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QUANTUM ENERGY PARTNERS SM www. quantumep. com IPAA PRIVATE CAPITAL CONFERENCE The Impact of the “Credit Crunch” on Private Equity Benjamin A. Stamets January 14, 2009
Firm Overview ► Quantum Energy Capital, LLC (“Quantum”) manages a family of energy-focused investment funds with a primary emphasis in the oil & gas, midstream, and oil field service & equipment sectors. ► Founded in 1998, Quantum currently has over $5. 0 billion in assets under management (“AUM”) across two investment platforms. Ø Quantum Energy Partners (“QEP”) § Private equity fund with $4. 0 billion in AUM. § Targets $50 -$300 million equity or equity-linked investments. Ø Quantum Resources (“QR”) § Producing property acquisition fund with $1. 2 billion in AUM. § Targets >$200 million long-lived oil & gas property acquisitions. ► Quantum’s investment team is uniquely qualified to support and be a value added partner to our portfolio companies. Ø In-house financial, technical, commercial, operational, legal and tax expertise. Ø Extensive experience as CEOs and division heads of private and public energy companies. QUANTUM ENERGY PARTNERS 2
Where We Were – Pre-August 2008, and… ► Ample liquidity in both the debt and public equity markets fueled investment and M&A activity. Ø Credit terms eased as global liquidity was at an all-time high. Ø Commodity prices supported increased borrowing bases. Ø Many new entrants arrived to provide capital to the space. ► Robust, liquid hedging markets. ► Super-charged corporate cash flows and increased CAPEX budgets. ► “Land grab” mentality emerged, as nearly every play appeared economic. ► “Buy and Flip” with hold periods of only 2 -3 years was common. QUANTUM ENERGY PARTNERS Source: Bloomberg. As of 1/13/2009. 3
…Where We Are Today ► Commodity prices experienced their most rapid declines in history (in $). ► Liquidity reversed course as the global credit markets entered crisis mode. Ø Lending ground to a halt as banks worried about their own balance sheets. Ø IPO market is effectively closed. Ø The cost-of-capital dramatically. has increased ► Hedging markets impaired heightened counterparty risk. by ► Cash preservation mode = reduced CAPEX budgets. ► Most resource plays are marginally economic at best. ► Bid-ask spreads too wide to transact. QUANTUM ENERGY PARTNERS Source: Bloomberg. As of 1/13/2009. 4
A Backdrop: The Global LBO Market Declined Materially in 2008 ► Global LBO volume hit an all-time high in 2006 with over $670 billion in transactions. Ø These transactions represented 19% of all M&A activity. ► Through 3 Q 2008, total LBO volume had shrunk to less than $99 billion, representing only 4% of all M&A activity. Ø This precipitous fall represents an 80% decline from YTD 3 Q 2007. ► Worse yet, 2008 saw 49 LBObacked companies file for bankruptcy vs. only 2 in 2007. Ø Of these, only two were energy focused: Sem. Group and CDX Gas. Source: Goldman, Sachs & Co. QUANTUM ENERGY PARTNERS 5
Industry Wide, PE Fund Raising Hit a Wall in 4 Q 2008… ► After four years of record growth, 2008 fund raising by private equity funds was down 18% below its 2007 level. Ø 363 funds raised $266 billion in 2008 versus $326 billion in 2007. Ø Leveraged buyout funds faired worse than other sectors, as only $181 billion was raised in 2008 versus $245 billion in 2007 – a 26% decrease. ► In the fourth quarter of 2008 alone, capital raising was down 57% versus a year earlier. Ø In 4 Q 2008 slightly more than $43 billion was raised versus $100 billion during 4 Q 2007. ► Many industry observers anticipate this fourth quarter trend will continue, exacerbated by losses in existing funds and liquidity and allocation concerns among institutional investors. QUANTUM ENERGY PARTNERS 6
…And Private Equity LPs Faced Their Own Challenges ► Limited partners (“LPs”), the institutional investors behind private equity funds, were not immune to the economic crisis that impacted almost every corner of the financial industry. ► As the value of their public equity and fixed income investments decreased dramatically, LPs found themselves over-allocated to private equity on a portfolio basis. Ø California State Teachers (Cal. STRS), one of the largest pension funds, saw its allocation to private equity jump from 9% in early 2008 to ~14% by year end. ► A robust secondary market for private equity commitments emerged. Ø Most public of these, Harvard University marketed its $1. 5 billion PE portfolio. ► For certain LPs, liquidity for capital calls became a problem as free cash and attractive sale opportunities dried up. QUANTUM ENERGY PARTNERS 7
