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Energy Investements IssueAlert (EI IA) 3/16/2005
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The energy industry is entering the big leagues when it comes to financing activities. In the past year, two investment funds have raised hundreds of millions of dollars to invest in the energy space through a previously little-used method - Initial Public Offerings, or IPOs.
Many outside the energy industry view it as a sleepy industry. But it does form the cornerstone of our economy and, according to Prospect Energy Corporation, generates annual revenues in excess of $700 billion with total asset value exceeding $1 trillion. The business is also highly fragmented with thousands of companies operating in the business. Government and industry association statistics indicate that in the United States there are currently more than 260,000 natural gas wells, 310,000 oil wells, 61,000 oil and gas fields, 2,000 active well service rigs, 5,000 independent oil and gas producers, 410 natural gas storage fields, 140 major pipelines, 1,400 coal mines, 13,500 propane storage points, 16,400 power generation units, 800 power marketers, 230 investor-owned electric utilities and 150 investor-owned gas utilities.
Prospect Energy Corporation (NASDAQ: PSEC) and NGP Capital Resources Company (NASDAQ: NGPC) see the industry as very attractive for investment. In particular they point to middle market energy companies where in just the U.S. oil and gas business there are more than 5,000 companies, of which less than 200 are publicly listed.
According to John Barry, CEO of Prospect Energy, “We believe that our focus on middle-market companies should provide a competitive advantage. We believe that transactions for companies and assets with values in excess of $100 million are more likely to involve professionally managed auctions, resulting in higher asset prices than would typically be obtained in negotiated transactions. As a result, large transaction sizes often achieve higher valuations and lead to lower relative returns on investment. By focusing on smaller, middle market transactions, we expect to benefit from forces that favor middle market investing, including more negotiated transactions as a percentage of all transactions, less competition, better pricing, better terms and better risk adjusted returns.”
As regulated investment companies, or RICs, Prospect Energy and NGP avoid paying corporate-level federal income taxes on their income. According to NGP's prospectus, they can therefore price investments on terms comparable to corporate tax-paying competitors, but still achieve greater net investment returns after tax net than their tax- paying competitors. Finally, investors are not subject to double taxation on dividends as with most investments and are not required to recognize unrelated business taxable income like investors in public master limited partnerships (MLPs).
Unlike private equity and venture capital funds, Prospect and NGP are not subject to the standard restrictions on such funds, which typically stipulate that any capital gains on investments can only be invested once and must be returned to investors after a pre-determined time period. Such provisions can force private equity and venture capital funds to seek returns on their investments more quickly than they otherwise might, absent such restrictions. The companies therefore have the flexibility to make investments with a long-term view and therefore hope they will have enhanced opportunities to generate attractive returns on invested capital.
Prospect Energy was organized on April 13, 2004. On July 27, 2004, the company completed its initial public offering by selling 7,000 shares of common stock at $15 a share, generating nearly $105 million in gross proceeds from the offering. The company is currently trading at about $12.95 per share. In the future, Prospect plans to fund a portion of its investments through borrowings from banks, issuances of senior securities and secondary offerings.
Prospect Energy concentrates on making investments in energy companies having annual revenues of less than $250 million and in transaction sizes of less than $100 million. In most cases, these companies are privately held or have thinly traded public equity securities. Prospect is interested in providing mezzanine capital for companies looking at development, growth, acquisitions, or recapitalization of either the company or assets. Such financing is typically less dilutive and can therefore be less expensive capital than equity. In addition, mezzanine capital is often offered without the lending party, in this case Prospect, taking a control position within the company, which is attractive to independently minded management teams.
Thus far, Prospect has made three investments in energy companies, with the remainder of its funds mostly invested in U.S. T-bills and cash. Prospect's first investment was the acquisition of Gas Solutions Holdings Inc., a natural gas gathering and processing company, amounting to approximately $30 million in subordinated debt and equity including an $18.4 million promissory note issued to Prospect at an interest rate of 18 percent per annum.
Recently, Prospect also announced investments in Natural Gas Systems, Inc. (NGSY:OB), an oil and gas producer with operations in Louisiana, and Unity Virginia Holdings LLC, a privately held coal mining and processing business in Wise County, Va. The Natural Gas Systems investment took the form of up to $4.8 million in senior secured notes plus warrants, while Unity Virginia Holdings LLC took the form of $3.9 million of subordinated debt and redeemable preferred equity.
While Prospect clearly has its eye on fuel-related investments, John Barry is quick to emphasize that the company lens is much broader than just that portion of the market. “We are generally looking for companies that have solid cash flows with growth-related financing needs or project-related financing with little technology risk and a clear expectation of positive cash flows."
NGP Capital Resources Company is a new financial services company organized by Natural Gas Partners to invest primarily in debt securities of small and mid-size energy companies. NGP's investment objective is to generate both current income and capital appreciation primarily through debt investments with certain equity components. Natural Gas Partners, founded in 1988, is a leading provider of private equity capital and sponsorship to the energy industry.
In late 2004, NGP Capital Resources Company issued 17,400,000 shares in total at $15 per share, for gross proceeds of $261 million and is currently trading at around $16.35 per share. According to the company's prospectus, it generally plans to invest in companies that have net asset values or annual revenues of less than $500 million. Its investment objective is to generate both current income and capital appreciation primarily through debt investments with certain equity components. The company is no stranger to energy-related investing. According to the company there have been seven NGP private funds with aggregate committed capital of approximately $1.6 billion, of which more than $1 billion has been invested in over 70 energy companies.
NGP's primary focus is on domestic oil and gas exploration, development and production businesses and businesses that gather, process and transport oil and gas. NGP also anticipates evaluating investment opportunities outside of the oil and gas business, such as coal and electricity investment opportunities. NGP expects its investments will generally range in size from $10 million to $50 million. The company has been quick to act, announcing on Dec. 20, 2004, that it has completed two portfolio investments in debt securities of private oil and gas production companies totaling approximately $67 million.
Financing activity is once again heating up in the energy business. The fuel business is particularly attractive at present with high commodity prices in that sector. Exploration and production companies are grabbing for capital to expand or reopen their operations. A number of investment vehicles are developing to support this increased activity, including the IPO where such investment funds can raise large amounts of capital to be invested in a portfolio of thinly traded or privately held energy companies.
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