Marty Staples On Topaz's Evolution and Return Proposition

Speaker 1:
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Aaron Bilkoski:
Hey, everyone. I'm Aaron Bilkoski, I'm a Cowen Group-based research analyst at TD Cowen specializing in Canadian oil and gas equities. We're here live at the TD Cowen Energy Conference in New York. With me today is Marty Staples from Topaz Energy, a unique royalty and infrastructure hybrid vehicle. Before joining Topaz as president and CEO Marty had spent the last decade at Tourmaline. I guess we get to see, or we have seen what a landman does when he runs a royalty company. No, in all seriousness, we typically do see the royalty entities run by two groups, there's the engineering like G&G crowd or there's the finance types and you're sort of in the middle which isn't surprising because your business model's in the middle. If we take a thousandth of you, your business, and your background, how did you end up at Tourmaline? And how did you spin that into a CEO role at a royalty company?
Marty Staples:
Well, I'm not sure if anybody has watched the show on Paramount+ called Landmen but I've got about 50 emails today on how good it is. I think just like any good landman story it's probably overdramatized and more exciting than it really is. My background started in Saskatchewan. I grew up in a small town called Kindersley, it was oil and commodity-based and so we had a farming town and we had an oil town. Was lucky enough to transfer into an oil and gas sector. I actually started in geology when I first got into university and realized right away I wasn't a geologist. Because the amount of work that those scientists put into labs and then further into their career by just mapping and being complete scientists, that just didn't gel well for me. By accident I ended up in the land program at the Haskayne School of Business and ultimately became a land person.
Let's fast-forward about 15 years from then, worked at a bunch of different small privates. We started a small company called Peloton in 2007. And if you think about the environment in 2007, 2008, we had income trusts leave the business, essentially what is a royalty company today, very similar to what income trusts were doing at that point in time. And then the second part of that, our fair share where we did a royalty review on the business. And you think about what that did to small business in Canada, it just went away. The junior model was broken. You had to get big, you had get big quick. Marry that to what was going on in industry. I think Tourmaline, and their predecessor being Duvernay, was the last company that really sold for a big multiple to Shell. And it was a $5.8 billion acquisition I believe. Duvernay sold I think July 8, 2008, and by July 4th all commodity prices started going down. So their timing couldn't have been better.
I got a call from Tourmaline in 2009. And I think the real reason I got the call is that the small company Peloton, I was stealing a bunch of deals from the land guy there. And he called me up and he said, "Hey, what the hell are you up to? If you're stealing deals from me you better just come work for me." Ultimately that's how I ended up at Tourmaline. Started at the end of 2009, early 2010. And saw it go from 3000 BOE a day to 330,000 BOE per day so a big expansion along the way. And I touch pretty much every deal we were able to do. I mean, always Mike the quarterback but he had to have some good wide receivers and running backs. I don't know, maybe I was a blocker at that point in time but I fit on the team okay.
Aaron Bilkoski:
I take issue with you saying that the royalty subsector is similar to the trust subsector. Or the trust sector. It's very different. In the royalty space you benefit from no capital costs, no operating costs, no abandonment liabilities. All those were burdens to the trust sector that you don't have. Would you agree with that?
Marty Staples:
Yeah. I mean, I was using it as an example where you pay back a bunch of money. And when we look at our excess, yeah, a return vehicle, I don't think it was similar to some of the liability that these income trusts were taking on, some of the capital erosion that was taking place. I mean, that's probably why it ended up getting shut down was just the lack of discipline inside the income stream space.
Aaron Bilkoski:
Sure. I alluded to it in my initial comment, but when you were spun out at Tourmaline, I think the decision was made early on in the process that you weren't going to be a pure play upstream royalty business you were going to be a hybrid vehicle, you were going to own midstream assets. Why was that decision made? Why not choose one or the other? And why did you package them into one business rather than some say your US peers who did launch a midstream spinco as well as a royalty spinco?
Marty Staples:
And I think what you're referring to is what Diamondback was able to achieve through their spin-out of a royalty company called Viper and a midstream called ... I think it was Rattler at the time. Rattler ultimately didn't work I think they went to a pure royalty model only. We looked at it, and, in fact, we thought about the midstream idea first. And I remember we crossed a few different teams about this infrastructure idea. One of the comments they made early on was "Hey, this is a great idea that you have and you're not getting full value. Infrastructure companies are trading at 10 to 12 times and you might get something close to that. But where it's really trading at a high multiple is on the royalty side."
I think at the time PrairieSky was trading at 25 times, very similar to where Franco-Nevada, where Wheaton Precious Metals are trading at today. We thought the combination of the two would give us a unique advantage to compete. There was already two public royalty companies out there. There were some very large-scale infrastructure companies out there being Pembina, AltaGas, Keyera. I'll just use those as a few ... As an example. We thought the unique hybrid marriage of these two would allow us to compete different, and we showed that. Recently we did a deal with Tamarack Valley where we did a royalty slash infrastructure deal where we combined the two. We did a deal with Headwater. We did a royalty slash infrastructure deal that really set us apart from our competitors. And so I think it allows us, being the only hybrid company in Canada, maybe North America now, to compete differently.
