Since the financial crisis of 2008, public markets everywhere have been skittish and prone to swings of multiple percentage points on a single trading day. Even so, in 2010 and the early part of 2011, the market appeared to have stabilized, and companies began to file S-1s and contemplate going public.

Here, executives from a service company and an upstream master limited partnership (MLP) discuss experiences and strategies employed in listing on the public exchanges in these interesting times.

Josh Comstock, president and chief executive officer of C&J Energy Services Inc., a Houston-based provider of hydraulic fracturing, coiled tubing and pressure pumping services, started the company in 1997 with a borrowed truck and $200 in the bank. The company added coiled tubing capabilities in 2001 and its first hydraulic fracturing fleet in late 2007, successfully taking advantage of opportunities generated by the U.S. shale boom.

C&J Energy Services Inc.’s chief executive officer, Josh Comstock (front and center), and chief financial officer Randy McMullan (front, left center) say a Rule 144A placement laid the groundwork for a successful IPO. They rang the bell on the NYSE just a month ago.

Now a billion-dollar public company with no outstanding debt, C&J can fund its growth plan in 2012 with cash flows and existing capital, as well as borrowings available under its existing credit facility, if necessary. But early on, its need for capital to fund expansion quickly outgrew its providers, culminating in the IPO that closed in August 2011.

“We would get a loan, get equipment, get another loan, and still I needed more equipment, more capital. We were constantly outgrowing loan limits,” says Comstock, whose business required evermore capital-intensive equipment over time. Comstock turned to private equity in August 2005, but due to significant expansion, outgrew the available funding by January of the following year. C&J then brought in deeper pockets with Energy Spectrum Capital and Citi Private Equity, which bought out the original private-equity sponsor at an attractive return.

“The private-equity model is to leverage high, shoot for the stars and make it work,” says Comstock. While transitioning to more robust PE funding, Comstock saw the domestic shale phenomenon beginning to take shape and knew he would need more frac fleets to take advantage of demand. But C&J was already bumping up against its debt covenants, and private-equity investors were nervous about the space. The company was forced to wait until May 2010 for the desired capital, a situation that Comstock laments.

“If we had had the funds when we wanted them, we could have better capitalized on market timing and so would be a year ahead as far as financial results,” he says. Delays in access to capital in turn delay delivery of equipment like transmissions, blenders and fluid ends. And that in turn would postpone growth. The missed opportunity planted the public-market seed in the minds of C&J’s management team.

A boom in shale drilling and demand for frac crews created opportunity for C&J Energy Services.

Private placement

In 2010, C&J’s existing 90%-private-equity owners wanted to monetize a portion of their investment before year-end. Due to the length of time required by the SEC for a registered IPO process, the company’s private-equity owners proposed a Rule 144A private placement of non-registered shares during 2010, with a promise to register shares in connection with an IPO in 2011. According to Comstock, the use of a Rule 144A provided the company’s private-equity investors with a partial monetization, while also guiding the company and its new investors down a clear path to an IPO in the immediate future.

The private placement was completed eight months prior to the IPO, which meant that by the time the IPO launched, the C&J team had already developed relationships with several significant institutional investors and knew how to tell the company’s story. Chief financial officer Randy McMullen says this experience was invaluable for the much larger IPO that would follow.

“Just a short time after the equity private placement, we were again getting in front of investors and, given the significant growth we had achieved quarter over quarter, had an even greater story to tell,” says McMullen, who was on the Rule 144A private placement’s three-week road show, doing eight to 10 meetings a day with Comstock. Investors built models in December that C&J had exceeded when the team returned to visit them in July for the IPO.

Following up a private placement with an IPO may have caused excess volatility in the company’s stock price. Some 28 million shares were sold by the private-equity owners and C&J in the Rule 144A. The 2010 investors retained the ability to sell their newly purchased shares into and following the IPO. Despite the increased volatility, however, both Comstock and McMullen believe that, ultimately, the positives outweighed the negatives.

“We were the last of the IPOs out there that priced above the range and we were significantly oversubscribed. Unfortunately, only two days later, the market started to deteriorate. In July, everyone believed in pressure pumping and the next month the market sentiments towards the sector fell apart,” says Comstock.

“Watching your stock price go from $32 to $13 will make you crazy. Still, we look at our IPO as having come out at the right time,” he says. Although his team closely monitors the stock price, their focus is on delivering consistent results in the field.

