Private equity has, like the upstream oil & gas industry itself, been caught out by the speed and scale of the downturn, a key practitioner with a long North Sea track record has admitted.
This had been the big play, and at all stages from going in very early and buying land, funding drilling campaigns, putting money into production, also right across the supply chain it became the place for PE. Over the last five years especially it was the sector that gave PE the best returns.
Now it’s bust time!
“Look at the damage inflicted on KKR in the US following the crash of Samson Resources Corporation,” says Graeme Sword, founding partner of Blue Water Energy, but best known in Aberdeen for his significant time at 3i.
“They’re probably one of the flagship firms and Samson would have been the flagship PE deal.”
Samson is KKR’s second big energy buyout to implode. Last year, Energy Future Holdings Corp. sought court protection and speculation in the US is that, together, these failures could “vaporise most of the roughly $5billion that investors in a KKR private-equity fund and the firm sank into the deals”.
Sword: “It’s been an absolute wipe-out; a huge amount of value destruction and that from one of the biggest, most established, smartest PE firms.
“That’s a lesson to us all. What has now been realised is that, to get the types of return that PE investors want, there is commensurate risk.
“It had been going around that, oh, oil & gas is a great place for PE because the cycle is stronger for longer. It’s now come to a grinding halt and PE now faces two large challenges:
“The first is that the portfolios the PE industry has built up have been typically bought at the top of the market; very often leveraged.
“So you’ve got the double-whammy of a leveraged balance sheet at the wrong point in the cycle.”
Sword’s view is that a lot of PE houses face a huge job repairing their oil & gas portfolios with no sign at all of the oil price storm abating.
He told Energy that, as a still young firm, Blue Water had mercifully escaped the worst impacts. Moreover, he pointed out that the partners are seasoned practitioners, especially when it comes to the North Sea.
He sees opportunities.
“Fortunately, we’re a new fund, we’ve not used leverage and we’re in the early stage of building a portfolio, so I guess I’m more interested in the whereabouts of the opportunities in this market area.
“I think investors are scared at the moment. The easy thing to do . . . and I’m not saying this is the right or wrong thing to do . . . is to sit on the sidelines.
“It (the oil-related PE market) really has pretty much come to a halt. There are very few deals being done. And you’ve got three constituents: sellers looking backwards and saying: ‘Well, actually, do I want to get into any transaction at this price level?’; you’ve got buyers looking forward saying: ‘Well, the world’s changed so we’re going to buy at much lower commodity price assumption’; and then there’s the hold option, which is: ‘unless I have to transact, why would I do anything?’.”
Sword reckons the investor community has been split by the current crisis. A lot of transactions done by PE have, in recent times, been driven by general funds with broad portfolios and which fancied a bit of oil & gas action; after all, who wouldn’t with oil at $100-plus? But such players are now being driven out by their own greed.
We’ve been here before at the end of the 1990s when Big Oil suffered its last big price quake.
Sword thinks this is a time when the specialist energy funds should be able to apply their knowledge, experience, exploit their networks and do business.
“But, in this market there’s a difference between good companies and good balance sheets,” he says.
“What I mean by that is, I think there are a lot of companies out there that have good quality assets, management teams, products, services, and, if you’re a long-term investor and you’re going to invest for the next five to seven years, you’ve got to work out whether such businesses can grow, with the right capital structure.
“I believe we will see more creative deals. You might see PE working a bit more with industry players; you might actually see more minority and partnering deals; but you will see less of the bread and butter buy-outs where PE is seeking to buy and make most of its return from a bit of financial engineering and leverage.
“Those days are gone . . . for now.
“What one now has to look for is, how can one partner with a management team, putting in the right capital structure to get through the downturn while making sure you have all the pieces in place to grow?”
Production is a critical issue for the UKCS and it is firms like Blue Water that over the past two years seeded new generation North Sea E&P companies . . . witness Siccar Point, Verus (out of Bridge Energy) and Origo Exploration.
All were created using PE money and at a time when the AIM market especially was savaging baby oil companies despite $100-plus oil. It is important to realise that PE is different from AIM. It’s much more hands-on, working with management teams on strategy, financing M&As, hopefully providing more than just capital.
So, does this mean that companies like Siccar Point are capable of riding out the present storm? After all, they’ve been very quiet. Is Blue Water, for example, willing to stick with its bet?
Sword: “We took a view . . . we being Blue Water . . . that there was going to be an opportunity to build a UK-based, North Sea full-cycle E&P company and we believed in the management team.
“We decided that the two things that were needed in this (North Sea pre-crash) market were going to be an experienced management team backed by long-term knowledgeable, supportive capital.
“Siccar point was set up . . . it’s been going now for 11 months; we’ve got a high quality team in place and we’ve been very active, looking at a number of opportunities.
“But we’ve found it difficult to close transactions because we have a difference between buyer-seller expectations. Most transactions we’ve been involved with have not happened because of price. Maybe not buying anything might position us well going forward. The team’s in no rush. We took a five-to-seven years horizon when we put Siccar Point in place.
“We have an aligned group of shareholders and management. We’re very active. We think this is quite a good time to build a portfolio in the North Sea.
“But we’re as committed as we were before the oil price collapse and, arguably, we think we’re going to see better opportunities.”
And the supply chain?
Well, Sword did mention that the UKCS supply chain was 25% or so overpriced when compared with Middle East offerings.
He thinks there are a number of interesting UK investment opportunities, but they are “quite over-priced”.
This sums up his view: “We have five service companies in the portfolio, firms that we have bought stakes in or control of over the last couple of years. Two of those are in the Middle East which we believe is a good place to invest. We can buy into the same earnings level for about 75% of the cost.”
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