Whether it's mezzanine debt or private equity for private or public entities, plenty of capital-raising alternatives abound. Here's an update on four capital providers.



In the wake of the recent precipitous slide in commodity prices, there may well come a time shortly when independents may face less receptive capital markets, less robust cash flows and increasing leverage ratios.

In such an environment, independents will need to seek appropriate capital-raising alternatives to shore up their balance sheets and to continue growing development projects that don't lend themselves to bank debt.

Fortunately, plenty of energy-financing alternatives are available to the upstream sector in these volatile times. During the past several years, new intermediaries and sources of mezzanine capital (debt with equity kickers) have entered the oil and gas arena, seeking returns for their investors in the mid- to high teens. Through this form of capital, operators with high-potential development projects, but little or no cash flow, can achieve higher advance ratios against their reserve base than those available through typical borrowing-base bank loans.

In addition, private-equity funds, the ranks of which have now swollen with the entrance of hedge funds and which seek returns north of 25%, have raised billions of dollars from the institutional market. Even though this form of capital may be higher in cost relative to mezzanine, it has nonetheless become highly popular with the seasoned managements of private E&P start-ups seeking aggressive growth.

Also, for publicly traded operators needing to raise equity quickly for opportunistic acquisitions, PIPE (private investment in public equity) transactions have ballooned in popularity. The key attraction for issuers: this private fund-raising route sidesteps the lengthy process of executing a traditional secondary stock offering in the public markets.

Among the many financial intermediaries and sources of these capital-raising products are Energy Capital Solutions, Trust Company of the West, BlackRock Energy Capital and GasRock Capital LLC.



Solutions savvy

Formed in the fall of 2001, Energy Capital Solutions (ECS), with offices in Dallas and Houston, is focused on intermediating private-capital financing and handling merger and acquisition advisory assignments for private and publicly traded E&P, oil-service and alternative-energy companies.

During the past five years, the firm has executed 58 transactions in the energy space. This includes 49 private-capital transactions worth about $1.2 billion -25 PIPE offerings; the balance, private-equity financings for private companies, mezzanine-debt and senior-debt deals. Meanwhile, it has advised on nine M&A transactions totaling another $1.2 billion.

"The momentum in the energy sector, high commodity prices, and stepped-up investing interest by both traditional private-equity funds and the hedge-fund community have dramatically increased the capital pouring into the E&P, oil-service and alternative-energy arenas-particularly through PIPE transactions," says J. Russell Weinberg, a managing director and co-founder of ECS in Dallas.

In the past two years alone, the firm has intermediated 23 private placements of equity, 16 of which were PIPE deals. In the upstream sector, these include a $21.5-million offering for Long Beach, California-based Pacific Energy Resources, an $8.5-million transaction for Houston's Texhoma Energy, and a $10-million deal for Admiral Bay Energy-a Denver operator for which ECS also put together a $40-million mezzanine facility.

"The advantage of a PIPE is that it gets the issuer much quicker access to equity versus going through an SEC registration process for a fully marketed secondary equity offering in the public markets, which could take several months," explains Keith J. Behrens, co-founder and ECS managing director in Dallas.

ECS has also been active in traditional private placements of equity. These include a recent $25-million funding for PetroEdge Resources, a private Houston-based operator, and a $30-million equity infusion for Manhattan Petroleum, a private Midland, Texas-based producer.

On the mezzanine side, the intermediary is currently working on a $75-million facility for Infinity Energy Resources to help recapitalize that publicly traded Denver producer.

Among M&A advisories, ECS this May represented SDX Resources, a privately held Midland-based producer, on the sale of some of its producing assets to Lime Rock Resources, a start-up of private-equity provider Lime Rock Partners, and which buys direct oil and gas property interests. This fall, the firm advised Houston's Grant Geophysical on that publicly traded service provider's $125-million sale to Denver's Geokinetics Inc.

What's in the pipeline? At press time, the firm was looking at seven or eight PIPE deals, four or five traditional private-equity offerings, three or four senior debt/mezzanine transactions, and a couple of M&A advisories that collectively add up to around $1 billion worth of deal flow, says Behrens.