Capitalized and looking

C&J’s remarkable revenue and net income growth suggest the company is meeting with success operationally. According to a November investor presentation, revenue grew nearly 240% from 2010 to 2011, while net income grew fivefold. McMullen has a clear vision for investing some of that income.

“The plan for 2012 is to continue to grow organically,” he says, noting that the company will be adding, at a minimum, another two frac fleets in 2012: one in each six months. This will bring the company’s number of frac fleets to eight and its aggregate horsepower by year-end to 258,000 from 194,000. The company could exit 2012 with as many as nine fleets and expects to add several coil tubing units to its current 18 by year-end.

The company is also in the process of completing its new West Texas facilities and is looking to expand its geographic footprint in both the U.S. and abroad. Comstock sees potential acquisition opportunities—which could also deliver new markets—arising from a consolidation among numerous recent entrants to the market.

“In response to the U.S. shale boom, we saw a lot of people rush into the business, primarily private-equity-backed companies,” says Comstock. Now that a few years have passed and PE funds may be looking to exit on a schedule, he foresees buying opportunities. Comstock believes some of the young companies with less experience and fleets on order will be acquired at fair multiples, and those that aren’t may have trouble with the logistics of sustaining growth.

“When we first ordered frac equipment in 2006, it took us two years to have it delivered because we were new to the business. We have kept our deliveries in check, but others have had delivery and deployment issues, even large companies,” says Comstock. C&J recently purchased one of its largest manufacturers of equipment and machinery, Total E&S.

In addition to equipment manufacturing, through Total, C&J also conducts equipment repair services and provides oilfield parts and supplies for third-party customers in the energy services industry, as well as meeting its internal needs.

The company’s acquisition of Total brought several strategic advantages. It reduced exposure to third-party supply constraints, provided greater control over and shorter cycle times for delivery of new equipment, and reduced the cost of new equipment.

According to Comstock, at today’s prices one might typically expect to pay $1.2 million per thousand horsepower. Prior to buying Total, C&J was able to get 1,000 horsepower for less than $1 million and now, post-acquisition, it can acquire it for some $800,000. The company completed the Total purchase before going public, with a new credit facility in place and the knowledge that it could pay down the financing debt with proceeds from the IPO.

“The public markets made us debt free. We now have an increased credit facility, access to capital, and are in position to quickly act on acquisitions and organic growth opportunities,” says Comstock.

In addition to the vertical integration and cost efficiencies achieved by acquiring Total, C&J’s in-house mechanic staff does much of its own maintenance and repair work. C&J will even buy directly from engine and transmission manufacturers.

“We have had times when Stewart & Stevenson was building a blender and couldn’t get an engine, and because we had a spare engine in our shop and the personnel with the knowledge and skill to get equipment working, we could get the blender into the field on a timely basis,” Comstock says.

Staying close to manufacturers and knowing what the long-lead time items are is another advantage for C&J as it competes with larger companies.

“We had 100 fluid ends, and now we have 300. We know they are hard to get and how fast you need to replace them. They can shut a fleet down. Lead time on blenders is around nine months, and some sand equipment can be six to eight months before delivery,” says Comstock.

Transforming into a successful public company may have given C&J better access “up the food chain,” but it has not moved up deliveries, he says.

Comstock believes that only long-term commitment leads to success.

“We don’t believe that success is measured by daily price movements. We are in a cyclical market and will have volatility over time. Investors need to look at historical performance and what companies have done over tough times, and how they have delivered.”

Cedric Burgher, chief financial officer of QR Energy LP, says a supportive sponsor is an asset for an MLP when raising capital in difficult times.

Taking it to the Street

Before going public in 2010, QR Energy LP’s assets were part of Quantum Resources, a private direct-investment oil and gas private-equity fund that has acquired more than $1.4 billion of conventional assets since 2006. QR is an upstream master limited partnership with mature oil and gas properties predominately in the Permian Basin, Ark-La-Tex and Midcontinent regions.

The company has proved reserves of 67 million barrels of oil equivalent (BOE) and fourth-quarter 2011 production was expected to be 13,200 to 13,400 BOE per day. QR expects its total 2012 budget, which includes drilling, waterflooding, recompletions and wellbore optimization, to fall in the $60- to $80-million range.

