Private equity firms are reshaping their deal outlooks, return expectations and investment criteria in response to structural changes in the energy sector, said panelists at the Mergermarket Energy Forum in Houston today.
Gone are the days when PE portfolio companies could grab acreage and leases, delineate by drilling widely spaced wells, and flip the acreage to public independent buyers looking to add reserves and drilling inventory, said Tim Perry, managing director and energy practice co-leader at Credit Suisse. Public buyers have seen significant declines in their share prices and have often opted for buybacks instead of acquisitions, noted Terry Padden, director at Simmons Energy. PE firms are seeing longer hold times and a higher intensity of development needed to build a company to an exit, with multi-well pad drilling replacing simple delineation wells, said Patrick Gimlett, managing director at AB Private Credit Investors.
This news service has previously reported on the changing landscape of energy private equity exits and how firms have shifted strategies to hold portfolio companies for longer, explore PE-to-PE deals and negotiated transactions versus auctions, and doubling down on attractive assets in hopes of a larger exit later.
Another model that is growing in popularity is remaining private and exiting over time through cash distributions. Ridgewood Energy, a private equity firm focusing on offshore Gulf of Mexico assets, has a “hold and produce” strategy and will only sell projects when the returns from a sale outpace returns from simply returning cash flow to investors, said Niloy Shah, executive vice president for Ridgewood Energy. Perry agreed and cited an unnamed portfolio company that had already returned 90% of invested capital to its investors after three years of ownership without selling any shares.
“We’re returning capital to our LPs every day through the drill bit,” echoed Patrick McWilliams, partner at energy private equity firm NGP.
Financiers have a role to play in the develop-and-distribute strategy as private equity firms look to creative financing in order to achieve higher drilling intensity on their assets. “Full-scale cube development is more capital intensive,” driving companies toward uni-tranche first lien debt as well as drillco and joint venture sources of capital, explained McWilliams. “Banks have been good about allowing distributions out of entities,” such as dividend recapitalizations and other unconventional structures, he added.
At the same time, distribution models are slower to grow because they are not using all their cash flow to fund growth, and as a result, run on lower leverage ratios – around 2x versus the high growth upstream ratios of 3x to 4x, Perry added.
Different types of funds are sprouting with a distribution recapture strategy, a lower-growth strategy than traditional private equity, said Perry. These may also have longer fund lives, he added.
Even non-upstream companies see the importance of generating free cash flow, agreed Jason Turowsky from Intervale Capital, which focuses on oilfield services and infrastructure.
Sales of noncore assets like water or gas gathering infrastructure, saltwater disposal wells, natural gas processing, as well as minerals and royalties are other strategies to extract a return in lieu of a traditional M&A exit, said Howard Barnwell, director of energy acquisition and divestitures with BMO Capital. Once an infrastructure system is built, it becomes less strategic to the E&P and more valuable to an outside buyer, he explained.
Panelists acknowledged that while traditional corporate sales and IPOs are still possible, the landscape has changed, and generalist investors still have not re-entered the capital markets. With a large variety of private equity exit options to analyze, “the model is more complicated than a half a decade ago,” said Credit Suisse’s Perry.
Perry and Credit Suisse in April advised Brigham Minerals [NYSE:MNRL] on its USD 260m IPO. While the roadshow for that deal was about one week, Perry said he and colleagues began educating institutional investors about the Austin, Texas-based minerals business about a year before then.
by Hana Askren in Houston