Wednesday, June 10, 2009

KKR Invests in Marcellus Shale; Thoughts on Taking Private Equity Money

Yesterday's Wall Street Journal featured an article about legendary private equity investment firm Kohlberg Kravis & Roberts (KKR) investing $350 million in East Resources, Inc., a major leaseholder in the Marcellus Shale with 1.2 million acres (PDF of article; print version at WSJ). The article also noted other private equity investments in the Marcellus, including Morgan Stanley Private Equity's recent investment in Triana Energy Investments, LLC and a joint venture between Avista Capital Partners and Carrizo Oil & Gas, Inc. where each company invested $150 million to acquire and develop Marcellus acreage.

This is a very interesting trend and is telling both of the market for private equity investments and how the market for new capital has changed over the past year since the Haynesville Shale land rush.

The three investments noted above came after the collapse of the lending markets, upon which private equity ("PE") companies depend mightily to do deals. PE companies (most known in previous years as leveraged buyout, or LBO, companies) are sitting on tons of cash and they have few good opportunities to invest. Unlike venture capital firms that invest equity in growth companies, PE companies make large equity investments alongside significantly larger debt investments made by other financial institutions. Without the debt providers, deals don't look so good. But it hasn't slowed the flow of investor money into PE funds, thus increasing the pressure to invest.

At the same time, the collapse of the financial markets has all but shut off access to both debt and equity capital for exploration companies, which crave capital to lease property and drill. When the Haynesville Shale was going wild in the spring and summer of last year, the financial markets were still wide open. Companies like Chesapeake and Petrohawk floated huge amounts of debt and equity in the market. When the markets shut down and the price of natural gas plummeted, capital hungry exploration companies were S.O.L. Chesapeake continued to engage in creative partnership agreements to generate cash, but other companies that depended on the markets had to wait out the freeze.

PE investments are an interesting solution to the capital problem. PE companies bring lots of potential equity, but their investments can be more expensive to companies than traditional debt and equity offerings. The PE company usually demands a healthy slice of ownership and the promise of a lucrative exit. The clock starts ticking when a PE firm invests in a company. They will want out in +/- five years and the only way to get them out is to sell the company or go public. It's not like debt where you pay it off and go along your merry way. The PE investors remain on the board of directors and can continue to agitate until they get their "liquidity event." I don't intend to portray PE companies as dark lords of evil or anything like that, but the decision to bring in a PE investor is a company changing one.

At this point, however, it seems like a workable solution for both parties to combine gas explorers and PE money...at least for now.

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