Houston-based 3Tec Energy Corp. is a great example of the rejuvenation and renewal so common to the volatile independent oil and gas industry. The 3Tec strategy follows a familiar recipe for growth. First, bring together experienced professionals (many of whom worked together in the past or were linked by funding ventures). Then, combine four small companies (some of which may need a rescue), and infuse the whole with savvy capital. Attract some heavy hitters with connections as investors, board members, management and geoscientists. Next, make a few timely acquisitions and show drilling success. Voila-another growth vehicle is born. Today, Nasdaq-traded 3Tec has net proved reserves of about 246 billion cubic feet equivalent, 72% natural gas and 75% proved developed. Net daily production is about 42 million cubic feet of gas and 3,300 barrels of oil per day. And the company it merged with, formerly known as Middle Bay Oil Co., Inc., is not recognizable. When we met him, chairman, president and chief executive officer Floyd C. Wilson was in his new Houston headquarters nursing bothersome bicycling injuries while in the process of melding the assets of four companies into one. At press time, in a personnel coup for the fledgling company, Al Walker, who for many years headed Prudential Capital's Dallas office and funded numerous E&P companies, agreed to join 3Tec as president and CFO." We would not have brought Al on board-that's significant for a company our size-unless we had plans to grow significantly," Wilson says. "Every one of our board members is active, creative, and in the business with great access to people and transactions. I call on them like crazy." Wilson says he's surprised how fast the company is growing, but he has done this before. He was the founder and CEO of Hugoton Energy Corp., a publicly traded Wichita, Kansas, independent. He grew the company, funded initially by Prudential Capital, to about 246 billion cubic feet equivalent of reserves, mostly in Kansas' giant Hugoton gas field, before selling it to Oklahoma City's Chesapeake Energy Corp. in early 1998 for about $326 million in stock and assumed debt. "At Hugoton it took us 10 years from startup to sale; here at 3Tec it's taken us eight or nine months to reach nearly the same size," Wilson says. "Now it's up to us to get our story out-we own a mature, predictable production stream with many development opportunities. We want to look at fields that have not yet seen modern exploitation methods such as 3-D or horizontal drilling. We will layer on top of that an impactual exploration program." When Wilson sold Hugoton, he moved to Dallas, retained three or four key employees and spent some time deciding where to go next. "I chose East Texas and the Gulf Coast area. There is still lots of work to do in those mature areas and we will do it using new technologies and aggressive development drilling." Wilson approached acquaintances at EnCap Investments LLC and they formed a partnership to buy properties, calling it W/E Energy Co. LLC. Initial capitalization was about $22 million in cash and producing properties. During the difficult months of early 1999, Wilson, believing that producing properties were too pricey, decided to find a battered E&P company, public or not, that he could "rescue" and grow. That's when he came across Middle Bay Oil Co., a Nasdaq-traded company in Houston. Its largest shareholder was George B. Kaiser, the Oklahoman who owns Kaiser-Francis Oil Co. and controls Bank of Oklahoma. Middle Bay was growing fitfully because of the drastic downturn in oil and gas prices in 1998 and 1999, which caused it to lose money in each of those years. In 1998 it had acquired all the assets of Enex Resources Corp. and its various limited partnership interests. It was drilling wells, but without a great deal of success. By the summer of 1999, it had about 11 million barrels of oil equivalent in proved reserves, 65% gas, and a dwindling bank account that made it difficult to continue acquisitions and exploration. "We were right up against our borrowing base so we needed additional capital to do anything more," says executive vice president of corporate development Steve Herod. "We looked at several opportunities and thought Floyd Wilson and EnCap were by far the best fit. There were a lot of challenges. We were a small company in an out-of-favor industry, with a small public float. Yet we saw big opportunities." So did Wilson. "The shareholders of Middle Bay were enthusiastic about a new capital infusion and new business plan," he says. Adds Herod, who remains head of business development, "There is nothing worse than being in a position of sitting still or barely hanging on like so many of our peers were doing at that time. Now the past doesn't matter-we've gotten a fresh start. Floyd is not letting any grass grow under his feet." In August 1999, W/E Energy LLC paid $10.7 million in common equity and five-year warrants, and another $10.7 million in senior subordinated convertible debt for a 36% stake in Middle Bay. Concurrent with the closing, Wilson became chairman, CEO and president. Then in December, W/E Energy LLC reincorporated Middle Bay in Delaware and changed the name to 3Tec Energy Corp. (Nasdaq SmallCap Market: TTEN). The company has applied to be listed on the Nasdaq National Market system. To help that along, the shareholders approved a painful 1-for-3 reverse stock split in January. Key investors include former U.S. Treasury Secretary William E. Simon's investment vehicle, Weskids LP, and Alvin Shoemaker, former chairman of First Boston Corp. Simon and Shoemaker have long invested in E&P companies. Today, the EnCap/Wilson LLC owns 24.7% of the outstanding shares, the public owns 27.3%, Kaiser-Francis Oil Co. 17.3% and Magellan Exploration's owners (which include EnCap) own 16.9%, Simon and Shoemaker own 8.3%, and Prudential Insurance Co. owns 5.5%. Wilson has the opportunity to earn an increasing percentage of the company's common equity as certain