In a world of $60-plus oil and $11 to $12 gas, producer desire to get upstream development projects under way has become greater than ever. But where do private E&P companies and small-cap publicly traded producers turn for both timely and aggressive capital for these projects? During the past two years, a number of established investment-banking firms, private-capital intermediaries and fund managers-responding to the ballooning investor appetite for direct energy investments-have dramatically stepped up private-equity financings, Rule 144A and Reg D private placements, and "private investment in public entity" (PIPE) transactions. Particularly aggressive in these financings have been the likes of Friedman Billings Ramsey, the Arlington, Virginia-based investment-banking firm, and Energy Capital Solutions, a Dallas investment-banking boutique. In addition, other seasoned private-equity fund managers and private-capital intermediaries-responding to the mass exodus of mezzanine capital from the energy space following the Enron debacle-have within the past year begun entering the mezzanine arena as providers of such capital. The new entrants include Houston's GasRock Capital LLC, formed by Weisser, Johnson & Co., and Houston's NGP Capital Resources, sponsored by Natural Gas Partners. At its peak, the annual dollar volume of energy mezzanine transactions in the U.S. was about $1.4 billion, says Scott Johnson, managing director of GasRock Capital. "But during the past three years, we've seen that volume running at about $300- to $400 million per year. So there's still plenty of room to do a good business in mezzanine." Sanders Morris Harris, a Houston investment-banking firm, shares much the same view. In fact, during 2004 and thus far in 2005, mezzanine funding has comprised $110 million of the firm's $265 million of privately placed energy financings. Also swelling the population of private-capital providers to the upstream sector is Avista Capital Holdings, a New York- and Houston-based entity formed this summer by 17 financial professionals who previously comprised much of the core of the Credit Suisse First Boston Private Equity group. Simply put, there's no shortage of private capital available to emerging E&P companies today. The real challenge for producers is to decide what type of capital or blend of capital is best suited to the projects on their plate and the level of returns and control they're seeking. Big on 144A Since the start of 2004, Friedman Billings Ramsey has completed 21 public and private E&P equity underwritings totaling $2.25 billion. Notably, six of those underwritings-totaling $1.8 billion-have been equity transactions in the form of either Rule 144A or Reg D private placements. Rule 144A is an exemption under SEC regulations that allows unregistered stock to be sold to qualified institutional buyers-those with assets of more than $100 million-with the understanding that those securities will become publicly registered within a relatively short period. Reg D is an exemption under SEC regulations that allows accredited investors-either high-net-worth individuals or institutions with less than $100 million of assets under management-to buy unregistered stock with the same understanding. 144A offerings, which often include Reg D investors, are attractive because they allow an issuing company, financial sponsor or parent company to realize a higher valuation for their assets-on par with what is available in the public market. Meanwhile the issuer enjoys a speedy transaction execution normally associated with asset sales in the private market, explains Chris Shebby, Arlington-based managing director in Friedman Billings Ramsey's energy-banking group. This year, among 144A transactions in the upstream, the firm completed a $440-million offering for Mariner Energy, a private Houston-based producer; a $447-million deal for CNX Gas Corp., a coalbed-methane operator 81% owned by Pittsburgh coal giant Consol Energy; and an oversubscribed, landmark $800-million offering for Rosetta Resources-a newly formed private Houston E&P company carved out of Calpine Natural Gas. To ensure financial flexibility for Rosetta, the investment-banking firm also worked closely with BNP Paribas. That banking giant put together a $325-million credit facility comprised of a $225-million revolver and a $100-million second-lien, term-loan. Why did Calpine choose Friedman Billings Ramsey for such a mammoth offering? "It was comfortable with our track record of executing large 144A transactions," explains George Hutchinson, managing director and head of the market-maker's Houston energy group. "Of the 25 private placements we've undertaken since 2001, we've successfully completed all." Hutchinson points out that his firm has also been recently active in PIPE transactions for E&P companies. PIPE deals involve the private placement of restricted, illiquid shares of a publicly traded company's common stock, usually sold to institutional investors or high-net-worth individuals within a very short period and at a very narrow discount to the listed stock price. These restricted shares are later registered by the issuer with the SEC, at which time they become