An Interview with Pete Miller, CEO of National Oilwell Varco

With operations in over 1,160 locations worldwide, National Oilwell Varco (NOV -0.42%) is a leading provider of equipment and services to the oil and gas industry through its three segments; Rig Technology, Petroleum Services & Supplies, and Distribution & Transmission. CEO Merrill "Pete" Miller has held a number of senior executive positions with NOV, beginning in 1996. Miller also serves on the boards of Chesapeake Energy Corporation (CHKA.Q), Offshore Energy Center, Petroleum Equipment Suppliers Association, and Spindletop International.

Miller joins Taylor Muckerman for a discussion of the oil and gas industry; where it is today, where it's heading, and how National Oilwell Varco intends to help it get there. They also look to the past to explore how NOV got where it is today and why it made the choices it did along the way. 

A full transcript follows the video.

Taylor Muckerman: Taylor Muckerman here with Pete Miller, CEO of National Oilwell Varco. I'm sure a lot of you have heard of it. It's a fan favorite at The Motley Fool. Thank you for having us today; very gracious of your time.

Pete Miller: My pleasure.

Taylor Muckerman: Just to start off, get into the offshore markets; really booming now and across the globe. Started with the Gulf of Mexico for many of our viewers, really came into the headlines in 2010 with Macondo, but picked up the pace since then.

Estimates are for over $100 billion in spending within the next 10 years on an annual basis. That's about three times 2012, so just to get your thoughts on how that could potentially affect your business.

Pete Miller: I think for National Oilwell Varco, it really impacts in a lot of different ways. First, and probably the one that most of our investors know best, is the actual building of the drilling rigs, jack-ups, and ships that have to go offshore and do the drilling.

That is ongoing right now. Probably in the last six months we've had more jack-ups ordered than probably have been ordered in a six month time frame in history. It's really pretty incredible, but it's because people need the good equipment

I think, post Macondo -- we actually were doing pretty well prior to Macondo as well -- and then post Macondo everything kind of shut down, in the Gulf especially. But people started to realize that you have to have the best equipment possible. You've got to have the best technology. Fortunately, we're there to provide that.

The capital side is really positive. However, I think the best kept secret at NOV is our Petroleum Services and Supplies business. That's really directly related to the drilling of wells. Those are expendable products. That's drill pipe, that's solids control, that's bits. That's all different things like that. With the expanded drilling offshore, we also are seeing an improvement in our PS&S business as well.

Muckerman: That's fantastic. When you're talking about new rigs coming online, some say that up to 100 could be needed by 2020, 2025. Do you expect that to be more rig replacement, or are you expecting that to add to the overall fleet size, for the most part?

Miller: A combination of both.

I think you're doing a couple different things right now, Taylor. First off, when you look at the drill ships, for the most part that's additive. The drill ships are really doing the exploration in the deep water, but those are new ships being added to the fleet.

Now, you take a look at the floaters that are out there, the semi-submersibles; those are more of the production and development rigs, and those go back to -- the first floater probably went out, maybe the early '50s -- and you're doing a lot of replacement there, but you're also doing some additive.

But I would say a lot of that is just going to be replacing the old fleet because, remember, some of those can only drill in 1000 feet of water, 1500 feet of water, and you have to have the rigs that can go into a New Horizon, which is going to be 10-12,000 feet of water.

But remember the rigs that drill in 12,000 feet of water can also drill in 1000 feet of water, so the flexibility and the enhanced flexibility of those rigs is what matters the most.

Muckerman: OK. You mentioned the jack-up rigs being a big portion of the business. The Gulf of Mexico seems like the growth there is kind of slowing down a little bit, but internationally do you see the jack-up rig market ready to take off, or is it in a similar state as the Gulf of Mexico right now?

Miller: No, I think it's taking off. When I say "ready to take off," it's taken off. We're seeing a lot of orders in that regard, and it's because people want the best equipment.

Again, it comes back to the same thing I was talking about earlier with the floaters. If you take a look at, say, a super 116-C jack-up rig, it can drill in 400 feet of water, but it can also drill in 50 feet of water. If you take an older jack-up rig, it can drill in 50 feet of water, but it can't necessarily drill in 400 feet of water, so that flexibility is really what people are seeing today, and that's why they want the new rigs.