"While we expect to be handling more PIPE transactions, we nonetheless suspect that, if the lull in commodity prices continues, this business will likely slow down," says Weinberg.

"Very simply, as the stock prices of small public companies decline, there will not only be less appetite on the part of issuers to sell shares, but also less appetite on the part of investors to buy them due to lower commodity prices and lower projected earnings."



Expanded reach

Since 1982, Los Angeles-headquartered Trust Company of the West (TCW)-with around $130 billion of assets under management, and a business unit of France-based Societe Generale-has been a direct investor in the energy space. Through its energy and infrastructure group, it has raised 13 energy funds totaling $6.6 billion and closed on more than 180 energy investments.

While well-known as a leader in energy mezzanine financing, the firm, since the late 1980s, has also been a provider of private equity to the energy sector. In addition, it has recently broadened its investment focus to now participating in much larger investment-grade, high-yield and second-lien-debt financings for the sector through its Global Project Funds.

"Ten years ago, we mainly did debt private placements or project financings-mezzanine, in the classic sense-while our equity investments were either preferred or modest, non-control common equity," says Kurt A. Talbot, managing director in the energy and infrastructure group for TCW Asset Management Co. in Houston.

"Today, although mezzanine is still a key component of our financing strategy, we play the entire balance sheet in our energy investments, including corporate-issued senior and second-lien debt, as well as controlling common-equity stakes in private companies."

During the past 12 months, Talbot's group has completed $185 million worth of traditional mezzanine transactions for seven E&P and oil-service clients. This includes a $50-million senior mezzanine facility last April for a private Midland-based producer focused on development drilling in the Permian Basin.

The deal's structure: a low-teens coupon plus an equity kicker in the form of a variable net-profits interest, designed to provide TCW's investors with a mid-teens rate of return.

"Because the project was essentially 100% drilling, with very little production and cash flow at the start, it wasn't something that lent itself to commercial bank financing," explains Talbot. "At the same time, the company didn't want to give up too much of the project's upside by accessing private equity. Mezzanine, they felt, was far less dilutive."

There are, of course, times when larger financing needs by a producer or service company require an alternate capital solution such as private-equity backing. In the past 12 months, TCW's Houston group has completed $345 million of such financings through which it seeks targeted returns of 25% to 35% based on investments of $100- to $400 million.

This March, a group of investors led by TCW acquired a controlling common-equity position in CDX Gas, a private Dallas-based operator, for $835 million. The recapitalization provided liquidity to the company to allow it to develop its extensive unconventional-gas asset base across North America.

What's ahead for 2007? Talbot says, "With the recent softening in commodity prices, less receptive capital markets, falling cash flows and increasing leverage ratios, producers will need to recapitalize. This, in turn, will present many opportunities for private-equity financing and traditional mezzanine, as many of the newer capital providers to the E&P space begin to cycle out of their oil and gas investments."



Small-producer focus

For small, private producers-those with assets considerably lower than $100 million-Houston's BlackRock Energy Capital Ltd. offers the opportunity to latch onto small bites of capital considerably below the $10-million level.

Cathy Sliva, who in 2002 became BlackRock's founder, president and chief executive officer, says that, in 1993, while she was with Tenneco Ventures, the E&P subsidiary of Tenneco Gas, she and others in that company recognized there were thousands of small E&P companies that needed growth capital in very small amounts-as low as a couple of million dollars or less-that were being more or less ignored by many commercial banks and mezzanine lenders.

BlackRock's strategy is to provide small amounts of incremental capital to private independents in return for which it holds a temporary overriding royalty interest (ORRI) in a producer's properties for however long it takes BlackRock to recoup its investment-plus achieve a contractual rate of return in the high teens. After that, the operator retains a 97% to 98% share in its producing assets; the capital provider, a 2% to 3% residual ORRI.

"We tend to view this type of financing as mezzanine, in that our funding and return objectives fall somewhere between bank debt and private equity," explains Sliva. "Notably, our structure is non-recourse to the company because we can only get repaid through our temporary override. So we're taking price and production risk right alongside the producer."

