DALLAS – Master limited partnerships, with a low cost of capital and an eagerness to accumulate mature cash-flowing assets, have influenced the upstream deal scene for the past several years. The trend is expected to continue as unconventional plays mature, making these assets ripe targets for an MLP buyer.
“When the drilling stops four or five years out, that’s when a play could be applicable to an MLP,” said Alan Smith, chief executive officer of Quantum Resources and QR Energy LP (NYSE: QRE). He spoke at Hart Energy’s 12th annual A&D Strategies and Opportunities Conference in Dallas recently.
“But at the end of the day, beauty is in the eye of the beholder,” he added. “We may significantly discount something with only one or two wells drilled, and they want us to drill a lot more … so someone with a higher cost of capital could still win in a bidding process if they are willing to pay for it and do the drilling more than we are.”
QRE went public in 2010 and has acquired $1.3 billion of assets.
There has to have been enough drilling to develop solid type curves “that we feel comfortable taking it on,” said Scott Smith, president and CEO of Vanguard Natural Resources LLC (NYSE: VNR). VNR went public in 2007 and has acquired $2.8 billion in assets. “All of us are very disciplined in our acquisition strategies, and we’re not going to stretch too far out on a limb.”
Indeed, short-lived natural gas reserves and properties with a low internal rate of return, or a low amount of proved producing wells, are not attracting good valuations and are not selling. But longer-life assets are perfect for an MLP.
“We need low-decline properties with low-maintenance capital requirements. It’s important to keep some dry powder,” said Quantum’s Smith. He said Quantum has about $300 million on hand and is always looking at deal flow.
“We want to do something that moves the dial. Since we are worth $2 billion, so we don’t look at small, $10-million deals unless it’s a bolt-on that we can close quickly,” he said.
Vanguard has about $900 million in liquidity, and last year it spent roughly $800 million.
“We’re far from done,” said Scott Smith. Vanguard’s sweet spot for acquisitions is between $200- and $500 million, although smaller bolt-on deals to existing acreage are also favored.
“For us, it’s all about the accretion. Does it fit our profile and is it ‘hedgeable’? We probably look at 150 to 200 deals a year and bid on maybe 20 of them. A lot of them quickly go into the garbage,” Vanguard’s Smith said.
“In that initial screening, you can tell in five minutes if you want to pursue it,” said Quantum’s Smith. “We evaluate in great detail 15 to 20 deals a year. On the private side [Quantum Resources], we are looking for a 20%-plus rate of return so we’re looking at the asset being 40% to 70% developed, but where we can drill and enhance that asset base.”
The landscape is competitive. Both public MLPs and what Vanguard’s Smith calls “the Private MLPs” are vying for assets. The latter include companies such as Merit Energy in Dallas or Sheridan Production Partners in Houston. These “private MLPs” aggregate private equity to make big acquisitions. Private-equity-backed C Corps are also always in the hunt as they seek to deploy capital and grow.
“Some of the private companies are looking to monetize before year-end, so we’re excited by that,” said Vanguard’s Smith. “We’re happy to be a non-op partner as well. For companies with a lot of proved undeveloped (PUD) assets they want to keep and drill up, we can buy a percentage today, drill it with them, and then buy the rest maybe two years from now.”