Muckerman: Post Macondo, rig upgrading has been a huge business for you all. I was just wondering, do you see an endgame in that, or is that something that's just going to continually be part of your business now that added blowout preventers and high-specification equipment is really becoming more and more important and required, and the higher day rates have become a bigger portion of that?

Miller: Yeah. That's going to be a continuing phenomenon. There's no way that ... once people have got that religion, they can't stop it, and they've got it. You're going to have to have five-year upgrades on everything you're doing out there, whether it's a top drive, whether it's a BOP, and you're going to have to go to the OEM to get it done.

For us to have the wonderful installed base we have, then that's kind of a gift that keeps on giving, because every five years we're going to be back out there doing business with our customers.

Muckerman: OK. When you look at offshore market, you think about the Golden Triangle of West Africa, the Gulf of Mexico and Brazil, but what else in the international market, when you think of offshore drilling, really brings a smile to your face?

Miller: I think right now you're starting to see some things in the North Sea again. You're starting to see a pickup, especially off of Norway. I think Statoil is doing more and more things. I truly believe the Arctic -- whether or not we do anything in Alaska, it's problematical -- but they're certainly going to do things in Russia, in different areas, and in Norway and places like that.

I think the South China Sea is another area that's really starting to show very good. Then you talk about West Africa, but one of the more exciting places is East Africa. When you look at what's happening there, and then coming off the west coast of India, essentially what you're seeing is there's all kinds of offshore basins that are pretty exciting today.

Muckerman: Do you think this is just a combination of onshore drying up, or do you think it's just the fact that technology is improving and they're really realizing that the vast reserves are located offshore right now?

Miller: Well, first off, land isn't drying up. But when you're talking about shales, which is essentially what's going on in most land drilling today, those are rapidly declining wells, and that's kind of being on a treadmill and you have to keep going.

But offshore, you're looking for the big elephant. You're looking for the Big Kahuna that you can hit out there and really get production without a 70-80% decline curve the way you get on land. Both of them are really doing well today, but I think on the offshore business it's just looking for that big field.

Muckerman: You mentioned both of them are doing really well today. In the North American market, you kind of had a bifurcation in the last few years, where right after Macondo offshore kind of settled down in the Gulf of Mexico a little bit until we could get our footing, while the land production really sped up.

But now you see North American land taking a step back as far as natural gas production, while offshore and the Gulf is booming. How do you think you can operate and balance that, once both of them start to pick up at the same time?

Miller: That's a problem I love to have. Those are the kind; we'll figure it out.

Actually, what you're seeing in the land market today is the number of wells being drilled hasn't reduced. Actually, as an industry, we're starting to look at -- rather than a rig count -- we're looking at well count.

You look at what's being done on pads, and they've really become very, very efficient. Then you've seen the shift from natural gas to oil. Well, depending on what this winter's like, I think you're liable next year to see a little bit of a shift back toward natural gas.

I think that's going to occur. Then with the expansion that you're seeing in the Gulf of Mexico ... but this industry is very good at being able to expand and contract. Unfortunately, we've got a lot of experience at doing it. It's a cyclical industry, whether you like it or not, and we can handle those kind of issues.

Muckerman: Being involved in rigs all around the world certainly helps hedge any downturns in specific geographic areas.

Miller: Absolutely. That's been our strategy all along, Taylor. We want to make sure that, as you take a look at the companies that we put together, you've got early , mid-, and late-cycle companies so someplace along that way, one of those parts of the cycle ought to be hitting, and it helps to mitigate the problems that occur in other parts of it.

Now, when we have all parts of the cycle hitting at the same time, that's nice to have.

Muckerman: Right. Just to touch on offshore one more time, with Brazil, it's been kind of a frustrating market for the offshore community with Petrobras (PBR 2.51%) and the Brazilian government kind of holding back on some of the auctions.

They talk about the Libra Field being auctioned off, hopefully in October, and now the Brazilian government is becoming a little bit more lenient on gasoline prices within the country, and even talking about helping Petrobras fund some of their drilling initiatives down there.

What do you see, moving forward with this? Do you see it loosening up? Is it finally going to realize its true potential, do you think?

