Early this fall, the capital canyons of Wall Street were filled with myriad puddles, as eight straight days of rain pelted the Northeast corridor of the U.S. But the mood in the corporate-finance conference rooms and on the floors of the NYSE and Nymex was anything but gloomy. The only storm the denizens of these domains saw was a steady torrent of energy-related M&A transactions and initial public offerings (IPOs), a stream of new oil and gas stock symbols on exchange tickers, and a blizzard of buy and sell orders in the oil and gas futures-contract trading pits. The message of the Street to a capital-intensive energy industry: open for business. But the tempo and nature of this deal flow had been building all year. Amid global resource scarcity, national oil companies (NOCs) as early as this spring began vying with international oils for new assets, as witnessed by the Chevron/CNOOC battle for Unocal. "We're in a whole new world today where a war for resources is under way," observes one global market-maker. Further evidence of the frenzy in crossborder M&A this year was Norsk Hydro's purchase of Spinnaker Exploration, Statoil's acquisition of EnCana's Gulf of Mexico assets and the sale of Kerr-McGee's North Sea assets to U.K. and Dutch buyers. Meanwhile, in purely domestic transactions, Occidental Petroleum was busy acquiring Vintage Petroleum, and Chesapeake Energy was busy buying every other domestic hydrocarbon asset not nailed down. Further augmenting deal flow this year: the ongoing equitization of financial sponsors' positions in E&P and oil-service companies. Indeed, going into this fall, Wall Street looked more like an air-traffic control center stacking energy-related IPOs in a holding pattern. "Financial sponsors of private companies are seeing very strong valuations in a very liquid public market, and are attracted to that as a way of raising capital and having a currency they can use for future acquisitions and growth," explains one investment banker. Also, with high valuations in the public market and a continued low-interest-rate environment, new yield-oriented upstream MLPs (master limited partnerships) or LLCs (limited liability corporations) are being created. Relative to the upstream MLPs of the 1980s, the new partnerships will have longer-lived reserves and production and, hence, more free cash flow for distribution. In addition, within the midstream MLP space, expect to see the emergence of more GP (general partner) IPOs like the one for Enterprise GP Holdings LP that was completed this summer. Says one banker, "Institutional investors see a publicly traded GP as having potentially higher growth, albeit less yield, than its related MLP." With such a parade to market of so many types of energy investments, and the continuing strength in crossborder M&A activity, the consensus on Wall Street is that 2006 is going to be a heady year for deal flow in the energy sector. After all, oil and gas are global commodities that are becoming scarcer, not more plentiful. Resource war To say that energy-related M&A activity for Lehman Brothers was brisk in the first nine months of 2005 would be a gross understatement. During that time, it advised globally on $43 billion worth of such transactions, $30 billion of which occurred in the E&P sector. Most notable was its representation of Chevron in that major oil's contested, record-setting $19-billion purchase of Unocal. "Originally, the stock-and-cash bid package we designed amounted to about $60 per Unocal share, but CNOOC subsequently came in with an unsolicited, government-subsidized, leveraged cash bid equal to $67 share," explains Grant A. Porter, New York-based vice chairman and head of the Lehman Brothers natural resources group. "This was the first time the market saw a government subsidy introduced into a commercial M&A transaction. It was like Boeing versus Airbus on steroids." (Airbus received a subsidy from the French government for its bid into the U.S. market.) In response, Lehman redesigned Chevron's package to a melded cash and stock value of about $63 per Unocal share that Unocal's board and shareholders ultimately reaffirmed. "This transaction signals that we're in a whole new world today where a war for resources is under way-between international oil and gas companies and the national oil companies (NOCs)," says Porter. "Simply put, the resource-short NOCs-faced with growing economies and increased dependence on energy imports-feel a compelling need to own resources around the globe to hedge a massive asset-liability problem." But buying resources isn't going to come cheaply, he points out. With resource scarcity and replacement costs rising dramatically, the long-term expectation for oil prices that people have been using in M&A transactions-usually a ratio of three times replacement-cost values-has changed fundamentally. "A year ago, people were using a long-term oil price of $35 in their transactions; today it's $50. This $15-per-barrel difference is evidence of the higher replacement costs for oil and gas production, and that differential is likely to climb to $20 over time." Understandably, the tempo of upstream M&A activity this year has led many domestic E&P companies to tap the capital markets vigorously, most notably, Chesapeake Energy Corp. "We've been one of the lead bookrunners on all their 2005 