In 1998, a team from Raymond James Financial met with senior leadership from a private energy company looking to go public.
Raymond James had been in energy investment banking for four years at that time, but focused on E&P and oilfield services. The bankers had never before approved an IPO underwriting for a company that built pipelines, NGL fractionators and storage units, which is what the executives were asking them to do. Underwriting is all about risk, but a conservative firm like Raymond James only takes on risk that is calculated.
As the bankers listened, they looked past the spreadsheets to gauge intangibles:
Management team: Do the leaders have a good track record, a solid knowledge base in the industry and, most important, the ability to gain the trust of Raymond James lenders?; and Business plan: The management team’s approach is critical—what do they want to do and where do they want to do it?
“We’re looking to build long-term relationships with companies that have excellent management teams, strong sponsors and solid business plans,” Mark Huhndorff, Dallas-based managing director for Raymond James, told Midstream Business. “We’re not afraid to walk away from a situation that doesn’t meet those criteria.”
But Raymond James didn’t walk away that day.
The bankers decided to underwrite the IPO, which yielded net proceeds of $247 million for the company and 17 years later, Raymond James has relationships with over 100 companies that operate in the midstream energy space.
And whatever happened to the original outfit, the one that convinced the bankers to risk entering a brand new sector of investment? Oh, it’s still around. It’s known as Enterprise Products Partners LP and its market capitalization is a muscular $57 billion.
Doing their homework
“Our approach across the board in all industry groups has been to identify companies that are early stage, private, requiring growth equity to achieve their business strategies of growing,” Huhndorff said. “We provide access to that capital, either through the private market or through an IPO in the public market.”
As those companies grow, Raymond James tries to grow with them, he said. The firm views the midstream space as a nice complement to its other areas of coverage, like upstream. Infrastructure becomes handy when the hydrocarbons need to get from field to market.
To develop their investment strategy for the sector, the bankers rely on the considerable research capabilities and other elements of the firm. An acquisitions and divestiture practice was formed in 2008 in the upstream group to focus on understanding properties and reserves in the basins and using that knowledge to buy and sell assets. Mid-stream bankers like Huhndorff rely on that intelligence as well.
“If you understand the reserves and the assets and the economics, you have a better understanding of what sort of infrastructure is necessary,” he said. “So much of a gathering and processing system relies on the volumes that are going to be going through there, so you need to have an understanding of the reserves behind that.”
That understanding is a critical component of the Raymond James approach. Deals are seen as part of a long-term commitment, not simply a one-time fee opportunity.
“One of the guiding principles that differentiates Raymond James from a lot of other banks is that they have a policy whereas any underwriting that the firm undertakes will only be done in conjunction with the research group supporting the fundamentals of the coverage, like upstream. Infrastructure becomes handy when the hydrocarbons need to get from field to market.
To develop their investment strategy for the sector, the bankers rely on the considerable research capabilities and other elements of the firm. An acquisitions and divestiture practice was formed in 2008 in the upstream group to focus on understanding properties and reserves in the basins and using that knowledge to buy and sell assets. Midstream bankers like Huhndorff rely on that intelligence as well.
“If you understand the reserves and the assets and the economics, you have a better understanding of what sort of infrastructure is necessary,” he said. “So much of a gathering and processing system relies on the volumes that are going to be going through there, so you need to have an understanding of the reserves behind that.”
That understanding is a critical component of the Raymond James approach. Deals are seen as part of a long-term commitment, not simply a one-time fee opportunity.
“One of the guiding principles that differentiates Raymond James from a lot of other banks is that they have a policy whereas any underwriting that the firm undertakes will only be done in conjunction with the research group supporting the fundamentals of the we got started,” Huhndorff said. “Given the strength of our retail brokerage network, which is about 6,500 financial advisers in North America, it was really logical to get involved in the MLP space because at the outset it was a retail product. It really wasn’t until around 2005 when guys like Tortoise and Kayne Anderson established institutional investment funds to invest in MLPs. In the last few years, the amount of institutional capital has really ballooned to invest in midstream MLPs.”
