It is not uncommon for E&P executives to raise capital from private sources more than once, to start new companies. They grow the start-up to a good size, cash out after a while, usually by merger, and start another E&P firm with a fresh round of capital-often from the same sources. Randy Hill has done this three times in the past decade. In 2000, he sold his second start-up, 1Vista Energy Resources ÷Ò , to 1Prize Energy ëõ , which itself has since been merged into 1Magnum Hunter Resources î . "After we sold to Prize, we took a week off, and then started over again," Hill told fellow start-up E&P executives at the annual 1Cosco Capital Management Õñ and Oil and Gas Investor private capital conference in Houston recently. In March 2000, he obtained fresh funding from 1Natural Gas Partners P to create 1Cortez Oil & Gas Inc. 2Ë , Dallas, with $23.8 million, including some contribution from the management team. It will emphasize, through an acquire-and-exploit strategy, the Permian Basin and Midcontinent. "Through Vista, we made Natural Gas Partners a very healthy internal rate of return of 34%, which is why we are back with them. They like to back horses that can get them home," Hill said. Cameron Smith, Cosco senior managing director, New York, said, "Once you perform with your assets... the capital provider will be happy to return money to you." Hill said, with a laugh, "If you aren't rich, you go to the 'angels'-friends and family who have more money than sense. If that doesn't work, this is the way to go, with traditional [private] capital aggregators." Natural Gas Partners has continued to hold its original investment in Vista, rolling it into Prize and now into Magnum Hunter, of which it owns 19% of outstanding equity. Billy Quinn, an NGP managing director, Dallas, says a third to two-thirds of the firm's investments are done with "recycled management" that it has worked with before. "Most of our companies sell for cash." The firm has placed $5- to $60 million for acquisition and exploitation in 66 deals. Its recent investments include 1Craton Energy Corp. œ´ , Houston, $15 million; 1Anderson Energy Ltd. ¯Å , Calgary, C$10 million (formed by J.C. Anderson, whose Anderson Exploration was sold last year to Devon Energy); 1White Oak Holdings Corp. ¯ì , Houston, $10 million; and 1Grid Resources Ltd. ß≥ , Calgary, C$1 million. When the public is wary to invest in energy companies, private equity executives know the time is right for them to put money into the sector. The pump is primed to produce big returns when the fortunes of the industry change. And the pump is now primed, conference speakers agreed. For exploration and production companies, now is an especially good time to fund drilling programs because drilling costs are low and commodity prices are strong. "If you have $3.25 gas and $25 oil, and you think it's not a good time to drill, you probably don't have a prospect," said Danny Weingeist, Houston-based managing director, 1 Kayne Anderson Investment Management s . And if at those prices, your firm is not generating net income "you ought to evaluate your program," he added. Kayne Anderson has signed 31 energy deals since 1992 with 16 companies. It is currently raising a second fund of approximately $250 million. "Drilling costs are about as low as they're going to be this cycle," added Jim Spann, chief investment officer, 1Energy Spectrum Partners LP Œ~ , Dallas. "Take advantage of this." Of $360 million of funds, the firm has placed $244 million since 1996 in 14 deals, including 1Bayard Drilling Technologies Inc. È , 1Pinnacle Natural Gas Co. ' , 1Spectrum Rotary Compression Inc. ,Ÿ and 1Tobin International `ƒ . Of its $112 million remaining to place, Spectrum seeks six to eight investments of $5- to $10 million each, to start. The firm just closed a deal to fund a pure exploration program-something many private equity providers are reluctant to do. 1Aquila Capital È9 doesn't fund exploration. "We do debt and I don't think anyone intentionally funds exploration with debt," quipped Rick Adams, Aquila Capital senior director, Houston. While its energy-marketer parent, Aquila Inc., is shoring up its balance sheet, Aquila Capital isn't doing debt deals of any kind. During the next six months, Adams says the firm likely will not take on any new clients while it rides out the storm. Since 1998, Aquila Capital has closed 55 deals with 26 clients for $10- to $100 million, totaling more than $1 billion of commitments. Adams agreed with Michael Keener, director, 1Shell Capital Inc. œW "When all your money comes from one place, it's easy to get but when it's gone, it's gone," Adams said. The recent closing of Shell Capital was not due to poor results, Keener said. The producer finance group reviewed more than 1,000 transactions, closed more than 20, placed $450 million and realized an average return of more than 25% on its portfolio. Keener closed a $70-million deal March 8 with an up-start, 1Greystone Petroleum LLC Ç , Houston; went skiing for a week; and returned to news of the shut-down from headquarters. A 25% return on $450 million isn't that much to a multinational oil giant like Shell. "It's unclear if this is a business for a multinational oil company or not," Keener said. Marty Phillips, managing director and principal, 1EnCap Investments LLC Äd , Houston, said that while his firm is a wholly owned subsidiary of energy-marketer 1El Paso Energy Corp. 3A , it is funded principally by institutional investors, so it isn't lacking access to capital. EnCap has placed $1 billion since 1988 and is currently working with $650 million in deal sizes of $15- to $60 million increments, of which it has already made four. Some past investments have included 13Tec Energy ıπ , 1Plains Resources ^5 and 1Matrix ( . Recently it has made investments in up-starts 1Ovation Energy LP ∏Ë , North Richland Hills, Texas, formed by former Encore Acquisition and XTO Energy executives; 1Laredo Energy † , Houston, formed by former Michael Petroleum management; and 1Sawtooth Energy Partners LLC ˛< , Fort Worth, formed by former UPR officers. With continued industry