financings-from common-stock to convertible-preferred-stock offerings-which will ultimately total nearly $4 billion," says Porter. The pace of energy financing this year has also been quickened by the emergence of 144A transactions as a fast track to going public. Rule 144A is an exemption under SEC regulations that allows unregistered stocks to be privately sold to qualified institutional buyers with the understanding that those securities will become public within a relatively short period. "The standard SEC-registered IPO is taking much longer to get to market today, as much as four to six months, so more issuers are using the 144A route to take advantage of today's market," says Porter. "We'll shortly be leading a $200-million 144A deal for a private producer and have several more in the pipeline." Also in Lehman's pipeline are IPOs for yield-oriented upstream LLCs or MLPs. The difference between these MLPs and ones in the 1980s is that the earlier MLPs had relatively short-lived production and no real free cash flow since most capital had to be reinvested to replace production, the banker explains. "Today's upstream MLPs have longer-lived reserves and production and thus free cash flow to monetize in the equity markets, with yields in the 7% to 9% range. Meanwhile, the issuers of these MLPs are getting a higher valuation per barrel of oil equivalent than they would through a standard IPO or 144A transaction." IPO parade The equitization of financial sponsors' positions in oil-service and E&P companies has been one of the main drivers of 2005 capital-markets activity in the energy sector, says Andrew Safran, managing director and head of the energy, power and chemicals group for Citigroup Global Markets Inc. in New York. The investment banker cites the roughly $500-million IPO of Dresser-Rand out of the First Reserve Corp. portfolio this August, and the $184-million IPO of shallow-water driller Hercules Offshore out of the Greenhill Capital Partners and Limerock Partners portfolios in late October. In each case, Citigroup was a lead book manager on the offering. "Financial sponsors such as these are tapping into investor interest in acquiring energy-sector stocks at the IPO discount," he notes. "They recognize that drillers and equipment manufacturers are going to benefit from higher commodity prices and higher E&P spending." In the upstream, the same phenomenon is occurring as both financial sponsors and seasoned producer managements seek to capture the high valuations available in the current bullish market for public E&P companies, explains Safran. "Right now, we're involved with a couple of upstream IPOs that will come to market in the near future-one for a private Midcontinent operator; the other, for a Rockies producer." Another broad market trend is the emergence within the midstream MLP space of GP (general partner) IPOs. This summer, Citigroup was joint book manager on the $500-million-plus IPO for Enterprise GP Holdings LP, the GP of the Enterprise Products Partners MLP. The attraction for investors: the GP interest imbeds the incentive distribution rights in an MLP, which enables the GP to capture a disproportionate share of an MLP's cash flow as certain targets are met with respect to distributable cash, explains Safran. "Institutional investors thus see a publicly traded GP as having potentially higher growth, albeit less yield, than the related MLP itself." He adds that a publicly traded GP gives an MLP a tactical advantage in terms of having an additional currency for acquisitions. Citigroup is also taking advantage of the recent boom in crossborder energy-related M&A activity. Through the first nine months of 2005, the firm handled $37.1 billion worth of global M&A advisories versus $13.1 billion worth for the same 2004 period. This includes representing CNPC International Ltd. in its $4.2-billion buy of Calgary-based Petrokazakhstan and advising Dutch firm Maersk Olie og Gas on its $2.95-billion acquisition of North Sea assets from Kerr-McGee. "We expect this trend in global M&A activity to continue, particularly since India and the Chinese are very focused on crude-oil-security issues now." What should also continue is asset repositioning by producers looking to concentrate on their core competencies while maximizing value for their shareholders. In this context, Citigroup advised Forest Oil Corp. this September on the spin-off and merger of Forest's Gulf of Mexico assets with those of soon-to-be public, Houston-based Mariner Energy. Says Safran, "When the tax-free transaction is completed, Forest shareholders will own, on a pro rata basis, shares in the new Mariner Energy, which will have a bigger Gulf of Mexico focus, as well as shares in Forest Oil, which now becomes a pure onshore North American resource play." Global M&A Houston-based Bill Montgomery, managing director and head of the natural resources group for Goldman, Sachs & Co., cites M&A-related activity as the main driver of upstream oil and gas financings this year. Through the first nine months of 2005, the market-maker handled $17.1 billion worth of energy-related M&A transactions in the Americas, up from a level of $5.1 billion for that period in 2004. Earlier this year, the investment-banking firm advised Pogo Producing Co. on its purchase of Canadian assets from Unocal. It then provided Pogo with a $1.8-billion bridge financing for that acquisition and was a bookrunner on a $500-million high-yield bond offering, which helped take out that bridge. In yet other Canadian M&A transactions, Goldman Sachs represented Deer Creek Energy Ltd., a small oil-sands producer backed by Limerock Partners, in its $1.1-billion sale to Total E&P Canada. It also represented Petrokazakhstan in the recent $4.2-billion sale of that Canadian company to CNPC International, and Calgary's Talisman Energy in its $2.2-billion purchase of U.K.