Wednesday, September 16, 2009

M&A, E&P and PE

Yesterday brought the news that publicly traded Texas oil and gas E&P company Parallel Petroleum Corporation would be acquired by private equity ("PE") firm Apollo Global Management. Parallel drills in Texas, most notably in the Permian Basin and the Barnett Shale, and New Mexico, and its portfolio is biased towards oil.

This transaction was a "distressed sale" because the company was facing a reduction in its borrowing base and likely would have ended up in default. It likely was a better for shareholders deal to sell out at a lower price than risk the damage a loan default would cause. Many energy industry observers have been expecting more mergers and acquisitions in this low price environment, but it hasn't really played out that way.

I wonder if this the beginning of a wave of energy M&A transactions involving PE companies. The PE world has been looking at the energy industry, especially natural gas because of the depressed commodity prices, so I would not be surprised to see more announcements in the next three months, especially since some of the fog of uncertainty surrounding natural gas is beginning to clear.

Many PE companies really like "distressed situations" and the gas industry is full of them. PE companies are sitting on mountains of investor cash and they are on the clock to make investments (most funds have a deadline for investment, otherwise they have to return money to investors and forgo substantial investment fees). But PE companies nearly always require lots of patient debt to make deals, so the demolished state of the financial industry has really put a damper on new investments. Now that banks are starting to come out of their foxholes to make some (very conservative) loans, the PE guys are very anxious to "do deals."

So far there have been several PE-backed pipeline investments (see Regency Energy) but not as many riskier deals on the upstream side of the business. Investments in E&P might be more difficult because these companies can be harder to "lever up" with debt, especially when commodity prices are volatile. An E&P investment would require a PE investor to pony up lots of equity cash, something they are reluctant to do. But if the choice is doing an equity-heavy deal versus not doing a deal, they are going to spend the money and do the deal. Trust me, it's how they get paid.

There are several private equity backed businesses out there, mostly startups, that are making noise. One of note is NFR Energy, which combines Nabors Industries and energy PE specialist First Reserve Corporation. The company has been very active in drilling Texas Haynesville Shale wells. Earlier this year famed PE investor KKR invested in East Resources, a Marcellus Shale operator.

It will be interesting to see if PE companies make investments in the Haynesville Shale. PE-backed companies tend to be very aggressive because the aim is to sell the company or have an IPO within five years. Since most of the Haynesville land has been leased, PE money might end up with smaller companies playing the fringes or in infrastructure projects. Or they might wait until leases start to expire and invest then. We'll see. Yet another interesting story to follow in the Haynesville Play.

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