freely tradable in the market. The advantages of a PIPE: the issuer gets access to equity in a timely manner-faster than through a public secondary offering-and the investor gets slightly discounted shares that are soon liquid paper. Within the past 24 months, Friedman Billings Ramsey has completed nearly $1.6 billion worth of energy-related PIPE issues, including a $1.3-billion common-stock offering for Consol Energy; a $200-million convert for Petrohawk Energy, a Houston producer; and a $51-million convert for Whittier Energy, another Houston operator. "Today, we're witnessing a robust oil and gas price environment wherein energy equities are back in vogue with investors," says Shebby. Currently, his firm is working on five 144A deals in the energy space-three for upstream operators and two for coal companies-ranging in size from $50 million to $1.5 billion. PIPE parade An investment-banking boutique with offices in Dallas and Houston, Energy Capital Solutions (ECS) was formed in the fall of 2001 to focus on intermediating private capital and executing M&A advisories for both private and mid- and small-cap publicly traded E&P and oil-service companies. Through this summer, the firm has lived up to its name, executing 18 private-equity transactions-13 of them PIPE offerings-as well as three mezzanine and four senior-debt financings. The aggregate value of these deals: $486 million. "All of us at ECS have previously worked for large investment-banking firms, raising capital for mid- to- large-cap energy companies," says J. Russell Weinberg, managing director for ECS in Dallas. "What we've done is apply that level of experience to helping smaller energy companies, private and public, using the credibility we had already established with institutional investors and other financing sources." The pools of capital the firm draws upon include hedge funds located in New York and Texas; major institutional investors such as Wellington Management; private-equity funds like Kayne Anderson, EnCap Investments, ArcLight Capital and Natural Gas Partners; mezzanine funds such as Trust Co. of the West and Macquarie Energy Capital; and traditional lending institutions. "Hedge funds, in particular, have been steadily increasing their exposure to energy. Right now, energy is hot," observes Keith J. Behrens, another ECS manager director in Dallas. "Meanwhile, traditional private-equity funds like Kayne Anderson and EnCap are raising newer and bigger funds. So the pools of energy capital are growing." Capitalizing on the swelling appetite for investment in the sector, the firm this summer closed on five PIPE transactions for publicly traded energy companies. They include a $12-million private placement of equity for Abraxas Petroleum Corp., a San Antonio-based producer; a $10-million deal for Contango Oil & Gas, a Houston-based operator; a $15-million private placement for Houston-based producer New Century Energy; a $21-million deal for Flotek Industries, a Houston oil-services provider; and a $7.3-million private-equity placement for Canary Resources, a Toronto-based operator engaged in U.S. coalbed-methane development. These transactions are in addition to a non-PIPE, $38.3-million private placement of equity completed for Hawk Holdings, a private Oklahoma City-based producer, and a $10-million private placement this May for privately held, Houston-based Coastal Drilling. Says Behrens, "PIPE deals can be done much quicker than a fully marketed secondary offering in the public markets. Also, there's much less public disclosure involved for the issuer until the offering closes." Indeed, the Abraxas deal this summer closed in only one week and the producer's shares were placed at just a 6% discount to the preceding 15-day average closing price of the company's stock. "Very often, because of the level of due diligence we bring to a deal-even a small one-and the concise articulation of the value creation inherent in an issuer's story, we're able to extract better-than-normal terms on a transaction for that issuer," says Weinberg. Currently, ECS is working on a $15-million PIPE deal for a Houston oil-services/engineering consulting firm and a $20-million one for another Texas oil-services company. In addition, it is pursuing a $20-million mezzanine financing for a private Midcontinent E&P company seeking to acquire Arkoma Basin properties. Since inception, the intermediary has also completed eight energy-related M&A advisories totaling about $1.1 billion. Notably, these advisories have often allowed ECS to bring its capital-raising abilities to the table as well. Combined transactions Based in Houston, Sanders Morris Harris is an investment-banking firm focused on emerging small- to middle-market companies-not only as an underwriter of private placements and public equity and debt offerings but also as an M&A advisor and co-investment partner. Within the energy space, the market-maker in the past two years has been active in agenting senior and subordinated (mezzanine) debt transactions and private-equity placements including PIPEs. This is in addition to M&A advisories and managing about $400 million of public-equity underwritings in the sector. In the case of