Miller: I think ultimately it's going to realize the true potential, but Brazil's just a different place to work. They've had infrastructure problems ... when you take a look at it, supporting the offshore business they've got one base, and that's essentially Macaé.

Well, Macaé is high jack. If you miss your boat slot there, you're going to have big problems getting your equipment out to the rig.

I think today, though, we're starting to open up different bases around the country. I think within the next three or four years the infrastructure will catch up, and I think Brazil will become a much smoother place to do business because of that.

Muckerman: Very good to hear.

Sticking with South America a little bit, shale gas is going to probably be a huge business there, especially in Argentina. Chevron (CVX 0.37%) signing over a billion-dollar deal with YPF down there. Then you look at China, also, with huge shale reserves estimated by the EIA.

I'm just wondering how you plan on attacking these international markets that really have been untapped when you compare them to the U.S. and Canadian shale, that we've really been able to exploit.

Miller: Yeah. We're actually in great shape on being able to do that, because both countries -- Argentina that you mentioned, and China -- we've got wonderful infrastructure already in place for NOV.

But interestingly, we're actually building rigs in Fort Worth, Texas, and shipping them to China, to help exploit the Chinese shale plays. I think they know that they need help. If you look at Sinopec (SHI), they've invested in the Eagle Ford. You look at SINOC, they've invested in the Mississippi Lime and different places like that.

That's not so much because they believe in the American market, but a lot of that's to learn. They want to get it figured out. China needs shale gas. They need it in the worst way. They've got pollution problems; a quick and easy solution for them is natural gas, and we're going to be there to help.

I believe, over the next four or five years, you're going to see international shale plays become every bit as important as the domestic shale plays, to NOV.

Muckerman: When you look at countries like China and Russia, and countries with national oil companies, what's the difference when you're trying to operate with them, versus larger integrateds like an ExxonMobil (XOM -2.78%) or a Shell (RDS.B), for instance?

Miller: I think for the most part it's the bureaucracy. It's the quickness of decisions being made. When you're dealing with an Exxon or a Chevron, they're big companies. They're looking at things from a strictly financial basis, and they're going to make quick decisions.

I think when you're talking about national oil companies, they've got to make decisions that not only look at the financial side, but also look at the political and the social side. They want a lot more local content and different things like that, and it's a longer process.

You learn how to deal with it, but we've been overseas for so long that it's second nature to us, being able to deal with people like that, and companies.

Muckerman: That's fantastic.

Just to touch on your company now a little bit more specifically, acquisitions are obviously a big part of your current business model, and in the past. I'm just wondering if a light bulb suddenly went off, or if that was your ultimate goal from the get-go, of you coming on with National Oilwell Varco to try and build that standard operating procedure for rigs, worldwide.

Miller: Absolutely. We had a vision, and that vision goes back to 1996.

NOV is actually a fairly old company. The oldest part of us dates to the 1840s and the oil well side of it dates to 1863 with Colonel Drake, so we've been around for a long time.

But the modern version of NOV started in about 1996 and, quite frankly, the whole industry was coming out of a terrible -- I won't even call it recession; it was a depression -- from about the early '80s to the mid '90s. This was a tough, tough business, and a lot of companies that made equipment went out of business. They went by the wayside.

We could see what was going to happen in the future. Equipment, anything mechanical, wears out. You can't say that it's going to last forever. It won't last forever, so it wasn't exactly rocket science. What we did is we started going out and buying distressed companies.

We were able to bring them together -- if you look at the things that we did in the late '90s, early 2000s -- and then probably the game changer for us was when Varco and National Oilwell came together. That was in 2005.

Then in 2008 we bought Grant Prideco, which gave us even more, and then in the interim there we were buying an awful lot of different (unclear) companies. We probably, in the last 12 years, have done 300 acquisitions, but every one had a specific purpose, and every one was part of a strategy to be the manufacturer for the oilfield.

Other people didn't want to do it. Schlumberger (SLB -0.48%) didn't want to be the manufacturer. Halliburton (HAL -0.47%) didn't want to. They were doing other things; that's OK. That's what we wanted to do, so let us have it, and now we've become the predominant manufacturer in the oil field.

