Apollo Trumps KKR in Shale Buyouts After Wildcatting EndsDavid Carey
For KKR & Co. and Apollo Global Management LLC, leaders of the biggest shale-field buyouts, the difference between failure and success may come down to 93 days.
KKR, led by Henry Kravis, in November 2011 agreed to buy Samson Resources Corp. for $7.2 billion, or 6.6 times the company’s cash flow. Three months later, with gas plunging, Leon Black’s Apollo struck a deal to buy EP Energy Corp. for $7.15 billion, though at a lower valuation relative to cash flow. EP, able to use excess capital to expand into shale oil as gas prices slumped, has turned a profit for investors. A similar effort at Samson stalled under too much debt.
The deals highlight the challenges for private-equity managers as they seek to invest a record amount in the decade-old shale revolution. Firms that made billions in the early stage of the boom by buying exploration rights for gas fields and then flipping them are increasingly forced to move into the more costly business of extracting oil, natural gas and gas liquids like propane and butane, after increased supply depressed prices for dry gas. For investors, who committed $44 billion to energy funds in the past three years, that portends lower returns and increased chances of failure.
“The land grab phase of the gold rush, where you could flip acreage early on, has largely passed,” said David Foley, who oversees energy investments at Blackstone Group LP, the world’s largest manager of alternative assets such as private-equity and real estate. “There will be more development drilling that will require more capital, and it will take longer.”
That change, Foley said in a phone interview, could end a 10-year run in which energy-dedicated buyout funds have beaten average private-equity returns by 2.4 percentage points and topped the Standard & Poor’s 500 Index by 9 percentage points annually through September, according to Cambridge Associates LLC, a Boston-based researcher and consultant.
The returns helped energy-targeted funds attract $44 billion since 2011, including a record $22 billion in 2013, according to the London-based research firm Preqin Ltd. KKR, also run by billionaire George Roberts, this month said it finished raising $2 billion for a fund to invest in oil and gas assets in the U.S.
Private-equity firms have been making money in shale gas and oil since the early 2000s. As supply increased, natural gas prices started to decline, culminating in the 2012 crash that saw gas prices drop as low as $1.90 per million British thermal units from a peak of $4.98 the previous year and more than $15 in 2005.
The slump put a halt to private-equity firms’ ability to buy undeveloped gas fields, bore a few wells, then flip the land to the big energy companies. Today the action has moved to shale with proven deposits of oil and natural-gas liquids, where profits are higher, and to extraction, rather than exploration.
“The public markets now attach the highest valuations to companies that have demonstrable drilling success and a large inventory of undrilled locations in the oil- or liquids-rich plays,” said David Miller, a co-founder of EnCap Investments LP, an energy private-equity firm with offices in Houston and Dallas.
Apollo’s EP Energy made the move to crude from gas. When the buyout closed in May 2012, a month after gas hit its low, natural gas accounted for about 70 percent of reserves and production, according to two people familiar with the deal, who asked not to be identified because the information is private.
Apollo and co-sponsors including New York-based energy investor Riverstone Holdings LLC and billionaire Len Blavatnik paid $7.57 billion for the company when including transaction fees. By that measure, which more accurately reflects the cost to finance the deal, EP was valued at 5.8 times the company’s adjusted earnings before interest, taxes, depreciation and amortization, or Ebitda, a common yardstick of deal value.
EP quickly sold natural gas drilling rights and poured almost $4 billion into developing crude-rich areas in Texas. Today, oil makes up two-thirds of EP’s assets and production, according to the people. EP’s steady cash flows enabled it to pay Apollo and its co-investors $542 million in dividends in 2012 and 2013 before going public this year.
Even though EP fell in its Jan. 17 stock-market debut after a smaller-than-planned offering, the share price implied an enterprise value, which combines debt and the company’s market value, of about 10 times Ebitda. That compared with a multiple of 6.6 for energy producers with similar profiles, according to Andrew Cosgrove, an analyst at Bloomberg Industries.
The stock closed at $19.47 yesterday, giving Apollo and its co-investors an unrealized profit of 39 percent on the investment. Charlie Zehren, a spokesman for Apollo at Rubenstein Associates, declined to comment on the investments.
“You might think a lot of private-equity-backed companies would be stuck with too much gas exposure,” said Marc Cardillo, managing director at Cambridge Associates. “But many have been able to pivot by deploying their excess cash flow into oil or liquids.”
KKR’s Samson wasn’t so nimble. The company, based in Tulsa, had proven dry-gas serves, including in 115,000 acres in the Haynesville shale in east Texas. KKR teamed up with private-equity firms Crestview Partners and NGP Energy Capital Management LLC in a deal funded with $4.1 billion of equity and $3.8 billion of debt, including deal fees and reimbursed capital costs. The total funding cost of the deal, agreed when gas was still trading at $3.46, was equal to 7.2 times Samson’s adjusted Ebitda of $1.09 billion in 2011. That’s 24 percent higher than EP’s comparable measure.