-based Paladin Resources Plc. In the U.S., the market-maker represented Gryphon Exploration, a private Gulf of Mexico operator funded by Warburg Pincus, in its $296.9-million sale to Woodside Petroleum, and Occidental Petroleum in its planned $3.8-billion acquisition of Vintage Petroleum. "Two types of sellers are driving the current upstream M&A market," says Montgomery. "There are investors such as private-equity sponsors that have backed management teams for several years, helping them grow their assets. These sponsors are now realizing the opportunity to monetize their investments amid very strong public-market valuations. "At the same time, there are E&P players looking to acquire assets with some kind of running room at reasonable valuations relative to their own trading levels, as was the case with Oxy in its purchase of Vintage." The investment banker adds that the desire of financial sponsors to take some money off the table while furthering the growth of the entities they've backed has also led to the ongoing explosion of IPOs, both in the oil-service and E&P sectors. Goldman Sachs will be a bookrunner on the pending $287.5-million IPO of Basic Energy Services, a Midland company that with the backing of Credit Suisse First Boston Private Equity has become the third-largest provider of workover rigs to the U.S. oil and gas industry. On the E&P side, the firm will also be a bookrunner on two other pending IPOs: one aimed at raising about $200 million in proceeds; the other, about $600 million. Montgomery believes that M&A and IPO deal flow within the upstream and oil-service sectors will continue to be robust in 2006 because "there are still a lot of sellers out there that haven't decided yet to pull the trigger." Using all tools Most of the capital-markets financing activity in the E&P space this year has been acquisition-related, concurs M. Scott Van Bergh, managing director, upstream group, for Banc of America Securities in New York. Among such 2005 financings for non-investment-grade issuers, the firm co-managed for Whiting Petroleum combined equity and high-yield-debt offerings totaling about $800 million, which allowed that Denver-based operator to acquire producing assets from Celero Energy, a private Midland firm. The market-maker was also recently a joint bookrunner on three acquisition-related financings for Chesapeake Energy: a $300-million convertible preferred issue, a $262-million common-stock offering and a $600-million high-yield-debt issue. And, it participated in several common-stock and high-yield-debt financings for Range Resources tied to acquisitions. "Independents are funding acquisitions with virtually every available tool in the financing tool chest-from bank debt to common equity-sometimes accessing more than one market at the same time," says Van Bergh. He expects more of this in 2006, as it relates to asset acquisitions, and the purchase of private producers or private companies sponsored by financial institutions. This isn't the only capital-markets trend Van Bergh sees afoot. "We also expect a substantial pickup in IPO issuance, particularly through fast-track 144A transactions, which increasingly are going to be led by the larger investment banks." Speed to the public market has become an important matter for issuers not only because there's a fear of getting stuck in registration going the traditional IPO route, but also because valuations in that market are very strong right now, explains Van Bergh. "In fact, they've caught up with and, in some cases, even surpassed M&A values. So there's not necessarily an advantage any longer to selling a company privately versus going public." The investment banker notes, in particular, a significant run-up in the public-market value of resource-play companies such as Bill Barrett Corp., Southwestern Energy, Ultra Petroleum and Quicksilver Resources. "During the next six months, we expect to see E&P companies coming public that, to some degree, have resource-play characteristics." Banc of America Securities was working at press time on two upstream IPOs scheduled to be marketed through 144A transactions before year-end. On the oil-service side, it will also be involved in the pending $575-million IPO for Dresser Inc., an Addison, Texas-based manufacturer of flow-control products and measurement and power systems. "Overall, before year-end, we expect to be involved in as many as 10 equity or high-yield transactions in the oil and gas sector." Wide-open markets The number of times and manner in which Chesapeake Energy has tapped the private and public markets this year is a good indication not only of how dominant acquisition-related financings have been in 2005, but also of how wide open the markets now are for energy issuers, observes Jerry Schretter, managing director and head of upstream energy corporate finance for UBS Investment Bank in New York. In funding its most recent $2.2-billion acquisition of Charleston, West Virginia-based Columbia Natural Gas Resources LLC from Triana Energy Holdings LLC, Chesapeake is using a broad array of public and private equity and debt financing, which recently totaled about $1.8 billion, he points out. "The overall funding, in which we have played a prominent role, shows the extent to which the capital markets are available today to the E&P sector." In other energy-related M&A transactions this year, UBS represented Andes Petroleum Co.