private-equity deals, the firm will act as a principal investor in amounts up to $10 million, while being an agent in raising additional private equity from accredited individual investors, fund managers and institutional investors, says Ric Saalwachter, managing director and head of the firm's energy group in Houston. Since the start of 2004, Sanders Morris Harris has agented within the energy sector $265 million of privately placed financings, according to Saalwachter, including $110 million worth of mezzanine-debt transactions, $108 million of PIPE offerings, $35 million of senior-debt deals and $12 million of private-equity placements. Notably, these transactions have been typically executed in a combined fashion for a client and coupled with M&A advisory assistance, allowing that client to achieve both the lowest all-in cost of capital for an acquisition and the best market valuation for an offering. This summer, an experienced management group wanted to acquire Anchor Drilling Fluids USA, a private Tulsa oil-service company. Sanders Morris Harris brought to the table four skill sets: it advised the management group on the $30-million acquisition, and raised $10 million of senior-debt financing, $10 million of mezzanine debt and $10 million of private equity as well. Subsequently, when a small-cap, publicly traded Houston producer wanted to complete the $56-million acquisition of a private operator focused on the northeastern Texas Barnett Shale play, Sanders Morris Harris brought to bear an even broader set of capital-raising tools. "Besides M&A advisory, we put together an $85-million financing package so that the company could also continue developing its existing South Texas oil and gas properties," explains Saalwachter. That package consisted of $15 million of senior bank debt, $25 million of mezzanine capital, $25 million of junior subordinated debt raised from a foreign oil and gas company, and $20 million raised through a PIPE offering. "We always go for the lowest blended cost of capital for a client, and senior bank debt and mezzanine financing certainly fit with that aim. As for PIPE offerings, they not only can be executed quickly but they also provide a higher market valuation for an issuer versus private-equity transactions." Last year, the firm agented a $50-million PIPE offering for Houston-based Continental Southern Resources, now Endeavour International Corp. Currently, the market-maker is working on a $60-million financing package for a small-cap, publicly traded Dallas producer looking to acquire an interest in a nonconventional Midcontinent gas play. The package would again likely include senior debt, mezzanine capital and PIPE components. Avista's vista Formed this past July, New York- and Houston-based Avista Capital Holdings is no stranger to the energy private-equity space. This group of 17 financial professionals has earmarked 25% to 30% of both its own capital and institutional monies to make direct equity investments in the E&P and oil-service sectors. It previously comprised much of the core of the Credit Suisse First Boston (CSFB) Private Equity group. Through mid-year 2005, CSFB Private Equity's $5.3-billion Fund III had made $1.3 billion of direct equity investments in the energy arena through 13 transactions. Within the private E&P sector in Denver, this included an initial $100-million backing for Laramie Energy, an initial $50-million funding for Enduring Energy and a $65-million investment in Medicine Bow Energy-recently bought by El Paso Corp. for more than $800 million. Also in the Rockies, CSFB recently committed an additional $30 million to Pinnacle Gas Resources, a Sheridan, Wyoming-based private operator, to buy undeveloped Powder River Basin acreage from Marathon Oil. On the oil-service side, it has grown an initial $25-million stake in privately held, Midland-based Basic Energy Services to $80 million. With acquisitions, Basic has become the third-largest provider of workover rigs to the industry, with a fleet of more than 300 rigs. "Currently, Avista Capital Holdings is assisting CSFB on a consulting basis to grow existing energy relationships such as these," says Steven A. Webster, Avista's co-managing partner and head of the firm's energy-investment activity in Houston. "At the same time, Avista as a stand-alone entity will seek to lead and co-lead new private-equity investments in the energy, health care and media sectors." Within the upstream, Webster envisions making initial investments of around $50 million-with the potential to grow that funding to $100 million or more-focusing on resource plays such as tight-sand gas and coalbed-methane plays. On the service side, its equity positions might run slightly higher, in the $100- to $150-million range. The ideal E&P investment candidate? "One that has a seasoned management team headed by the likes of Medicine Bow's Mitch Solich, who also successfully grew Shenandoah Energy, Laramie Energy's Bob Boswell, who previously headed up Forest Oil, or Don Wolf, who earlier grew Westport Resources." Within Avista's current pipeline of potential upstream investments, the private-capital provider is looking at an initial $50-million funding for a private