Muckerman: When you look at your competition right now, you look at companies offshore in the subsea business, not necessarily intruding on your FPSO business, but you look at FMC Technologies (FTI), GE (GE 0.68%) is really pouring a lot of money into the energy space right now, and then the joint venture with Cameron (CAM.DL) and Schlumberger, getting into their one subsea joint venture.

I was just wondering if you see that potentially becoming a threat, or if they're just going to stay in that subsea technology market that you guys have kind of let them have at the moment?

Miller: Actually, the things that we do are complementary to what they do. Quite frankly, they've got the manifolds and everything on the ocean floor. I've got the flexible pipe and the FPSO on the surface to be able to take care of that.

Would we want to get in that business? Sure, I think it makes some sense, but it's pretty frothy. It's a pretty expensive business right now. We don't like to buy things on the expensive side. We wait until they get a little cheaper.

But we feel like we've got a wonderful position in FPSOs and flexibles, and that's going to enhance what they do, so as they get more and more production manifolds in, we're going to be able to hook them up and it's going to be great business, I think, for all the companies mentioned.

Muckerman: You mentioned it being "frothy" businesses. Is that something that you consider, or are you looking at the technologies that you want to acquire, first and foremost, or are you looking for a good deal, first and foremost?

Miller: Well, I think first and foremost you have to look for something that fits. Generally speaking, that's going to be a technology, that's going to be a product, and it's consistent with our strategy. Then you've got to look at the price.

But you've got to be patient, too. A lot of these companies that we've bought, we've had discussions for three or four years, and then all of a sudden the moon and stars align appropriately and you just move. You go ahead and buy them at that point.

I think my first conversation with Varco was in 1998, and we announced the deal in August of '04, and closed in March of '05, so we're patient people.

Muckerman: Obviously working out for you, and that confidence that you have in your acquisition strategy. How much weight do you rely in that when you're analyzing a deal, thinking to yourself, "We can bring this company in without a problem?"

Miller: You know, it really matters a lot. A lot of companies, you're going to have to spend time on "What's our integration philosophy? What are we going to do? How are we going to get the synergies?" We know how to do that.

We've got an integration manual like this. It used to be like this, but every mistake we made, we kept adding to it, so it's a pretty thick manual right now. But the one thing we don't spend a whole lot of time on is how are we going to integrate it? We've got SWAT teams that go in and get that done real quickly.

The biggest issue is, does it fit strategically? Do we need the product? Does it give us something that we don't currently have? If it does, good. Let's go get it.

Muckerman: What do you think has helped out with that from the top down in your company culture, to really allow your employees to buy into these new companies coming into the fold like that?

Miller: I think the thing that's been so attractive is people have understood that it provides opportunity. I tell everybody in this company, "I'm not sure what a CEO's supposed to do," but one of the things that I do try to do is provide opportunity to our employees. You provide that opportunity by growing.

As you continue to grow and people get the chance and actually see the opportunity, then they become charged up and say, "OK, I've got to help on this next acquisition." When they look at an acquisition coming in, they look at the opportunity it affords both to the employees, and to our customers, and to our vendors, and that gets everybody pretty well motivated to make sure we're doing it right.

Muckerman: Just before this interview, you announced a spinoff of one of your business lines into a separate IPO. As far as I know, that's pretty unique for you guys; rather than a tuck-in, you're spinning something off.

I'm just wondering about the thought process of that, and then your continued relationship with the company once it is a separate entity?

Miller: Yeah. Well, what we did is we announced yesterday that we were going to spin off, to our shareholders, our distribution business. It's an emotional deal, no question about it, because we're company builders. This one, though, it made a lot of sense.

Distribution was to the size that it really was very much of a stand-alone company, and it's something you could very easily break off from what we had.

When you take a look at the size of it, when you look at the numbers, it could very well be valued at $2.5 to $3 billion. I'm telling you what analysts are telling us, not necessarily what we believe there, but the point is it made sense to go ahead and spin this off to our shareholders.

It's a stand-alone company, it's got comparables that you can look at throughout the industry and be able to measure this, while at the same time the margins for the remainco, if you will, the legacy National Oilwell, pick up a little bit because distribution by definition always had a little bit lesser margins.

We think it's going to give the analysts -- people like you -- a better opportunity to be able to look at the company and say, "OK, I understand this part of it, and I understand this part of it," and probably get a better valuation because of that.