Aaron Bilkoski:
Right. And maybe this was just my misconception but I viewed Topaz as a financing vehicle that would help Tourmaline in its business. It was offering better cost to capital financing and that it would allow Tourmaline to make more acquisitions. But really you've diversified yourself away from Tourmaline over the years. I guess two questions. One, would you agree with my initial characterization of the business at the time of the spin-out?
Marty Staples:
Yeah, absolutely. I think you hit the nail on the head. We were there to help support any type of acquisitions. And I remember Mike sitting at a table saying, "Hey, we're going to spin out this Topaz and it's really going to give us an opportunity." Because think about what was happening in 2019. From 2014 to 2019 we'd seen equity start to retreat. Private equity had left the private space and public equity had completely abandoned oil and gas. And there's a few things because of that. Number one, there was an ESG movement taking place throughout North America and Europe, for that matter, and they saw energy as uninvestable. We had to find our own way to go and acquire what we thought was a generational opportunity of acres. And creating Topaz allowed us to do that. And so when you think about the narrative that was around place in town and energy you had to get creative.
I think there's a few other companies that the lights went on for, the first one being Advantage, the second one being Tamarack Valley, they wanted to change their business. I got a call from Steve Buytels over there and said, "Hey, that thing you're doing with Tourmaline, is it available to everybody out there?" And I said, "No, not everybody. We want high-quality operators with high-quality assets." And that's the big thing, not everybody got a royalty deal, not everybody got an infrastructure deal. But there were certain groups that we wanted to align with and build our business out. Headwater is now one of our working interest partners. We also have White Cap, NuVista, Strathcona. So seven very well-known public entities that make it very easy to model what our business is.
Aaron Bilkoski:
Right. And I think that's what makes it unique relative to some of the more diversified models is you have a very clear strategy with very clear counterparties that are relatively predictable. Do you view those as strategic partners or do you view those as counterparties that are now just drilling on your land?
Marty Staples:
Oh, no, I think the strategic partner comment you make is one that rings really true for us. I mean, we do want to be the partner of choice. You think about six deals with Tourmaline, five deals with Tamarack Valley, two deals with Headwater, two deals with White Cap. And we hope we can repeat that business. Let's be honest, there's less and less operators that exist inside the basin. There's consolidation happening. We want to be the partner of choice to help advance their business. Not only are we attracted to high-quality counterparties but they have a tremendous amount of drilling inventory that exists on their acreage. We have over 20 ... Or 25,000 locations identified on our realty lands. That's 75 years of inventory on Tourmaline alone. Think about the decades of opportunity that exists inside this program that we're involved in.
Aaron Bilkoski:
You alluded to I think seven key counterparties. How many would you like to have? Is there an ideal number?
Marty Staples:
I think I used to say 14 in 2020 when we started the company but I'd say probably 1/3 of those companies don't exist anymore because Tourmaline's bought them. They bought Black Swan, Jupiter, Modern. I'm missing a bunch here. Half of Saguaro, Bonavista, Crew. They've taken a lot of corporate mandates down and so there probably isn't the same number anymore. If we look around 10 to 12 I think that's probably a fair number for us to think about how many partners we want to have inside this complex. 90% of our revenue is on those seven operators that I talked about. From an analyst sales guy, very easy to identify what Topaz is up to. In fact, we've got some analysts that don't even call us they just model it out and know the answer before we do a lot of times. You might be one of them, Aaron.
Aaron Bilkoski:
Do you ever look at the basin and say, "Hey, maybe we should go a step below these large investment-grade credit-worthy counterparties and try to buy royalties?" Or enter royalty arrangements with the tier below that thinking that hey, we can get a better deal entering an agreement with a second-tier company knowing that these larger entities will more likely than not eventually consolidate them.
Marty Staples:
I talked about the quality inside this portfolio. I mean, we are always very mindful of not diluting the existing business just for a return. And I think that's what sets us apart for our business is the amount of quality we'd be able to add. We have done that from time to time but it would have to be at an inexpensive rate. So we're not going to pay a tier one price for a tier three asset. I think if they're willing to look at themselves and say, "Yeah, this is probably a tier two, tier three type asset, that's the price it's going to get." Yeah, we might add that to the complex. We did a deal with a small private oil company in 2021, it was a great deal for us. I think we're looking towards 30% IRR on that project because we were very countercyclical in our acquisition timing. And that thing paid out in two and a half years.
And so you think about royalty companies or royalty acquisitions paying out in two and a half years, that's a great spot for a royalty company to be. And it hasn't declined. The assets actually improved, it's producing more. They've sold parts of their assets to their operators. Currently, we have Caltex Trilogy drilling on 27 sections that they bought off this company. We're pretty satisfied with some of those deals that we did on what I would call lower-tier opportunities at the time.