The QR strategy begins with the careful selection of assets. According to QR’s chief financial officer, Cedric Burgher, MLP assets need to be mature properties with long reserve lives and low decline rates, essentially low-risk oil and gas production, with a moderate amount of maintenance capital required to maintain production. Not all oil and gas assets fit the MLP structure.

Second, Burgher believes an upstream MLP must have an experienced management team to operate the assets and find complementary acquisitions. Commodity hedging is the other main leg to the strategy. To protect their cash distributions, upstream MLPs hedge a much higher percentage of production for a longer duration than do corporations.

To grow the company, QR has to locate and close accretive acquisitions as well as execute upon its lower-risk development inventory. The company is fortunate in that it has multiple ways to access deal flow. Not only can it compete in the third-party acquisition market, it can drop down assets from its sponsor Quantum Resources, as it did in October of 2011; participate in joint ventures with the latter on larger transactions; and potentially access deals from the portfolio companies of Quantum Energy Partners, a private-equity fund with $4.5 billion of assets under management.

“We believe this gives us a competitive advantage in the marketplace, allowing QR to grow in multiple ways,” comments Burgher. The acquisition that set the table for Quantum Resources to execute on an upstream MLP was its $893-million acquisition of assets in its core areas from Denbury Resources Inc. in May 2010. This deal tripled Quantum Resources’ production and quadrupled its reserves, creating the critical mass to create an upstream MLP.

Quantum Energy Partners had been a part of the listings of Linn Energy (a QEP portfolio company) in 2006 and Legacy Reserves in 2007, giving it valuable experience with the MLP format.

“Consequently, the team knew what to expect in the listing process and we were able to complete it in less than three months,” says Burgher.

“The condition of the equity markets was at the forefront of our minds as we pursued the QR IPO. The equity markets had been choppy since 2008, so when we saw the offering window open in 2010, our leadership team was eager to complete the IPO before the window closed.” says Burgher.

The company filed its initial S-1 on September 30, 2010, and completed the deal 77 days later on December 16, in less than half the time of a typical upstream MLP IPO.

Ultimately, this IPO was the largest upstream deal done in recent history—$345 million, including the 15% green shoe. It was $100 million larger than Linn’s IPO and approximately double the average size of the three upstream IPOs done in 2011. But the size of QR’s offering did not hinder the company’s ability to place the units, which were priced in the middle of the IPO range, at $20.

Burgher notes that most MLP units are held by retail investors, but institutional investors are increasingly entering the MLP space. They are attracted by historical returns and the lower risk profile, in spite of a partnership structure that is generally more complicated and administratively burdensome than a corporation.

Valuations have been a mixed bag for energy-related IPOs since 2010.

Dropping down

In summer 2011, QR prepared to acquire an additional $577 million of assets from its sponsor, Quantum Resources, but found the equity market less amenable to a public offering.

“We had an unexpected obstacle to our planned second drop-down. We intended to do a straight equity offering to partially fund the transaction, but in August 2011, the equity market dried up and our units were trading below the IPO price,” says Burgher.

QR looked to create another option rather than issue equity at an unattractive price. The management team and sponsor came up with the idea that the sponsor, Quantum Resources, would finance the required equity for the transaction with convertible preferred units that could be converted at $21—a much more attractive issuance price.

“Our sponsor knew the drop-down transaction would be highly accretive and create significant value for QR. It was willing to take a unique form of equity to facilitate the deal in a tumultuous market,” says Burgher.

The deal demonstrates the competitive advantage of having a supportive sponsor, he says. The transaction doubled the size of the company on October 1, 2011, and allowed QR to announce a 15% increase in its cash distribution in the fourth quarter. QR now pays a quarterly distribution of $0.475 per unit.

MLPs typically hedge more than half of their production for several years. QR aims to hedge 65% to 85% of its oil and gas exposure for a three-to-five-year period.

Burgher is optimistic about the 2012 acquisition market. He anticipates that independents will continue to sell their conventional assets to fund unconventional programs, providing growth opportunities for QR to pursue. Though he foresees healthy competition for deals in the upstream MLP market, he believes that QR will be able to make acquisitions enabling it to grow its distribution further. QR’s financial position is strong, with $130 million of available credit under its bank revolver and limited exposure to European banks.

“We hope the capital markets will be there to support our pursuit of accretive acquisitions and distribution growth in 2012,” he says. “However, if equity markets are soft, we will still have better opportunities than most of our peers thanks to our relationship with a strong sponsor.”

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