The Good News: Energy PE “Re-Loaded” in 2008 ► Many of the major energy focused private equity players raised new pools of capital prior to the downturn and multiple new entrants emerged. Source: Oil and Gas Investor estimates, Quantum estimates. QUANTUM ENERGY PARTNERS 8
Very Much Open for Business, But the Landscape Has Changed ► Private equity investors will be forced to “over-equitize” their investments. Ø Higher hurdle rates for investment (≥PV 15 vs. ≤PV 10? ). Ø Less credit and more scrutiny given to non-PDP reserve classes. ► For debt that is available, senior secured lenders are tightening their underwriting criteria, characterized by: Ø More expensive, with LIBOR spreads widening by at least 100 bps. Ø Shorter tenures with required amortization. Ø More restrictive maintenance covenant packages. ► Project financings without near term cash flows and any construction or counterparty credit risk will be very challenging. ► Deal sizes will likely be smaller. Ø Companies operating within the bounds of their equity commitments. Ø Bank financings beyond the size of a “clubbed” deal will be difficult. QUANTUM ENERGY PARTNERS 9
Expectations for the A&D Market in 2009 ► A&D market was effectively closed in the 4 Q 2008 and today a backlog of delayed sales exists. ► However, at current prices and valuations, no one wants to sell control unless they have to. ► Divestiture market may remain slow until the second quarter: Ø Borrowing base redeterminations will force certain companies to pare assets in order to reduce bank borrowings. Ø Companies will high-grade their portfolio of projects in a cash flow and capital constrained environment. Ø Distress could lead to consolidation, generating additional asset sales down the road. ► Greater potential for farm-outs and joint venture opportunities as capital constrained companies face lease expirations. ► Much depends on the lending market as more credit is required to provide liquidity to the A&D market. QUANTUM ENERGY PARTNERS 10
How Quantum is Approaching the Current Market ► We are believers in the long-term fundamentals of the energy industry. ► Continue to seek out complete, proven management teams with sustainable competitive advantages. Ø Challenging markets put a premium on talent. ► Remain creative and nimble with regard to investment structure. Ø Equity line of credit with start-ups still possible. Ø Growth equity in existing, operating businesses will be more common than in 2008. ► Expect longer hold periods of 5 -7 years. ► Acquisition strategies are generally more attractive than resource plays or pure exploration. ► Must be prepared to fund development projects with 100% equity. ► Great example: Primary Natural Resources III Ø Quantum backing Rich Talley, Mark Sheehan and Jack Fritts with $100 million commitment. Ø Acquisition and exploitation strategy. Ø Primarily focused in mature basins of Midcontinent, Panhandle and Permian. QUANTUM ENERGY PARTNERS 11
In Summary ► Energy-focused private equity funds have ample available cash. Ø Quantum is open for business (as are many of our competitors). ► Credit, when available, will be more expensive. ► Over-equitization of transactions will increase hurdle rates. ► Bid-ask spreads remain too wide to transact. ► Creativity in deal structuring will be important. ► Forced selling in distressed situations likely by mid-2009. Ø But robustness of A&D market will depend on the credit and hedging markets. ► On the one hand…private equity likely to be patient, waiting for the “fat pitch. ” ► But on the other… 2009 could prove to be the best buyers’ market in a decade. QUANTUM ENERGY PARTNERS 12
Quantum Contact Information ► For more information on Quantum, or to submit information on your company, please call or send your information to the following: Alan Smith Managing Director – Oil & Gas (713) 335 -0050 als@quantumep. com David Bole Managing Director – Business Development (713) 328 -0022 dlb@quantumep. com Ben Stamets Principal (713) 335 -0085 bas@quantumep. com Quantum Energy Partners 777 Walker Street, Suite 2530 Houston, TX 77002 Phone: (713) 225 -4800 Fax: (713) 225 -5700 www. quantumep. com QUANTUM ENERGY PARTNERS 13