Last year’s deal flow in energy turned from drought to deluge, as equity issuances in the sector surged with the rebound in crude prices. But even as E&Ps strengthened their balance sheets with equity raises, a two-year dry spell persisted in the IPO market. That is, until the final quarter of last year, when the E&P and oilfield services sectors each had two IPOs cross the finish line.

How confident are investment bankers that the drought is over? And how likely is it that the energy equity calendar in 2017 will include not just follow-on offerings, but also a healthy number of IPOs?

Clearly, the initial response of crude prices in the wake of the Nov. 30 OPEC meeting in Vienna has helped boost confidence, with the West Texas Intermediate commodity curve ris­ing to $1 to $4 above the $50 per barrel mark

through December of 2017. Stock market senti­ment has also been on the rise, as U.S. markets have rallied following the successful campaign of newly elected President Donald Trump.

If IPOs in the energy sector this year don’t reach double-digit figures, it will likely be because—as in some cases last year—equity holders opt for an alternative path, such as the more certain outcome of a cash sale, according to observers. But even then, equity markets will likely still see increased activity, as a sale will likely require a follow-on offering by the buyer to finance its acquisition.

The still somewhat tenuous fabric of the IPO market was illustrated by the mid-Decem­ber IPO of Wildhorse Resource Development Corp., which filed to sell 27.5 million shares at an initial price range $19 to $21/share, but ended up pricing the offering at $15/share. Wildhorse’s activities have included developing acreage in the Eagle Ford Shale, par­ticularly Burleson County, and the Terryville Complex in North Louisiana. The stock settled the first day of trading at $15.06/share.

Moreover, the validity of a “dual-track” process—in which companies can explore the rela­tive merits of both going public and making an outright sale— has also been on display. Two potential IPO candidates chose to take the path of an outright sale: Brigham Resources Oper­ating LLC and its midstream affiliate accepted a $2.43 bil­lion bid from Diamondback Energy Inc., while Vitruvian II Woodford LLC negotiated a sale to Gulfport Energy Corp. for $1.85 billion.

Queuing up

The prospect of a “very significant IPO market” next year, barring a lower unfore­seen shift in the oil and natu­ral gas markets, is what Rob Santangelo, head of equity capital markets in the Americas for Credit Suisse, sees on the horizon for this year. Credit Suisse acted as lead left manager for three of the four IPOs successfully transacted in the fourth quarter of last year.

In the E&P sector, Santangelo predicted four to six companies eventually going public, but noted the initial roster of candidates could nominally be much higher—even a dozen—before some drop out or are lost to a “very vibrant A&D market.

“It’s hard to estimate the number that will go public, because there’s also a very vibrant A&D market,” said Santangelo. “A lot of these E&P deals have a dual-track aspect to them. Sometimes it’s explicit, and they’re doing it formally, and sometimes it’s implicit, and their phone is ringing.

“In terms of companies that could reasonably expect to go public, it’s eight to 12,” he contin­ued. “To my knowledge, we’ve never had that many companies actually go public in one year. What’s more likely is that half of them will IPO and half won’t, and we’ll have an E&P industry that did two IPOs in 2016 and will do four to six in 2017. But you could have as few as two IPOs or as many as eight or nine—I doubt they’re all going to go public.”

In the oilfield services sector, up to six com­panies could similarly go public, according to Santangelo.

However, a distinction vs. E&P candidates is that “a smaller percentage of those are likely to be bought out, because there’s not as active an M&A market in services as there is in the E&P market,” observed Santangelo. “So maybe we’ll have four to six IPOs in oilfield services this year.”

Credit Suisse was lead left manager for the two oilfield service IPOs done late last year—Mammoth Energy Services LLC and frack sand supplier Smart Sand Inc. Both had market capitalizations below $1 billion, and “there’s good appetite for small- to mid-cap names,” said Santangelo. However, to reach a larger audience of potential buyers, “the sweet spot is probably $1.5 to $4 billion in market cap.”

As to which basins would give rise to IPO candidates, Santangelo pointed—not sur­prisingly—to the Permian and Scoop/Stack. In addition, “you may have more D-J Basin; you’ve already had one,” he said, referring to Extraction Oil & Gas Inc., one of two E&Ps that went public last quarter. “And you’re likely going to have the Haynesville and, up in Can­ada, the Montney.”