With capital from its four partners, equity backing from the Redstone Cos. in Houston and the support of several area banks, BlackRock since 2002 has invested or has committed to invest some $200 million in 28 E&P companies. In addition, the company has 15 potential upstream investments totaling $55 million in its deal-flow pipeline.

Typical of BlackRock's investment strategy are a series of incremental financings for Vada Energy, a private Baton Rouge-based operator focused primarily onshore Louisiana.

"Our first investment in Vada was less than $1 million in 2002," says Sliva. At that time, the company's oil production was about 135 barrels per day. Since then, BlackRock has completed seven more financings totaling $7 million for acquisitions, workovers and development drilling.

"Currently, Vada's output is around 800 barrels per day. In addition, during the past few years, it has opportunistically sold off several of its Louisiana properties for millions of dollars."

Another investment example: BlackRock in 2003 provided $450,000 to Tammany Oil & Gas LLC, a private Houston-based producer focused on acquisitions and development drilling onshore and offshore Texas and Louisiana. By the end of 2006, through a series of incremental investments, the capital provider's overall financial backing of Tammany will eclipse $20 million, $7 million of that coming in just this year alone.

"We're excited about [deal flow] in 2007 because the commodity-price market is softening enough that many smaller producers should be able to come together more readily on acquisition transactions, which they otherwise may have found difficult to complete in the record-price environment we saw earlier this year," says Sliva.



Mezzanine-minded

Up through June 2005, Houston-based Weisser, Johnson & Co. spent 14 years helping energy companies raise funds from mezzanine-debt and private-equity providers. But after sizing up the dearth of players and capital available in the energy mezzanine space during the post-Enron era, it decided to also become a principal, not just an intermediary, of mezzanine money.

The result: its formation of GasRock Capital LLC, backed by two financial institutions in New York and the Midwest with a combined $10 billion of investments under management.

Since then, GasRock has closed on five E&P mezzanine-debt investments. "Each of these facilities has a four-year maturity, a coupon in the 10% to 12% range, and an ORRI designed to achieve targeted returns in the mid- to high teens," says Frank Weisser, GasRock's managing director. In the case of smaller, early-stage, higher-risk deals, the ORRI is a little bigger, bringing returns slightly above 20%.

"What we've focused on so far in the upstream are transactions in the range of $10- to $100 million; however, we're willing to invest as little as $2 million in a company if we're confident the facility will grow beyond $10 million within a year or so," says Weisser.

In October 2005, the firm completed a $30-million mezzanine facility for Miller Energy, a private Lafayette, Louisiana-based operator to finance that company's acquisition, and later exploitation, of Barnett Shale potential in Erath County, Texas.

This year, GasRock closed a $45-million facility for Dallas-based Westside Energy, an Amex-listed producer aggressively focused on drilling in the Barnett Shale; a $25-million facility for Denver-based Saddle Rim Energy, a private operator seeking to acquire and develop small oil fields in the western U.S.; a $30-million financing for a subsidiary of Houston's EnDevCo, an OTC bulletin-board-traded E&P company; and a $40-million mezzanine deal for Z2 Oil & Gas, a private Tulsa-based operator developing Big Foot Field in South Texas.

The EnDevCo subsidiary financing allowed it to acquire and develop the Short Junction Field in central Oklahoma.

At press time, the firm had term sheets out on four other financings with an aggregate value of $250- to $300 million. "What's notable is that, while two of these are mezzanine-related, the other two are project-equity investments-a new area for us," Weisser says.

In the latter two cases, special-purpose entities would be set up to hold GasRock's direct investments and working interests in producing and undeveloped properties, while the E&P partners in the joint-venture vehicles would operate those entities.

"Once we reach a return hurdle of 12% to 20%, the majority-if not all-of the assets in the joint-venture entities would revert to the operating partners," explains Weisser.

"For many producers that have an aversion to a debt component in a financing structure, project equity is an attractive alternative to mezzanine."

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