The buyers’ plan, to invest surplus cash into oil- and liquids-laden reserves, was thwarted when falling gas prices eroded revenue. Gas stayed below $3 for most of 2012, driving down Samson’s adjusted cash flow by 36 percent in the first nine months of that year -- not enough to cover interest and capital costs, according to a filing. Cash flow increased 3 percent in the same period last year.
“Samson has been outspending its cash flow,” Gary Stromberg, a credit analyst at Barclays Plc, said in a telephone interview. “The Haynesville was a core field for Samson, and it is marginally economic at current gas prices.”
KKR valued its investment in Samson at 20 percent below cost as of Sept. 30, the latest available date. In April, KKR hired industry veteran Randy Limbacher, 55, as Samson’s chief executive officer, replacing David Adams, who left at the end of 2012.
“Our path has been progressing down the track of more liquids and oil,” Marc Lipschultz, KKR’s head of energy investing, said in a telephone interview. “We have a lot of work to do, and we have a great management team in place.”
John McCready, a spokesman at Samson, declined to comment.
Samson is the second big bet for KKR to be undermined by slumping gas prices. In 2007 KKR led the record-sized $48 billion buyout of Energy Future Holdings Corp., a Dallas-based utility whose revenues are linked to gas. The commodity’s decline has pushed Energy Future to the edge of bankruptcy, jeopardizing the $3 billion that KKR and its affiliates put into the deal.
KKR’s record in shale includes big wins. In 2010 it sold gas driller East Resources Inc. for a $1.2 billion, or 360 percent, gain after owning it for less than a year, according to a person familiar with the firm. An investment in oil explorer Hilcorp Energy Co. brought a 170 percent profit, said the person, who asked not to be named because the returns are private.
In the years since, KKR and other shale investors have been victimized by their own success, as the increase in production they helped finance depressed gas prices and undermined some of their larger bets.
“In general, dry gas plays have very marginal economics and the industry is no longer pursuing them,” said NGP chief executive officer Kenneth Hersh, whose firm co-invested in Samson. Carlyle Group LP, the Washington-based private-equity firm, is a part owner of NGP.
There are exceptions, including an NGP-owned company. In 2012 and 2013, after gas prices cratered, Rice Energy Inc., backed by Hersh’s firm, bought drilling rights in the Marcellus shale formation in Pennsylvania. The Marcellus is among the few U.S. dry-gas basins left where explorers can turn a profit at current prices.
NGP’s $300 million bet has paid off, with revenues more than doubling last year. Rice Energ went public on Jan. 23, giving NGP a more than 200 percent partly realized gain. Hersh declined to comment on Rice Energy.
Blackstone similarly staked positions in Marcellus gas after the price collapse. According to Foley, the low prices Blackstone paid and the Marcellus’s high-yielding rock give Blackstone a break-even price level of about $3. Propelled by a cold wave, gas prices climbed above $6 last month before falling to $4.38 yesterday.
The best pickings, investors said, may come from assets that major oil companies and large independents are pressured to sell. Over the last three years, companies that spent lavishly on gas and oil drilling rights in the late 2000s have begun to cull their stockpiles to concentrate on higher-return shale oil and liquids stakes.
New Zealand Money
KKR has widened its energy program to accommodate the evolving market. In 2012 it raised a $1.25 billion fund to buy mature, fully drilled acreage that large companies no longer want to own. KKR’s new $2 billion vehicle, which began to deploy money last year, helps energy producers buy acreage from others or bankroll new wells they lack the money to drill. The New Zealand superannuation fund committed as much as $250 million with KKR for energy deals, with $75 million of that given to the latest fund, according to a statement yesterday,
The latter fund’s deals include a drilling partnership in the Eagle Ford with Comstock Resources Inc. In July, it teamed with Exco Resources Inc. to buy Eagle Ford acreage from Chesapeake for $685 million. Neither fund targets private-equity-level returns, said Lipschultz, who is 45, adding that it would be difficult to replicate the gains KKR reaped several years ago in East Resources and Hilcorp.
For higher returns, KKR now looks to Canada, whose shale basins are less worked over than those to the south. In 2012 KKR earmarked up to $250 million for Westbrick Energy Ltd., a Calgary-based oil and gas driller in Alberta’s Deep Basin. In January, KKR said it would open its first Canadian office in Calgary, which will focus on energy deals.
“It’s possible to get in early in Canada, which looks like the U.S. did two years ago,” Lipschultz said.