Archrock, Inc. (AROC) Earnings Call Transcript & Summary

Good morning. Welcome to the Archrock conference call. Your host for this morning's call is Megan Repine, Vice President of Investor Relations at Archrock. I will now turn the call over to Ms. Repine. You may begin.

Thank you, Krista. Hello, everyone, and thanks for joining us on today's call. With me today are Brad Childers, President and Chief Executive Officer of Archrock; and Doug Aron, Chief Financial Officer of Archrock. Yesterday, Archrock issued a press release announcing its acquisition of Total Operations and Production Services, LLC or TOPS. In a separate filing, we announced select preliminary financial results for the second quarter. And this morning, we announced the pricing of a common stock offering. If you've not received copies, you can find these materials as well as the presentation discussing the transaction on the company's website at www.archrock.com. During this call, we will make forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934 based on our current beliefs and expectations as well as assumptions made by and information currently available to Archrock's management team. Although management believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Please refer to our filings with the SEC for a list of factors that may cause actual results to differ materially from those in the forward-looking statements made during this call. I'll now turn the call over to Brad to discuss the transaction.

Thank you, Megan, and good morning, everyone. I appreciate you joining us on short notice. As you've read, we're excited to announce that Archrock will be acquiring TOPS, the leading provider of electric motor drive contract compression services in the Permian Basin. This transaction is an exciting milestone for Archrock that builds on the meaningful progress we've made orienting our business for the future and for long-term success. We believe this transaction will further solidify our position as the premier contract compression services company and enable us to continue serving customers' growing demand for lower carbon solutions. As I said, TOPS is the leading provider of electric motor drive contract compression services in the Permian. The TOPS fleet is young, deployed primarily in gas lift and equipped with innovative remote monitoring technology. Led by CEO, Brian Green, TOPS has a talented team of employees committed to delivering cleaner energy across the U.S., but we're excited to welcome Brian and the TOPS team to Archrock. First, let me touch on the terms of the transaction. Archrock will acquire TOPS and its approximately 580,000 horsepower for $983 million in cash and stock. The stock portion will be funded by issuing 6.87 million newly issued shares of Archrock common stock to be paid to the seller Apollo. Then Doug will talk about the other parts of our financing strategy later in the call, but a key takeaway is Archrock remains committed to the company's stated target leverage ratio of between 3x and 3.5x. Before we review the significant strategic and financial benefits of this transaction, I want to talk about how this acquisition fits into Archrock's overall strategy. As a leading compression company, with 70 years of operating experience, we regularly evaluate M&A opportunities. However, we maintained both our discipline and our rigorous standards for asset quality, safety, customer relationships and value creation. With today's robust market growing natural gas production and compression demand, one of our top priorities has been investing in high-quality, high-return and highly standardized compression assets. And equally as important, we have been funding these investments within our cash flow, so that we've been able to deliver on our commitments to increasing cash returns to investors while maintaining a strong balance sheet. This transaction with TOPS aligns with our strategic focus and is an exceptional opportunity to expand our contract compression operations, diversify our capabilities and increase sustainability across our fleet. With TOPS, we're adding 580,000 horsepower of young compression assets, including approximately 500,000 operating horsepower and a substantial and contracted backlog of new equipment. In doing so in a way that reinforces our best-in-class capital allocation and financial strategy makes this an incredibly compelling opportunity for Archrock and our investors. We believe this transaction has 4 key value drivers. First, the acquisition of high-quality assets with contracted cash flows adds meaningful low-risk growth. Second, the acquisition enhances our scale and complement our existing Permian Basin compression capacity. Third, this acquisition accelerates the growth of our electric motor drive fleet and augments our internal electrical expertise. And fourth, this transaction is consistent with our financial and capital allocation priorities and we expect it will facilitate the accelerated return of capital to shareholders. I'd like to now dive deeper into each one of these 4 value drivers. First, this transaction immediately adds high-quality assets with contracted cash flows to our TOPS fleet. Since 2016, we've worked continuously to upgrade our fleet, markets, customer relationships and technology. I'm proud of the strong market and financial position we've established as a result of these efforts, and believe that the TOPS assets will build on our momentum and further enhance our competitive position. I want to highlight a few key aspects of the TOPS fleet that make these assets the right fit for Archrock. First, this is one of the newest contract compression fleets, particularly when looking at asset packages of this scale. The average age of the TOPS fleet is 3 years, making it cost-effective and efficient. Next, TOPS equipment has market-leading technology. As I mentioned at the outset, TOPS is it sell remote monitoring on its electric units, and as you know, we've been focused on innovative technology and process investments to digitize and increasingly automate our operating platform, adding TOPS capabilities to our fleet further advances our technology capabilities. The units that we are acquiring are 95% utilized today, and