Will we have a continuing relationship? You bet. I think the distribution company will continue to distribute parts and things that are made within the legacy National Oilwell Varco, mainly because they're the best people to do it.

It's that simple. We built it that way, and just because they're spun off doesn't mean they won't still be doing it. It'll be a lot more, though, of an arm's-length transaction, even though we do that pretty much today. It'll be even more so, but they'll still continue to have just a great relationship, the way we do with a lot of distributors.

Muckerman: Sure. You mentioned margins with this business in particular. You saw margins for the overall company contract over the last quarter, mainly due to customers wanting their equipment in a much quicker timeframe, and you then having to work overtime to provide that.

Is that something that you're going to continue to see, or that company will continue to see, or is that something that was one-off in nature in the last couple of quarters?

Miller: Oh, I think we're getting hold of it pretty well. What we are is we're victims of our own success. We have done so well at delivering products that customers came out and said, "Well, let's knock another six months off."

"Yeah, OK." Well, that becomes a little bit more difficult, but we're getting it. We've got a wonderful manufacturing group, and those folks know how to do things well.

To think, the other day we completed a drill ship in 26 months. That's pretty unbelievable, to think that in just a shade over two years you've got a complete drill ship that's out and working and drilling. I think that's a testimony to what the shipyards in Korea can do, what the shipyards in Singapore can do, and what we do, working in conjunction with them.

Has it created a couple of strains? You bet, but our margins still begin with a two. I would say that's not half bad -- and they're double digits -- so we feel pretty good about that, but we know that we have to get them better, and we're doing that.

Muckerman: Yeah, we follow this company quite regularly on a lot of our podcasts that we provide. It's part of our everlasting portfolio; our CEO Tom Gardner basically build a portfolio of companies where he's never going to sell them, and he recommends that for our investors as well.

When we've talked about that over the last couple of quarters, everyone's mentioned the revenues continue to grow.

We'll take an earnings hit for a quarter or two because we realize that the business itself is still growing, while other companies' revenues have kind of slowed down a little bit, even though they're pulling some financial accounting tricks to boost their earnings. It's not too much of a worry for us.

How have you been able to increase those sales? Is it a National Oilwell Varco thing, or is it industry specific?

Miller: I think it's a combo of both. At the end of the day, I tell people, "No one ever got fired for buying IBM (IBM -1.05%), and nobody gets fired for buying NOV." You get a lot of companies that are upstarts that want to come in there and get on our turf, but I think we protect that turf pretty well.

We're gaining even new customers, but we're gaining more and more loyalty, while at the same time the industry's expanding, so you're getting a couple pops. There's a greater demand, but we're getting a bigger part of that greater demand.

Muckerman: Part of your investing community that is not worried about getting fired, but he enjoys buying into your company; Warren Buffett upped his stake to 7.5 million shares in National Oilwell Varco, and he's not the kind of guy that buys into something that he doesn't know.

What were talks like with him? I'm sure you spoke on a pretty regular basis when he was initiating those deals, so what's it like to sit down with Warren Buffett?

Miller: We basically talked to a lot of the people on the staff. What I find with them is that they're very, very thorough. They understand the business. These aren't people that are jumping in to make a profit in a quarter and get back out.

I think their analysis of the business is probably as in-depth as anybody that I've ever seen. They ask questions that are prescient. You can sit there and you go, "Wow. I'm surprised that they would know that."

They've really dug into it. They went out and talked to customers. They talked to people that we did business with. They talked to vendors. When you look at the thoroughness, and that's why we feel really good -- we love all of our shareholders -- but we really love the fact that he has enough confidence in us that he's saying, "We're going to put some money right there."

We think that's almost the seal of Good Housekeeping. That's a neat deal for us.

Muckerman: When you mention their level of detail and thoroughness, they obviously had some concerns. If you could maybe just discuss the top three things that they were worried about, moving forward with National Oilwell Varco.

Miller: I think most of -- it's not just them. I think most analysts, when you take a look at us, you're always going to be worried about the macro nature.

I think that, for the longest time, building rig equipment wasn't even cyclical; it was almost episodic. It just happened here, and it happened here. Well, we're past that, but I think a lot of people still are in the paradigm of saying, "Is this, in fact, episodic?" I think that's a key issue.

