Technology is a Critical Solution to the Changing Energy Ecosystem

By: John Sinders

The fallout from reduced production growth was evident in OFS providers’ third quarter results. Most OFS providers reported continued pricing pressure and a slowdown in demand for their services on U.S. land drilling and completions activities. Service companies have begun to realize that it is not enough to wait for “better times” of higher oil prices to increase demand for services and commensurately push prices up, but that they need to realign their businesses to target services that improve efficiency through innovative solutions at a reasonable cost. Almost uniformly, the most efficient way that OFS companies are attacking this issue is through the development and investment in scalable technologies that automate otherwise manual tasks. Over the last four-years, the number of earnings calls mentioning this transition has tripled, and is clearly a focal point of the future.

Energy Companies Struggling to Attract Investor Capital, as a Greater Emphasis is Placed on Free Cash Flow (FCF)

The publicly traded OFS index is a good proxy for investor sentiment on the industry –capital allocators have grown increasingly concerned with Energy companies’ ability to consistently generate free cash flow, and skittish around the volatility of the broader industry environment. To attract capital and bolster multiples, E&P companies have squeezed service providers to do work cheaper, and in fewer days –the result has created a challenging situation for OFS companies; an industry primarily driven by day-rates and unit pricing. The Q3 OFS industry earnings calls are littered with citing of eliminating crews and equipment, with hopes that a tighter market will help bolster pricing and bring some stability to the industry.

OFS Companies Using Technology and Automation to Combat Pricing Pressures and Improve Value Proposition

OFS companies are exploring R&D solutions to develop technologies that will give them an edge in the bidding process, while also helping to alleviate pricing pressures from operators. These types of technologies are being developed across the energy ecosystem, and specifically offer a value proposition of improved performance at a lower rate. One of the fastest-growing segments in the energy market is smaller, lower-middle market (LMM) companies, acting as outsourced R&D for larger companies unwilling to commit to the fixed costs of developing differentiated scalable technologies. These smaller companies are solving for a critical pain point in the industry, and have attracted an increasing amount of Venture Capital and Private Equity attention.

Lower-Middle Market Technological Solutions Are Increasingly Attracting Investor Interest

Lower-middle market companies that have a proven product are quickly becoming hot-commodities in the M&A ecosystem. Strategic buyers are drawn to scalable technologies that may require higher-multiples to purchase, but often require a smaller check size than investing in in-house R&D efforts. Similarly, Financial Buyers (Private Equity and Venture Capital firms) are attempting to deploy a record-high amount of capital and are gravitating towards opportunities that can grow despite a tough macro backdrop, while simultaneous aiding their (often struggling) portfolio companies. These dynamics have led to ~40% of M&A transactions in the industry being from technology-enabled solutions, which is twice as much as what it was in 2016.