Could IPOs make up much more of overall equity issuance than the sliver it contributed last year?

“I think it might be up to 20% to 30% of equity,” said Santangelo, albeit with the caveat that it’s “inherently unknowable.” If a prospec­tive IPO turns into an A&D transaction, for example, “you go from doing a $1 billion IPO to doing a $1 billion follow-on offering for the purchaser. A lot of the follow-on offerings will be to finance acquisitions of companies that otherwise would have gone public.”

Public vs. sale

What are some of the factors companies con­sider when opting to go public or instead make a sale?

“Value is not the only factor dictating which path they go down,” observed Santangelo. “You have to examine management’s willingness to run a public company. And you also have to consider the time-horizon of the investment. Most people, even those selling, believe that if they stay with companies longer, they’ll be worth more. They believe in the prospects of their companies.”

For Citi, the optimistic tone coming out of the recent OPEC meeting only served to augment an already growing backlog of potential IPO can­didates, according to Steve Trauber, the firm’s head of global energy investment banking.

“Our backlog had been building well before the OPEC meeting,” noted Trauber. And while there is a degree of skepticism as to “whether OPEC compliance with its agreed cuts and caps can be maintained, the good news is that there is a lot of positive sentiment in the market place,” he said.

Citi’s near-term backlog of IPO candidates currently stands at 13 companies and could grow to about 20 to 25 companies if you look out over an 18-month timeframe, according to Trauber. The near-term backlog breaks down into roughly 80% upstream candidates and 20% oilfield service candidates. Since the OPEC meeting, Citi has received invitations to make pitches to another four potential issuers, he added.

Not all are expected to go public. “At least a few will end up getting sold,” he said.

Trauber remains a strong proponent of mov­ing early to raise equity in what could be an increasingly competitive market driven by a strengthening IPO calendar and ongoing needs to re-equitize parts of the upstream and oilfield services sectors. And all this ahead of the Saudi Aramco plan to raise $100 billion in a 5% equity offering—an amount five times bigger than the previous largest-ever equity issue.

The massive IPO planned by Saudi Aramco is projected to come to market in late 2017 or, more likely, 2018. Citi was one of three book-runners for Saudi Aramco’s earlier $17.5 billion debt issue in October of last year.

“If you need equity to execute your business plan, it’s better to think about it earlier than later,” said Trauber. For example, if equity mar­kets are “digesting” following a period of high equity issuance, “you can’t assume the equity market will necessarily be there,” he warned.

In terms of basins expected to see IPO activ­ity, “near term, it’s the Permian, Scoop/Stack and a potential for the Haynesville, given much improved economics,” according to Trauber. Although the Scoop/Stack is smaller than the Permian, making it in some cases harder to accumulate acreage in scale, the returns there are “exceptional,” he said.

“Some of the E&Ps there have a real interest in going pub­lic, because they see a lot of growth ahead of them,” he observed. “And there are some that are going to dual-track it.”

North of the border, Trauber also considered the Montney as being prospective for an IPO.

IPO valuations

In terms of evaluating the relative merits of an IPO vs. a sale, Trauber said current valu­ations “had tightened significantly, so there’s not much of a near-term arb. The arb comes when you look at what the growth opportu­nities are for the business. If you’re a private equity sponsor, you say, ‘if I hold it for just another 12 to 24 months, I’ll get a signifi­cantly higher valuation, and I can always sell it then.’”

In determining IPO valuations, investors are currently focused on multiples of Enterprise Value-to-EBITDA based on 2018 EBITDA, according to Trauber. This results in some “pretty robust valuations” based on publicly traded peers, he observed, “and that’s what is driving a lot of the interest to monetize.” For E&Ps, he continued, it’s a lot easier to estimate EBITDA than it is for oilfield service companies, as E&Ps have control over their well count and can monitor type curves and verify various other factors.

But with valuations based on 2018 EBITDA multiples, the scope for missteps is limited, said Trauber.

“People recognize 2017 is a recovery year, and it’s going to be a critical year for exe­cution,” observed Trauber. “If they don’t exe­cute, and there are a lot speedbumps on the road, then that can change the optimism and positive sentiment for the IPO outlook,” he cautioned.