are backed by fee-based contracts. Finally, TOPS currently serves an outstanding group of customers. Roughly 75% of TOPS horsepower is contracted with the company's top 10 customers. These are major blue-chip Permian producers and integrated players. In Archrock, we are looking forward to strengthening and expanding our relationships with some of the shared customers and adding new key long-term relationships. Turning to value driver #2. The transaction is expected to result in enhanced scale across a highly complementary geographic footprint. We're confident that this acquisition has the potential to enhance Archrock's position as a leading provider of contract compression in the United States with pro forma operating horsepower totaling 4.1 million and pro forma enterprise value in excess of $6 billion. The acquired assets are exclusively serving customers in the Permian, where Archrock already has a complementary presence further improving our position in this important basin. Not only are these assets located in a high-growth area, but they will round out our service offering in the Permian, given TOPS focus on gas lift. Substantially all of TOPS horsepower is deployed on gas lift, where compression is used to reinject natural gas into producing wells to help lift liquids to the surface. These applications use a wide variety of horsepower, low- to mid-range horsepower equipment is located at or near the wellhead or large horsepower compression equipment for centralized gas systems servicing multiple wells. TOPS is focused on mid-range electric horsepower with approximately 2/3 of the fleet ranging between 300 and 1,000 horsepower per unit. Gas lift compression is directly tied to oil production compared to pure gas production, gathering and transportation. It's used like an ESP or other artificial lift technology to help relieve the pressure in the wellbore to facilitate oil production. We see strong U.S. oil growth ahead, especially in the Permian, where production is expected to grow 30% over the next decade. We expect this should drive steady demand for gas lift going forward. Turning to the third key value driver. We're focused on powering a cleaner America, and helping our customers reduce their emissions footprint. This strategy has informed the organic expansion of our own electric motor drive horsepower over the last several years as we've seen demand steadily grow across geographies, horsepower categories and customers. We further electrified our fleet through high-return new build investments and by converting some of our existing units to electric motor drives. With favorable long-term industry trends toward electric compression, we believe this transaction represents a unique opportunity to jump start our electric motor drive compression capabilities and enhance Archrock's position and electric motor drive compression. Through this acquisition, we anticipate an increase in Archrock's electric compression fleet to approximately 648,000 horsepower. On a pro forma basis, electric compression assets will comprise 15% of our fleet. There are meaningful advantages to using electric motor drive compressors instead of gas-driven compressors beyond reduced emissions. The first is superior uptime. We believe customers benefit from higher mechanical run times with electric motor drive compression compared to gas-driven engines. The second is reduced maintenance. Electric motor drive equipment can be [ supported ] to maintain with fewer moving parts, resulting in longer major overhaul intervals and lower maintenance expenses. We've seen both of these benefits with our own electric compression assets and look forward to more fully capitalizing on these benefits through this transaction. Turning to the fourth value driver I want to highlight today. The transaction economics are attractive for Archrock and its shareholders. We're buying a rapidly growing business with a substantial and contracted backlog. We expect the TOPS operating fleet of approximately 500,000 horsepower will grow rapidly as newbuild horsepower is delivered and begins generating revenue under contracts. We estimate the acquired assets will generate approximately $136 million of third quarter 2024 annualized adjusted EBITDA, exclusive of any synergies. The purchase price translates into an attractive transaction multiple of 7.3x third quarter 2024 annualized adjusted EBITDA, which is meaningfully below Archrock's current trading multiple. We do expect to realize some synergies, which will create further upside, but I want to emphasize, this transaction is about accretive growth, not cost cutting. TOPS has been run in a very cost-effective manner. So we're not targeting immediate cost synergies. As we go through the integration process, we do expect to find opportunities to leverage best practices and capture new efficiencies. As we work through the integration and planning processes in the coming weeks and months ahead, we'll be looking for such opportunities. We expect the acquisition to be more than 10% accretive to earnings per share and at least 20% accretive to cash available for dividend per share in 2025. This increased earnings per share will further enhance our financial flexibility and enable us to deliver on our capital allocation priorities of generating shareholder returns, maintaining a strong balance sheet and funding high-return investment in our fleet. In particular, we believe the increase in pro forma discretionary cash flow will provide Archrock greater financial flexibility and capacity to increase dividends to our shareholders over time while maintaining industry-leading coverage. In summary, the TOPS acquisition is value accretive and consistent with our strategy of maintaining a high-quality fleet of operating horsepower units, operating in high-growth basins, continuously improving the performance and profitability of our business and offering our customers innovative solutions to meet their uptime and their emissions objectives. We look forward to continuing these efforts as we welcome the TOPS employees to the Archrock family. With that, I'd like to turn the call over to Doug to discuss key aspects of the transaction's pricing, consideration structure and financing.

