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E&P Private Equity Opens The Capital Floodgates - Good Or Bad For Public Investors?
Nov. 14, 2016 9:15 AM
Summary
Private equity sponsors have raised significant funds earmarked for investment in E&P assets.
After patiently waiting since the oil price drop, private equity activity has picked up dramatically as bid/ask deal spreads have evaporated.
Several E&P companies sponsored by private equity firms have sold out in recent months, largely to public companies who then conducted stock offerings to pay for the transactions.
Private equity activity in property purchases and development joint ventures have picked up dramatically, largely outside of existing public companies.
Readers and investors should monitor private equity activities to discern trends and identify the beneficiaries, realizing how pervasive the impact of private equity is even on public E&P companies.
Readers are certainly familiar with E&P companies whose stock they own or follow, but they may not know or care about companies that are private and are funded by private equity sponsors. In fact, many readers may be tempted to ask, "Who cares about private equity at all?" The short answer is that despite the fact that private equity is largely unavailable for public investment, the impact that private equity has on the E&P industry is widespread and dramatic.
For those who might not be familiar with private equity sponsors, they are groups of individuals, usually with commercial banking, corporate finance or investment banking experience, who raise money from large institutions, pension funds, university endowments, etc., to invest in the E&P industry. Their typical strategy is to fund various management groups in the acquisition and/or development of oil and gas assets on behalf of their funds, each of which has a different portfolio and timing. In general, private equity investments usually have a five- to 10-year time horizon during which the sponsors attempt to grow the value of their assets through the portfolio companies, after which time they will often exit and monetize the investments through asset or corporate sales, IPOs, etc.
Who are the primary private equity sponsors, and what are their assets under management? The following chart lists the major players, their assets and the number of companies they had existing investments in as of 2016. Based on these figures, private equity controls almost $90 billion in assets and has 250-plus portfolio companies.
Private Equity Sponsor
Assets
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# of
$ Bln.
Companies
EnCap
$6.5
43
TPG
$6.0
2
Apollo
$5.0
6
Warburg Pincus
$4.8
7
Blackstone
$4.5
4
Quantum
$4.5
18
Riverstone
$3.9
15
Natural Gas Ptrs. (NGP)
$3.5
32
KKR
$3.3
5
Denham
$2.0
6
First Reserve
$1.7
7
Kayne Anderson
$1.6
30
Yorktown
$1.5
12
Others
$39.2
63
TOTAL
$88.0
250
Sources: EnCap, RBC
Since the beginning of the year, funds have continued to pour into private equity, as evidenced by the following closings announced. Both 2015 and 2016 have shaped up to be good years to attract funds to E&P due to the perceived potential to "catch the cycle" from the bottom. Most of these funds have yet to be invested.
Private Company Private Equity Sponsor Type Counterparty Location/Play Price
Aug- 16 Kayne Private Energy Kayne Anderson Private Equity NA NA $1,550
May-16 Lime Rock Resources Lime Rock Private Equity NA NA $754
May-16 Post Oak III Post Oak Private Equity NA NA $600
Nov-16 Juniper Capital II Juniper Capital Private Equity NA Various $500
Nov-16 Sequel Energy Blackstone Private Equity NA Various $500
Aug-16 Apollo Nat Res II Apollo Private Equity NA NA $400
Jul-16 IOG Capital IOG Private Equity NA Various $260
Note: Blackstone (NYSE:BX), Apollo (NASDAQ:APOL), TPG (OTCPK:TSSP) and KKR (NYSE:KKR) have publicly traded operations that are broader than merely oil and gas investments.
Private equity is hardly a new phenomenon; it has been around for decades and the sponsors have experience in financing through many different price environments. EnCap, the largest sponsor, was formed in 1988, and has invested over $12 billion in more than 200 companies alone. All fund sponsors are certainly dependent on results from prior funds to attract new capital, and many investors return through multiple funds, ensuring a fairly regular source of funding even when the investment climate changes.
How come you don't hear much about them? Their strategy is not to actually run companies but rather to provide equity financing, and it is the portfolio companies that readers may be familiar with. Investors in Antero (NYSE:AR), Approach (NASDAQ:AREX), Bill Barrett (NYSE:BBG), Bonanza Creek (NYSE:BCEI), Concho (NYSE:CXO), Diamondback (NASDAQ:FANG), EP Energy (NYSE:EPE), EV Energy (NASDAQ:EVEP), Eclipse (NYSE:ECR), Gulfport (NASDAQ:GPOR), Halcon (NYSE:HK), Legacy (NASDAQ:LGCY), Memorial Production (NASDAQ:MEMP), Mid-Con (NASDAQ:MCEP), RSP Permian (NYSE:RSPP), Vanguard (NYSE:VNR), and W&T (NYSE:WTI) all were originally funded by private equity, and most companies came public via IPOs in the 2000s as oil and gas prices increased dramatically. In the prior "wave" of IPOs, private equity sponsors received cash for a portion of their holdings, but retained often significant holdings that fell in value if they did not liquidate before prices fell.
Several companies originally funded by private equity have already declared bankruptcy, including Linn (NASDAQ:LINEQ), Midstates (NYSE:MPO), QR Energy - which merged with Breitburn (OTCPK:BBEPQ) - SandRidge (NYSE:SD), Sabine Oil & Gas (OTCPK:SOGCQ), and Samson Resources. Memorial and Vanguard may soon join the list. The point is not to say that the private equity sponsors ultimately made or lost money on their investments in the previous round of exit financings, but rather to point out how many of today's companies were funded by IPOs of companies with private equity funding.
After prices fell in 2014, public sources of financing largely dried up, especially for the most leveraged producers. In 2015, the emphasis was on balance sheet restructuring using 2L (second lien) financing and debt swaps, with little true M&A or private equity activity. The expected wave of private equity portfolio company investments never materialized, even though estimates were that private equity totaling $100 billion or more ($200 billion with leverage) might be available.
In 2016, the dam appears to be breaking, or at least springing a leak. With respect to anything in the Permian (the Midland and Delaware Basins) the floodgates have opened. Public companies with lower leverage and growth prospects to finance have attracted new money, while private equity portfolio companies have become very active. A resignation that prices are not going to recover quickly has set in, and as a result the differences between bid/ask prices on transactions has narrowed or been eliminated. The pace of transactions since July 1 is remarkable, especially in the Permian Basin (the Midland and Delaware Basins).
You might ask, "Isn't that a good thing?" After all, companies that are overleveraged desperately need additional capital either to keep their banks at bay or ultimately to refinance their unsecured debt as it comes due, if the debt markets do not come back in time. The dynamic is fairly fluid as markets react, but the early indications I see, at least for some of the major transactions involving private equity, are concerning. Rather than seeing private equity invest in public companies or conduct IPOs while retaining significant holdings in transactions based on their optimism over future potential, private equity is selling for cash to public companies, which then turn around and raise money from the public to fund their purchases at prices that many consider inflated.