Ira Green is a managing director and head of energy capital markets at Simmons & Co. International. Simmons, based in Houston, merged with Piper Jaffray Cos. in February of 2016, providing clients with a broader plat­form in terms of investment banking services and greater distribution of its research. Its research now reaches more than 1,000 insti­tutional buyside accounts.

Simmons was a joint book-runner in the two oilfield service IPOs completed in the latter part of 2016. The two offerings shared a common feature, according to Green, in that both gave investors exposure to a rebound in North American activity via companies whose balance sheets, post-IPO, were debt-free.

“There has been demand from investors, particularly on the oilfield service side, to play the U.S. land segment,” said Green. “And when you look at the available publicly traded investment opportunities in that sector, there’s a limited number that are not overleveraged. Put differently, the buyside doesn’t like lever­age in the current market, and it needs a liq­uid investment. The two IPOs that came out in oilfield service had no leverage after the use of proceeds.

And it was a way for the buy- side to play it.”

Moreover, the success of the two offerings was a wake-up call for others planning an IPO, according to Green. With a successful OPEC meeting added to the mix, he recalled, potential issuers were thinking, “‘We just saw Mammoth go, we just saw Smart Sand go, we better get working on our S-1.’”

Green noted that most potential issu­ers were filing confidentially with the U.S. Securities and Exchange Commission under the JOBS Act (Jumpstart Our Business Start­ups), with plans to launch an offering either late in the first quarter or, more likely, in the second quarter of this year. He estimated that five or six oilfield service companies were considering going public “at some point in time in 2017.”

Forecasting multiples

One dynamic highlighted by Green was that oilfield service IPOs were, like E&Ps, also being valued on a multiple of EV/EBITDA based on 2018 EBITDA estimates. Investors know that 2016 was a hard year for oilfield services, he said, with prospects improving in 2017, and they triangulate by looking out to 2018 to see if forecasts “make sense” com­pared to actual EBITDA in the peak year of 2014.

“Here we are pricing an IPO in the fourth quarter of 2016 and what investors are really looking at is 2018 EBITDA—it’s pretty amaz­ing,” he commented.

In the E&P sector, holding a dual-track pro­cess is now “the norm as opposed to the excep­tion,” said Green. “The reason is that private market valuations are not as far apart as public valuations in areas of scarcity and attractive returns, such as in the Permian—and more specifically the Delaware Basin—as well as the Scoop/Stack play.”

In addition, he cited the Utica play, pointing to Vantage Energy LLC’s agreement to a buy­out rather than continuing plans to go public. “Outside those areas, the arbitrage is probably a little bit wider, so a dual-track may or may not make sense. But if you’re in the Delaware, Midland, Scoop/Stack or Utica, it makes sense to run a dual-track.”

By contrast, in the oilfield services sector, “the arbitrage between private market valuation and public valuations is much greater,” he said. “A lot of that has to do with the public market valuing companies on 2018 EBITDA, while the private market may be valuing them on trailing 12-month EBITDA, at this time, 2016 EBITDA. There’s a much bigger discrepancy in the arbitrage between multiples.”

As a result, Green said, “If everyone were ready to go today, I’m not sure you’d see as many dual-track processes on the oil services side. That’s not to say that some won’t, but the logical route at this point in time would be for them to go the IPO route.”

The “devastating” magnitude of the down­turn has meant small- and mid-cap companies in both E&P and oilfield services have in some cases turned to IPOs as a means of deleverag­ing and participating in the upturn, according to Jeff Tillery, managing director and head of capital markets at Houston-based energy spe­cialist Tudor, Pickering, Holt & Co.

“What the downturn did was to flag how crit­ical a company’s balance sheet can be if you get the cycle timing wrong,” said Tillery. “To the extent a company had any material financial leverage on its balance sheet, it has been dev­astating in some cases during the course of the downturn.

“What’s appealing about these companies potentially going public is they use the IPO to delever. And that’s been true for the IPOs we saw late last year, in which the initial proceeds wiped out a big chunk, if not all, of the net debt on the balance sheet,” he continued.