Thanks, Brad. Good morning. I appreciate you joining us this morning. As Brad mentioned earlier, we are acquiring TOPS for total consideration of $983 million which will be funded with a combination of $826 million in cash and $6.87 million newly issued Archrock shares to the seller. Archrock intends to fund the $826 million cash portion of the total consideration with a combination of equity and debt. On the equity portion, I'm pleased to say this morning, we announced the pricing of a common stock offering, raising net proceeds of $223 million at an offering price of $21 per share. This represented an 8% discount to Friday's close and a 3.3% premium to our 30-day volume-weighted average price. In addition, the underwriters have a 30-day option to purchase up to an additional 1.65 million shares of common stock from Archrock. We have made strong progress over the last several years in reducing our leverage, ending the most recent quarter with a leverage ratio of 3.2x. We remain committed to maintaining a leverage ratio of between 3x and 3.5x and our financing approach for this transaction is in line with this disciplined strategy. The TOPS acquisition has been unanimously approved by the Archrock Board of Directors. As you would expect, the acquisition is subject to receipts of customary regulatory approvals and other customary closing conditions. We currently anticipate closing this transaction by the end of 2024. We expect that TOPS will operate much as it does today as a subsidiary of Archrock. TOPS has both high-caliber equipment and a talented team that we are excited to welcome to Archrock, and we are confident in our ability to effectively integrate the acquired assets into our existing business. Archrock has a strong track record of successful asset integration, and we look forward to building an even stronger Archrock together for the benefit of our employees, customers and investors. With that, we'd now like to open up the line for questions.

[Operator Instructions] Your first question comes from Selman Akyol with Stifel.

Congratulations. First, can I just ask you sort of what operating costs are associated with these engines as we think about the difference between revenues and EBITDA?

So the main difference between the operating of the electric motor drive is literally the motor itself is a lot less cost and activity incentive to operate, but you still do operate the compressor. And so we still have the same kind of lubrication system on the compressors is still present, but what you don't have is the same volume and quantity of moving parts in the engine, that the electric motor drive as you know, is more like a generator, it just -- it spins without the same level of maintenance intensity. And that does have a very positive impact to maintenance activities as well as maintenance expense.

Got it. And then just turning over to the capital allocation. And it sounded like you'll be in a position to continue growing your dividend and you had been doing some stock repurchases as well. So can you just maybe talk about that as you see looking out into '25 and just any comments you can make around that?

Yes. Number one, capital allocation, priorities at Archrock remain the same. We are very much focused on increasing and growing our dividends and distributions to our investors as we grow our business and as we grow our profitability over time. We're also committed to funding our growth at existing operating cash flow and delivering free cash flow as an enterprise. The TOPS acquisition is not only consistent with that strategy, but it enhances our ability to continue to do that as well as increases the cash flow that we can then use to improve our dividend and grow our dividend over time.