-a joint venture of Chinese petroleum companies-in its $1.42-billion acquisition of EnCana's upstream and midstream interests in Ecuador. It also represented Kinder Morgan Inc. in its $5.6-billion buy of Terasen Inc., a Canadian heavy-oil producer. Still, there are other financing trends emerging in the energy space. Although the E&P sector is generating significant excess cash flow today, the industry is maturing and can't reinvest that excess cash flow at superior rates of return, Schretter notes. "Investors are asking companies to buy back stock with that excess cash flow; leading to a lot of recapitalizations." Meanwhile, the E&P sector is also responding to shareholder demand for yield-oriented returns by creating income-generating upstream MLPs or LLCs, he adds. The banker cites a recent SEC filing by Pittsburgh-based Linn Energy for an Appalachian Basin-focused LLC that expects to generate an 8% annual yield. Also, because oil-service and E&P companies now have the opportunity to get a valuation in the public market that may exceed what they'd get if their entities were sold privately, "we should see a strong IPO market through year-end and into 2006," says Schretter. Within the service sector, UBS will be a lead manager on the planned $575-million IPO for Dresser Inc., joint bookrunner on a $100-million one for Nova Scotia-based Secunda International Ltd. and joint bookrunner on a $300-million IPO for Houston's Complete Production Services. "Deal flow next year in the energy space should be stronger than in 2005, particularly in the M&A arena," Schretter predicts. "Buyers globally have become much more aggressive in terms of what they're willing to pay for an acquisition and there's more global competition for oil and gas assets." Multi-product platform No single type of energy-finance activity has dominated the 2005 deal-flow calendar for JPMorgan Securities; rather, it has been active this year across the entire spectrum of capital-markets transactions in the oil and gas space. "We led several offerings this year to fund organic growth in the upstream, including a $600-million equity issue for Southwestern Energy, which allowed that producer to move ahead with development of its Fayetteville Shale play in Arkansas," says Doug Petno, managing director and head of energy investment banking for JPMorgan Securities in New York. In acquisition-related financings, the market-maker was also lead bookrunner on a $100-million common-stock offering for Range Resources and on high-yield-debt, common-stock offerings and bank financings for Whiting Petroleum that totaled some $500 million. Within the oil-service sector, the firm was lead bookrunner on a giant $2.5-billion follow-on equity offering for Halliburton on behalf of the Halliburton Asbestos Trust. But another event this year-Carl Icahn's run at Kerr-McGee in early 2005-brings into focus the broad range of JPMorgan Securities' market capabilities. "The company, facing a proxy battle with Icahn, brought us in to lead its advisory effort," says Petno. "Ultimately, we led a $5-billion financing to bridge a recapitalization whereby Kerr-McGee ended up repurchasing about $4 billion worth of its stock." Also, to support this leverage and de-risk the company, the market-maker led the hedging of about 75% of Kerr-McGee's production for three years. In addition, the banking firm is currently acting as an M&A advisor to the company on the sale of certain E&P properties to help it refinance the bridge debt related to its stock buyback. On top of this, JPMorgan Securities is also joint bookrunner in the pending IPO of the company's chemical business. Says Petno, "This is an excellent example of how we're able to assist a client through an integrated, multi-product platform." Looking ahead, the banker sees increased IPO deal flow. Besides leading a proposed $150-million offering for Union Drilling, a Pennsylvania-based land driller, the firm has three IPOs in its pipeline for E&P companies. "The owners and shareholders of all these companies see very strong valuations in a very liquid public market, and are attracted to that as a way of raising capital and having a currency they can use for future acquisitions and growth," says Petno. Turning to M&A, he notes that buyers are now willing to pay premium valuations in order to enter a new basin, whether that's Norway's Statoil, which JPMorgan represented this year in its $2-billion buy of EnCana's Gulf of Mexico assets, or Chesapeake branching out into another U.S. basin. "This is a consistent theme that ties back to the scarcity of resources, and companies around the globe being forced to leave their backyards to seek new growth opportunities."

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