The investor perspective

The attraction of an IPO for an investor at this juncture in the energy cycle is twofold, accord­ing to Tillery. First, an IPO presents to portfolio managers a story in a “part of the market cap spectrum where the menu of choices has been significantly reduced during the downturn.” Sec­ond, it presents to them a clean balance sheet.

“These IPOs definitely check the boxes in terms of the right market caps, where there is some scarcity value,” he commented. “And all of them thus far have presented a very clean balance sheet.”

By way of example, TPH data indicate that in the summer of 2014 there was a universe of 25 oilfield service companies with market capitalizations of between $500 million and $2 billion and which had leverage of less than 2.5x debt-to-EBITDA. By December of last year, the universe of companies using the same criteria had shrunk to as few as seven companies in the oilfield services sector.

“That’s what the IPO candidates potentially capitalize on,” said Tillery. “There’s a scarcity of choices. And to the extent there’s an asset base, management team and a story as to why the company wants to go public, you potentially have a receptive audience.”

Last year, TPH was a book-runner on the Smart Sand IPO and a co-manager on both the Mammoth Energy Services and Extraction Oil & Gas IPOs.

While Tillery anticipated the E&P and the oil­field services sectors would surpass midstream in terms of number of IPOs this year, he did expect the door would gradually open to mid­stream companies going public.

“We think the midstream capital markets will continue to improve through 2017, which means the IPO option will be more available than it was last year—admittedly, a low base,” said Til­lery. “There are a number of private companies being built and achieving significant scale. The question will be, ‘how deep is the M&A buyer universe at that particular time to finance really sizeable potential transactions?’”

Will IPO opportunities widen beyond the more favored Permian and Scoop/Stack plays?

“As the cyclical recovery gains more steam, we think there’s going to be a more varied opportunity set,” said Tillery, striking a note of optimism.

Michael Schmidt is a managing director and co-head of the E&P practice at Seaport Global Securities LLC. He is a nine-year veteran of the firm, which covers energy broadly, both in terms of equity and fixed income. In addition to a strong capital markets focus, the company has an active advisory and restructuring practice.

Schmidt estimated that five to seven new E&Ps are likely to be public by December of this year, with IPOs by oilfield service compa­nies trailing by a substantial margin. The E&P estimate is the result of successive waves of attrition from “roughly 30 names that could be in the hopper” initially. This would come down to about 10 names choosing this path, with three to five then ending up being acquired as part of a dual-track process of monetization.

Preferred exits

On choosing between going public or making a sale, much usually depends on the preferences of the private equity sponsors typically backing E&Ps. Schmidt cited sponsors NGP and EnCap Investments LP as being “clearly comfortable owning public shares,” for example, whereas Kayne Anderson Advisors LLC has tended to focus less on public exits for their portfolio com­panies. “You have to look at the propensity of each private equity fund,” he noted.

Companies that have emerged from a restruc­turing process may also add to the IPO calendar, said Schmidt.

“There are a handful of restructured com­panies that at some point will relist or list for the first time, because it is a way to get the now unnatural holders out of the stock,” he said. “Creditors and bond holders post-reorg are holding equity in restructured companies, and those guys don’t necessarily want to hold equity or aren’t set up to do so. We’ve built a business selling that second hand equity.”

Examples of this type of situation could be Venoco Inc., Magnum Hunter Resources Corp. and Swift Energy Co., to name a few, according to Schmidt. “It would make sense for the bond holders to take those companies public or to do a public equity transaction pursuant to an S-1 if they’re already public.”

On the E&P side, Schmidt did not rule out an early start to the 2017 IPO calendar. If the market has numerous data points for valuing a deal, he said, E&Ps may not need to wait for updated year-end reserves and financial reports, especially in the case of Permian players and, specifically, those in the Delaware Basin.

“In these cases, aggressive companies don’t have to prove their year-end reserves, largely because the market around them has already proved up the acreage value of their assets,” he said. “If they could get out early, that would be very interesting.”

What happens if the IPO trend gathers momentum and runs longer than market partic­ipants expect?

“If the IPO market in the E&P sector catches some steam, then all those that filed confiden­tially last year will get done, and then some guys will try to push out the next tier down,” said Schmidt. “Eventually, the market will get too hot, and the cycle will begin again.”

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