolt-ons, again, the organic-ish growth profile around 15 at 8 times with multi-decade contracted CPI escalator, 50% EBITDA margin. Doesn't sound right to you? It doesn't sound right to me. So what does it sound like? It sounds like waste. You look at Casella, GFL, Waste Management, Clean Harbors is one of the more industrial players and those companies tend to be 14 to 18 or even more. I would argue WaterBridge has better returns on invested capital and better growth. So if you're looking for a peer-based comp set, this is really more of an infra waste business than it is a midstream business. So for it to trade in line or better than infra and waste, I think as the market appreciates the growth, the margin and the pricing wouldn't shock me. And we try not to use multiple expansion in our base case. So go back to the organic growth rate, add some M&A. If the company pays down debt, buys back some stock, it's pretty easy to get excited. But then if you do add on that re-rate which we think is more than justified, then the numbers get really compelling.
· Matt Reustle, James Davolos
[00:00:00] S0: It's definitely interesting enough based on what you laid out from a organic perspective alone. [00:00:00] S1: Yeah, we haven't even talked about the beneficial reuse because you can't monetize it or even think about the economics today. But to the extent that you can clean this water and use it for agricultural purposes or even industrial uses, that adds another component that will probably be here someday. But definitely not within 12 to 18 months. [00:00:00] S0: Right? Yeah, makes sense. And then just thinking about the sensitivity of the business and where there would be most swing in terms of outcome here, what do you hone in on just in terms of the key variables, things that matter the most?
· Matt Reustle, James Davolos
[00:00:00] S0: Right? Yeah, makes sense. And then just thinking about the sensitivity of the business and where there would be most swing in terms of outcome here, what do you hone in on just in terms of the key variables, things that matter the most? [00:00:00] S1: To the extent that we are very comfortable that Permian production is going to be stable to the extent that there's a shift, do we think it's going to shift more west into the Delaware where there's more volume? There's also some more gas opportunities which to the extent you believe in the AI and the power generation thesis, a lot of that macro ties in very well to just the stable, if not growing Delaware Basin production volumes. So that's your KPI, because as long as volume is stable, if not growing, then you have the addressable market established and then it's really, can they capture volume? Can they push price? And the debit agreement? The final investment decision on Speedway, the completion of Kraken is showing us that all these cross references to the thesis are in place. And so now it's just looking at the sensitivities of what is the volume growth, at what price and then at what margin. And that's your toggles in terms of looking at the valuation. And then that's where it's fairly clear cut. Where it gets a little bit more murky is, okay, are these returns on an incremental invested capital as high as we thought? Is the addressable market for that as big as we thought? That's the second layer to the analysis.
· Matt Reustle
[00:00:00] S0: That makes sense. Yeah, it's very interesting. I came into this with one subsegment of the oil market—the frac sand businesses I had in mind. And I was like, how can I separate this from frac sand? The first was I was thinking about this in the injection mindset rather than the disposal. But I think there's been plenty more to that. As we close these conversations out, we try to hit on the lessons as you step back and try to take away the lessons from this, from LandBridge, from TPL. What would you use as a lesson that you can take from those businesses and think about elsewhere when you're investing?