I think the macro economy ... are we going to continue to grow? What are the prices of oil and gas going to do? I think if you believe in the energy business, we're a pretty easy investment. If you don't believe in the energy business, then I think you have to kind of take a deeper look.

I think for the most part that the analysts that are looking at us today, it's more about, "What's the macro going to do?" and, "If the macro slows down, that's going to impact these guys." It's not so much company specific as industry specific.

Muckerman: If you're an investor looking for the positives in National Oilwell Varco, what are maybe three things that you should continually focus on to make sure that you're hitting your marks?

Miller: I think if you take a look at what we're doing with technology -- we talk about new products all the time, because you've got to keep changing your product. If you're making the same thing you made 30 years ago, you're going to have a tough time.

I think one of the frustrations that we have is that a lot of analysts don't look at the quality of the people in the company. I think we're a spreadsheet; "Here are the numbers," and that's what it is.

I would offer that if I took you around this building and introduced you to a lot of the people that are here, you're going to come away saying, "That's a motivated workforce, that's a workforce that's excited, and that's a workforce that's very talented." I think when you see that, that's great.

I think the third thing that people don't realize is our footprint. We've got 1250 locations in 62 countries. Who's going to replicate that? That is very expensive to do. It doesn't matter where you are, where you want to take that rig. West Africa? We're there. Brazil? We're there. South China Sea? We're there.

When you look at that template that we have, that's a real competitive advantage for us because I'm going to be supporting you wherever you want to drill around the world.

Muckerman: Serious barrier to entry there.

Miller: Absolutely.

Muckerman: You mentioned your people, and that's one of the first things that The Motley Fool looks at, is management and the company culture.

Obviously, 2012 Morningstar CEO of the year; had to be a very great feeling for you and your company as a whole, because you didn't do it yourself. If you could just talk about the feeling, both for you and the company, when that award was bestowed.

Miller: It really is an award for the company. It's not just me. I mean, I'm kind of lucky to have the job that I've got. People just made mistakes and put me here, I guess; I'm not sure.

The point being, I think it really showed the people in the company that, "Hey, the outside understands who you are." We talk about three things around here. I'm kind of different in the fact that I don't think a company like ours can have a culture. We're too spread out. In 62 countries, you've got all different cultures, you've got all sorts of things.

Muckerman: You have to rein it all in.

Miller: But what we can have are things that we demand out of our folks. The three things we talk about all the time are integrity, accountability, and the third one -- and most important -- is have fun and enjoy what you're doing.

If you do those three things, irrespective of what country you're in, I think you're going to enjoy working here and you're going to be motivated and you're going to find out this is a great place to work. As a result of that, the results come up to the top, and they speak for themselves. That's why we get awards like that.

Muckerman: You spoke about integrity and fun, and that's two of our five core values at The Motley Fool, so we see some similarities there.

Talking about management and that award, what other CEOs or management teams -- not just in the energy sector in particular, but just around the globe -- do you really look at as innovative, and other companies could probably turn to them and learn a few things?

Miller: I think most of mine is going to be historical. When I look back, when I started my career I started it with a company called Helmerich & Payne (HP -0.12%), which is a great land drilling contractor. The CEO at the time was Walt Helmerich, and he probably taught me more about business than anybody I'd ever seen.

But I think when you look today and you go, "OK, who are the people that have been the most transformative, that you can learn something from?" number one for me is Herb Kelleher. You look at Southwest Airlines (LUV -0.84%).

When I was your age, you never flew unless you had on a coat and tie. Today you've got guys in sweat suits on there, because what the guy did is he made flight possible for everybody, across the spectrum, but he also made it fun. I think that's where the fun side comes, when you talk about it.

The other one, and it's pretty simple too, is Sam Walton. Here's a guy that put together a business model of affordable stuff. He redefines supply chain, he redefines logistics definitions. When you look at guys like that, you can learn an awful lot from what they've been able to accomplish.

Muckerman: Very well. Thank you very much for your time. I think that's all I have, unless there's anything else you'd like to say to our investors and readers worldwide?

Miller: No. We appreciate your support, and thank you very much for being here.

Muckerman: Thank you very much. Pleasure.

Miller: Great.