consolidation and a dislocation of quality people, "there will be a new quality management team next week [looking for funding]," Phillips said. Hardy Murchison, vice president, 1First Reserve Corp. Bï , Houston, said, "Even though we'd like them all to sell for cash and reinvest with us, we want the exit strategy that's best for management." The firm's current portfolio has a market value of more than $1.6 billion. It is presently placing $1.4 billion. Some investments include 1Dresser Inc. Vÿ (Dallas), 1Pride International ±Ë (Houston), 1Superior Energy Services )Œ (Harvey, Louisiana), 1Highland Energy Ø (U.K.) and 1Berco Resources Ì (Buffalo, Wyoming). "A broadly diversified portfolio allows us to exercise ultimate capital discipline. We don't have to do certain types of deals in a certain time frame," Murchison said. Another investment was in Greystone Petroleum. First Reserve put up $60 million. With Shell's $70 million, the new Houston-based producer was started in March with an initial capitalization of $130 million. Wil VanLoh, managing partner, 1Quantum Energy Partners œd , Houston, has $320 million under management and makes $10- to $35-million deals. Some recent investments include 1Meritage Energy Partners LLC Æ˙ , Denver, $15 million; 1Tri-C Resources Inc. ´≠ , Houston, $15 million; and 1Cougar Hydrocarbons +h , Calgary, C$6 million. Two of Quantum's four principals have technical experience. "We don't want to second-guess our management teams, but our technical focus allows us to put capital with management teams that will try to grow more aggressively through the drillbit. We look for more technical upside," VanLoh said. Morgan Stanley Private Equity's fourth general fund consists of $3.3 billion, of which $1.6 billion has been placed in myriad businesses in deals of more than $75 million each. It has a three- to seven-year holding period, according to John Moon, executive director, New York. Its third fund's internal rate of return (IRR) was 51%. Since it was formed in 1985, its IRR has averaged 35%. Seven percent of investments have been in energy companies. 1Riverstone Holdings LLC »› , New York, a joint venture formed in 2000 with 1The Carlyle Group Z¸ , Washington, D.C., is raising $1 billion to invest in energy and has made $220 million in deals to date, including $60 million in Frontier ASA, a Norway-based driller; and $100 million in 1Legend Natural Gas LP _Y , Houston, formed earlier this year by former 1North-Central Oil Ê2 (sold to 1Pogo Producing in 2001) executives. "We may take exploration risk one day. For now, it is acquisition/exploitation," said John Lancaster, managing director. Calgary-based 1ARC Financial Corp. á is looking to expand its gas-focused investing to the U.S. and abroad. Its current fund consists of C$310 million, of which 20% is invested in deal sizes of C$5- to C$25 million, according to Kevin Brown, president and managing director. Meanwhile, 1Duke Capital Partners â does deals of $10- to $100 million and has a target portfolio of $1 billion in 2003, according to Chip Webster, executive vice president and managing director, Houston. Some investments it has made include 1Meridian Resource Corp. ∏9 , Houston, $8 million; 1EnerVest Olanta LLC Á , Houston, $24 million; 1Canadian 88 Corp. î , Calgary, C$50 million; 1Callon Petroleum t , Natchez, Mississippi, $95 million; and Cougar Hydrocarbons Inc., Calgary, C$25 million. These numbers bear out what Cosco's Smith said at the conference. "In the last five years there has been tremendous growth in the number of private capital sources. We've tracked about 70 sources of capital, and they have about $72.5 billion in capital available." Of the total, Cosco has identified 47 funds that will invest in corporate equity by taking a stake in an E&P firm, and 36 funds that invest at the property or asset level through a partnership with the E&P company and through mezzanine debt. "I believe private capital is much better suited to our industry than capital from public markets," Smith said. "It is contrarian and may fund a business plan, even if you have no assets yet, whereas public capital will not." And it invests when prices are down. Private capital has evolved because public markets will make capital available only for large companies issuing at least $50 million, he added. Public energy equity offerings averaged $85 million per issuance during the last three years, but many companies need money in smaller amounts. Also, the patience of the public investor is not long, whereas private capital is patient, sometimes for as long as seven years. Bryant Patton, executive vice president, 1Camden Resources •Â , Dallas, said, "There is no panacea for raising private capital." He has been raising it for 23 years, first as a financial intermediary targeting college endowments and other investors. Camden was formed in 2000 to focus on drilling in South Texas. Its initial capitalization was from Yorktown Partners, New York, along with a 15% contribution from Camden management. "Management must be at risk [with some of its own funds in the deal]. There must be a philosophical mesh between the capital provider and management," Patton said. "You both have to have the same view of the business. And if needed, hire capital formation expertise to facilitate the process. Otherwise, you can get bogged down or not know what questions to ask." Cortez's Hill said to remember that private equity providers are not investing in your company for the very long term, to "create an Exxon." "They want to realize a return and cash out-but that doesn't mean you are then out of business, because you can start another company and do it every five years or so." Shell's Keener, who has a more than $200-million portfolio for sale, involving seven deals, suggests that executives looking for capital admit their business-plan weaknesses, because the holes will be found during the due diligence process anyway. Not admitting or knowing them could compromise the pitch. And listen to what each capital provider has to say, including criticism. "Take the advice, because there's a lot of good advice out there."