return targets are met. In November 1999 the new company negotiated a $250-million revolving credit facility led by Bank One. Other participants were Union Bank of California, Wells Fargo Bank, CIBC Inc. and Bank of Nova Scotia. That same month it acquired, for $86.8 million in cash and 500,000 shares, the assets managed by Floyd Oil Co., a private acquire-and-exploit firm based in Houston, and backed by a number of college endowments and other institutions. Founder Alex Floyd, based in Raleigh, North Carolina, retained Floyd Oil and a large group of producing royalties. Included in the deal were 165.5 billion cubic feet equivalent of net proved gas reserves. These properties resulted in a pro forma additional EBITDAX (earnings before income tax, depreciation and exploration expense) of $20.6 million for 1999. Wilson relocated to Houston in January 2000. The following month, he did another deal, acquiring Magellan Exploration LLC from certain EnCap affiliates for common stock, warrants, convertible preferred stock and a 5% back-in interest in 12 exploratory prospects. The deal included 26.6 Bcfe of net proved reserves, 66% gas. Now the company's property base looks like this: Forty-three percent of the value is in the Gulf Coast region, onshore and in state waters; 22% is in the Permian and San Juan basins; 20% is in East Texas and 15% is in the Midcontinent area. The acquired Magellan properties are the spicy part of the growth recipe. Breton Sound Block 34 and the Bay de Chene field in Louisiana state waters and the Garden City field onshore Louisiana show additional exploration upside based on 3-D data the company has shot. Several of the technical staff of Magellan joined 3Tec so there is continuity. "We have assembled an attractive property base and with the acquisition of Magellan, have added significant exposure to drillbit growth," Wilson says. "My desire was to have higher production from fewer wells than we had in the Hugoton Field. Our assets in East Texas and the Gulf Coast are deeper, and they have higher daily production than the wells in the Hugoton Field but retain significant development potential." What lies ahead? 2000 is a building year; the full benefits of the merged companies will come into focus next year. Current production is nearly 60 million cubic feet equivalent per day but the exit rate by December could be up to 85 million. The 2000 capital budget is about $25 million, with 90% for development work. Drilling on the Magellan properties starts in mid-2000. "Magellan was a typical deal for us in that we are the third or fourth owner and 3-D had not yet been utilized to direct drilling operations on the properties. There is a significant amount of proved undeveloped reserves and 10 or 15 very attractive exploration projects spread over those three fields. Our R/P [reserves-to-production] ratio is 12 years-the Gulf Coast cash flow will complement that." The company had six rigs drilling at press time. "What's important to me is that with each transaction, we have kept a core group of people. We chose the skill sets we need. You can build a company through acquisitions and drilling but investors need a return on their investment," Wilson says. "We tend to embrace rather than resist the transactional nature of this business. We're open to any kind of transaction. You have to abide by your partners' need for a rate of return and an exit strategy." The plan is to grow by acquisition and/or merger and build a sizable E&P company, with EnCap as a sophisticated backer. "Access to EnCap's deal flow is a plus as is their acumen in structuring transactions." EnCap has not abandoned project financing, its traditional funding role, yet it is stepping up to the corporate equity plate. "What was exceptional about this deal is that 3Tec is the first startup EnCap has financed," says EnCap managing director David Miller in the firm's Dallas office. "Floyd built a $350-million company before selling it, so we felt he had the skills to grow a half-a-billion-dollar company. We initially invested $22 million and attracted another $5 million of private equity from Prudential Insurance Co. of America. With the growth 3Tec has shown already, and Floyd's track record, the company is well-positioned to access public equity." That's precisely the plan. Now that the company has "deal guys" capable of making acquisitions and who have capital markets experience, the time is ripe for 3Tec to show investors what it can do. The debt-to-book value is about 65%. "I think you need to be a $250-million market cap company with a good chance of going to $500 million," Herod says. "That gets you more attention from the institutions, so one of the first things we want to do is get the market cap and public float up. We've got a great platform for growth: we are mostly gas, mostly PDP [proved developed producing reserves] and we operate most of our value. We have a solid development program in East Texas, with good exploration upside on the Gulf Coast properties." Wilson says his challenge now is to grow the company's liquidity and get more shares into public hands, and to do so in choppy capital markets. And although he says property prices are still high, he wants to do another acquisition this year. "We want to grow without trashing the balance sheet. We're still getting our hands around the transactions we've made, and we're shooting and reprocessing seismic. In June we'll spud the Alpha well on Breton Sound, with several additional wells scheduled on the Magellan acreage before year-end." Wilson says he expects about $35 million of operating cash flow this year from $70 million of revenues, assuming $23 oil and $2.60 gas prices. He has hedged half the oil production-and little of the gas, being so bullish on that commodity. "I built Hugoton bit by bit with bank financing and sweat equity. This time, I arranged for the equity first with EnCap. Partners with cash are the best." Say amen.
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