Got it. And then just last one for me. Do you see this as a springboard of being able to take electric engines into other basins?

We've been operating electric motor drive horsepower for more than 10 years. In the past, the primary market that looked for electrification on an electric motor drive was actually in the Rockies for emission reasons, and they were kind of ahead of everybody on the emissions front for regulatory reasons in that area. But what we've seen is with a much higher focus on emissions that it is now expanding the Permian being the main growth driver for oil and gas production in the United States today is leading the charge really on the move for more electrification. So the short answer is, yes, we do expect over time that more plays will electrify as the grid expands and power becomes available. But it's going to require a significant investment in power infrastructure in all of the plays in order to facilitate that. Today, we're seeing those investments primarily in the Permian and the Rockies.

And Selman, I might just reemphasize. Brad said at the open of the call the TOPS is the premier provider of electric motor drive compression in the United States in the Permian, largest fleet in that area. We're really excited to work with Brian and his team and be able to take that expertise that they've garnered. So yes. I mean I think it is fair to say that when you're acquiring the best in the industry, we'll continue to enhance that and push that forward.

Congratulations.

Your next question comes from the line of Jim Rollyson with Raymond James.

Congrats. Question on the $136 million annualized 3Q EBITDA. I'm assuming the roughly 500,000 operating horsepower in the total of 580,000 the difference is that mostly stuff that's on order or idle? I'm just kind of trying to see where that run rate might go kind of where they stand on orders for equipment, those kind of things, just kind of see where that trajectory might be headed next year.

The 500,000 is operating today. The incremental 80 is fully funded in the -- by the seller in -- on the balance sheet today for TOPS and is contracted with customers and will be going to work.

And it's -- look, Jim, as to why provide you a Q3 roll forward, look, this is a business that has seen a lot of demand and TOPS has been managing that really well. They've been adding approximately 15,000 horsepower a month, slightly more than that through the first 6 months of this year, and we expect that trend to continue as you get from that 500,000 to 580,000. So we're trying our best to give you the most current reflection of what that fleet looks like, and I think we did that in that $136 million number.

Yes. No, that's perfect. And I presume from a going-forward basis, it sounds like the 15,000 horsepower a month, is that a kind of run rate you guys would expect to continue based on what demand looks like?

Actually, I think that, that 15,000 per month is between 15 and 20. And with the 80, you can see that the backlog that's just in the 80 already has a number just like that built into it. So I think that it's a fair estimate of what they've accomplished on a year-to-date basis in 2024, it's a good estimate of what they have in the backlog today. But we're pretty ambitious that as the market grows, we can continue to expand that, noting that we have our own electric motor drive business to build on as well. And so that understates I think, a bit what we expect to do going forward.

Perfect. That's helpful. And Brad, maybe last one, just on the gas lift side, you guys have had obviously a portion of your business gas lift and the TOPS fleet, as you mentioned, is predominantly all gas lift. Just kind of curious where you are on a percentage on a combination from a gas lift perspective. I presume it's consistent with your Permian exposure, but curious.

Pre-acquisition, our percent of our fleet on gas lift was about 21% pro forma, bringing TOPS on to the Archrock platform takes it up to about 30%, and we're very excited to see that horsepower category increase going forward as we think that the oil field is going to continue to focus on electrification. This acquisition puts us in the driver seat really to help drive that solution for the benefit of our customers in the marketplace going forward.

Absolutely. And last one, Doug, on the debt funding of the portion of this transaction, is that something you're just going to at least in the near term, probably use the credit facility to do and then maybe turn that out down the road?

I think that's fair. Look, we've got to get Q2 reported, I think we're able to get an equity deal in under -- just under the wire, Jim, I think if you did the math on the remaining cash to be raised, you'd find that, that would put us at the top end of our credit facilities. So whether it's either a term loan from a bank group or I think right now, it seems to me that the high-yield market has been pretty receptive we would anticipate funding that the remainder with debt given the successful equity offering yesterday.

Perfect. Congrats again.