MLPs will survive
The commodity price-fueled downcycle has prompted concerns by many over the outlook for both the sector and the MLP structure, neither of which are shared by Raymond James.
“There’s a certain reason why people have used the MLP structure for midstream assets,” Clark said. “Eliminating one level of taxation creates a better, tax-efficient structure that investors obviously like, with yield plus growth. I don’t see that changing for some time.”
He noted, however, that when companies grow to a certain size like Kinder Morgan (market capitalization of $70 billion), the general partner “tax” becomes inefficient from a cost-of-capital standpoint and conversion to a C-corp structure makes sense. Obviously, few companies fit into that category, and Clark believes that MLPs will continue to be a valuable structure for most in the sector, in spite of the struggles experienced this year.
“Because of the structure, we went through a Goldilocks-type period where the valuations were significantly higher than all other spaces in the energy industry,” he said. “That was probably more a function of investors needing yield securities and, with interest rates being as low as they were, there was really no place to get any yield from investments. So a lot of the money flowed into MLP funds, MLP securities and, you could argue, maybe pushed the valuations to a level where they were priced so that growth really had to continue at a pace which was really not sustainable.”
So MLPs have been seen under a harsher light this year, but the downcycle doesn’t necessarily translate as a doom cycle.
“I don’t think the MLP structure as a whole is dead just because we’re in a low commodity price environment and a lot of these valuations have taken a hit,” he said.
Similarly, Huhndorff takes a matter-of-fact approach to the midstream sector’s outlook: It will continue to grow because it has to continue to grow.
“A good analogy might be: is real estate dead?” he said. “Do we need any more real estate? As long as we’ve got population growth and old things coming down and new things going up there’s going to continue to be a need for guys that develop real estate, and there’s going to be buying and selling of those assets along the way.
“Midstream’s not going to be dead,” he continued. “It’s a necessary component of getting the product to the market. As long as you have growth and energy needs, you’re going to have a related growth in midstream.”
Near-term outlook
Eventually, but not quite yet. The industry swoon is expected to continue into 2016, with capital markets enduring sluggishness for a while.
“We probably need to see some of the bellwether names raise capital before we see the IPO market open up, but I think it’s going to take a while,” Huhndorff said. “It’s going to be a few quarters before we start to turn the corner. On the advisory side, we’re looking at opportunities in restructuring, in consolidation, private placements. When the public markets are the way they are now, as a banker, you look for opportunities that aren’t really contingent on the public market.”
One option, for example, is to sell securities to a relatively small number of select investors.
“We’ve had some discussions with investors recently about private placements, and the long-term outlook is pretty good,” he said. “Those investors sense that now is actually a pretty good time to try to invest when the valuations have gotten oversold.”
Clark expects consolidation among public companies to pick up next year to cull an overpopulated space, continuing a trend marked by transactions involving The Williams Cos. Inc. and Energy Transfer Equity LP.
“There are still, by a lot of measures, too many public companies out there fighting for the same volumes in the same basins,” he said. “There’s too much overhead and too many different management teams that could easily be consolidated for cost synergies and commercial synergies. For some of the public companies, the cost of capital on the equity side has risen to a level where it’s just not sustainable.”
The distributions are just too high, Clark said. It’s too difficult to be competitive for acquisitions or organic projects when the yields reach into the 20% range. Those types of companies will either have to consider cutting distributions or becoming part of a larger company with more scale and lower cost of capital.
Who is best positioned to thrive in this cycle? Those farthest from the well-head, meaning companies that operate interstate pipelines, long-haul pipelines and Federal Energy Regulatory Commission-regulated, integrated, refined product or natural gas pipelines that move product to the end user.
“From my observations, the further away you get from the wellhead, the less exposure you have to commodity prices and the more you’re just dependent on volumes going into your system,” Huhndorff said. “Those types of companies with those types of assets are probably in a better position to withstand an extended period of low commodity prices.”

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