Aaron Bilkoski:
When I look back over the past 15 or so years that I've been covering the sub-sector ... 15 years ago I think royalties were perceived as financing of last resort for companies. And I think there was a hesitation to, I put in quotes, "Burden assets with royalties on them." I feel as though that view has softened materially over the last probably 10 since the PrairieSky IPO. Do you see that same dynamic taking place? And if so, what's changed that?
Marty Staples:
The biggest thing that's changed it is I think the cadence of how high these royalties used to be compared to now. We, I mean, on average have about a 4% gore across our royalty portfolio. If you think about the Clearwater, you've got royalty relief inside. The way that this is set up with the C-star calculation, it allows an encumbrance to be put on an area like the Clearwater. When you used to see 10 to 15% gores on acreage, manufactured on acreage, it became the last thing any operator, engineer, finance person would want to do, they'd always pick another section. I think if you keep that royalty small enough it entices this operator to actually continue a program on those royalty acres. And yeah, you're right, I think PrairieSky changed it, they changed the game a little bit. Not to say Freehold was running a bad business in any capacity. I think all these businesses, Freehold, PrairieSky, ourselves make each other better.
Aaron Bilkoski:
Right. In terms of your cost of capital to counterparties, we've seen interest rates come down a little bit over the last month or so. Do you think that's a tailwind for your business or a headwind for your business?
Marty Staples:
I mean, interest rates came down and probably will continue to come down. But what I've seen is a lot of the price grids that people are renewing debt on haven't, in fact have gone up 75 to 150 basis points. If companies are raising equity, if they're taking on debt, they still should sprinkle in some Topaz. I think it's part of the recipe for them to efficiently use their cost to capital.
Aaron Bilkoski:
If I go to your Q3 report, the thing that caught me by I wouldn't say surprise but really stood out to me was the amount of net capital that was spent on your land. I think that's a metric you probably follow reasonably closely. As you look out to 2025, is there a number of either gross or net capital that you think could be spent on your land that you would say "Wow, that's great, I'm completely satisfied with that number?"
Marty Staples:
Yeah. Last year we saw $2.4 billion, that was 2023, spent on our royalty lands out of a $26.4 billion complex. That was 9% of the cash spent in Western Canada. We do see similar rate. We're over $2 billion already in 2024. We'll see some five-year plans come out into 2025 January-ish. I think if we're $2.5 Billion right now, we have 30 rigs running on our acreage so very active operator. One thing I think we'll have to watch really close is how much of the drilling is happening and how much of the completion is happening. I do get concerned there's going to be a lot of DUCs out there, and that's drilled uncompleted for the audience. And with those DUCs, you've got to understand what the cadence becomes for actually completing these wells and getting on stream. And these aren't like wells you can just go and complete overnight and have them on stream within a week, that's probably a three-month process because these are super pads now they take a lot longer to do.
Aaron Bilkoski:
Right. That's not necessarily a bad thing for you. You're building an inventory of almost on production rather than an inventory of potentially drilled wells.
Marty Staples:
No, exactly. And that's the benefit and beauty of the royalty business is we're not in a big rush to make sure every molecule gets on today. In fact, it might be beneficial to hold some of those molecules back because we get a better gas price, better oil price for them when they're hitting these or completing these or on streaming these wells at a higher commodity cycle.
Aaron Bilkoski:
Right. And you alluded to five-year plans being rolled out in January, or updated five-year plans being rolled out in January. When I look at some of your counterparties five-year plans, it's pretty obvious to me that they're holding back on some of the potential projects that exist within their portfolio. Where do you see surprise upside in some of your counterparties five-year plans?
Marty Staples:
Yeah, good question. I think Tourmaline right now hasn't communicated their Northeast BC plan inside their five-year plan. You've got Crown and Birch, Conroy, Westo, all that haven't been communicated. And we anticipate at least one of those will be communicated into January, I think, depending on what gas prices do. We're in a good spot. I think this is all opportunity that's going to get communicated and you'll see the big surprise come into 2025.
Aaron Bilkoski:
Is there anything we didn't touch on that you'd like to?
Marty Staples:
I always like to end with the dividend and how sustainable we've made that dividend. We talked about the infrastructure business and how 25% of our revenue covers almost 50% of our dividend. It's a natural hedge on our business. We do hedge a little bit of volume. But we've been able to increase the dividend eight times since 2020. That's a 65% increase. And so you've got a growth business that exists inside Topaz that grows around four to 7% organically. This is without any new M&A. And we've been very acquisitive, we've done $2.6 billion in acquisitions. And so while you see all these acquisitions take place, and this small organic growth, you get paid to wait. What a great business where you get paid to wait. Nobody pays you to wait.
Aaron Bilkoski:
Fantastic. Thanks for taking the time, I appreciate this.
Marty Staples:
You bet. Thanks.
Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.

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