From a Mystery Q4 Earnings Call:
I would also like to spend some time this morning reiterating and elaborating on XXX capital allocation priorities. First, our North Star is maximizing shareholder value. That’s always been the goal and that dictates everything we do here. On that point, we believe the key to maximize XXX shareholder value is to maximize free cash flow per share.
Cash is finite. Over the long term, what the company can pay in dividends, repurchasing shares and invest in itself are fundamentally limited to the cash it generates. Thus, if we can expand free cash flow on a per share basis, and not just near term but also long-term productive capacity for future free cash flow per share, then we will be able to sustainably and consistently increase our capacity to return greater amounts of capital back to shareholders. The more cash we can ultimately return to shareholders, the more valuable to enterprise. If maximizing free cash flow per share is the goal, the question then becomes how do we achieve it. Our primary options are to invest in organic opportunities, buy back our stock, acquire external assets or pay dividends or some combination thereof. Each one of those options contains an economic and strategic reality.
Our job is to determine the long-term returns for each option and then allocate capital accordingly. If we can do that well, we create shareholder value. In practice, there are no simple answers, but we try and solve these items with the fundamental bottoms-up intrinsic value approach.
So let’s quickly go through our capital allocation options, deconstruct how we evaluate returns and where those returns and priorities stand today. Starting with organic investment. Here, we look at what opportunities are available to leverage the company’s existing assets, people and expertise to expand this business. Potential organic investments are predicated on generating double-digit returns on capital while also balancing our preference for high margins and a capital-light business model.
Let’s discuss share repurchases. When you buy back company shares, you’re basically still buying assets. It’s just that these assets are already owned by the company. The question is, what is the return generated by buying back your own shares? We look at share buybacks in a similar manner as we look at purchasing external assets.
Those assets generate a cash flow stream. What we do is, go piece by piece and evaluate the full cash flow potential over the life of each asset. After aggregating the various components of the business, we can measure that value against the price to acquire. That price for a buyback is our publicly traded share price. There’s just as much art as science to this given all the various inputs and we do our best to generate reasonable assumptions.
After aggregating everything, we have an internal appraisal of our intrinsic value. We can then measure that against the stock market’s appraisal of those exact same assets. If we can generate a double-digit IRR… then buybacks become an extremely attractive option to deploy significant capital.
We approach M&A similar to buybacks. We evaluate each asset from a bottoms-up intrinsic value approach. The same assumptions we use to value our own assets, whether it’s commodity prices track-by-track, resource potential or surface and water opportunities, we use to analyze third-party assets.
Again, the goal here is to generate at least double-digit IRRs in invested capital and incremental free cash flow per share. For any package that’s a meaningful interest to us, in addition to extensive financial analysis, we also performed significant asset and operational due diligence if the company only has modest opportunities to deploy capital towards organic or external growth and if buybacks are relatively less attractive then dividends are another effective way to return capital back to shareholders.