Rockies producer and a smaller, $30- to $35-million equity backing for a private onshore Gulf Coast operator. Says Webster, "Our goal over the next year is to make hundreds of millions of dollars of private-equity investments, both in new and existing portfolio companies. In addition, we're working on some investment monetizations, with Medicine Bow being a good recent example of that effort." Deep pockets Primarily engaged in principal investment activities across all industries, the New York-based Blackstone Group since 1985 has raised about $15 billion of private-equity capital, investing some $12 billion of that through 90 transactions. When its $11-billion-plus Blackstone Capital Partners V Fund closes this October, it will have raised better than $26 billion for corporate private-equity transactions. "The overall energy space has become an increasingly important focus for us," says David Foley, senior managing director in the firm's corporate private-equity group. "In fact, most of the approximately $715 million we've invested in this space has occurred within the past two years." Through its Blackstone Capital Partners IV Fund, the firm in March 2004 committed $135 million of private equity to Kosmos Energy, a private Dallas oil and gas exploration company focused on drilling offshore West Africa. The balance of the overall $300-million equity commitment was provided by Warburg Pincus & Co. and management. The attraction for Blackstone? "We had a very high opinion of the Kosmos management team," says Foley. The company's president and chief executive officer, James C. Musselman, and its executive vice president of exploration, Brian F. Maxted, presided over the turnaround and growth of Triton Energy before its $3.2-billion sale to Amerada Hess. Also, the Kosmos exploration team had a demonstrated track record of success in the region through Triton's major oil discovery offshore Equatorial Guinea. "We also liked the exploration economics in the region," notes Foley. "When we studied the historical drilling-success rates offshore West Africa, the size of the fields discovered and the potential opportunities still available for a seasoned management team with credible sponsorship prepared to move quickly, we got comfortable with the risk and return profile on exploration dollars spent." Additionally, the investment firm liked the idea of working with Warburg Pincus, with whom it got along well, plus the fact that Pioneer Natural Resources had agreed to fund a portion of the overhead for the Kosmos exploration venture and participate in certain drilling projects. Foley stresses that Blackstone isn't wedded to a particular basin or play when it comes to making private-equity commitments in the oil and gas sector; rather, its focus is on how well a management team fits with a particular type of reservoir. In its upstream private-equity backings, the firm seeks to make investments of at least $100 million per transaction, with the sweet spot more in the range of $350- to $600 million per transaction. Blackstone also has an appetite for doing public-to-private deals, that is, buying into public independents that might have some challenge or issue that's causing them to not be fully valued by the market, then taking them private to achieve a higher value. Mezzanine merits After 14 years of helping energy companies raise capital from mezzanine-debt and private-equity providers, Houston-based Weisser, Johnson & Co. announced this summer the formation of GasRock Capital LLC. The new entity will make direct mezzanine-debt investments in the upstream space as well as in midstream energy projects and companies. "When Enron collapsed and dragged down most of the merchant-energy companies that comprised the majority of funding sources in the energy mezzanine arena, we began thinking that maybe it was time to consider getting into this business as a principal and fill some of the void created," says Frank Weisser, managing director of GasRock. Although there are more providers of mezzanine capital around today than a few years ago, he points out that the level of that type of financing for energy companies still isn't anywhere close to what it was before the demise of Enron. "At its peak, the annual dollar volume of energy mezzanine transactions in the U.S. was about $1.4 billion," says Scott Johnson, another GasRock managing director. "But during the past three years, we've seen that volume running at about $300- to $400 million per year. So there's still plenty of room to do a good business in the mezzanine-finance area." Weisser points out that the new firm has received financing commitments from two hedge funds in New York and the Midwest that have a combined $7 billion worth of investments under management, "so GasRock has a very large checkbook for funding." Johnson notes that because acquisitions are becoming increasingly harder to make, particularly in smaller sizes under $100 million, the primary use of mezzanine funds today in the upstream has shifted to development-drilling projects. "Given current high natural gas prices and the need to get more production online as quickly as possible, we believe there'll be a continuing supply of newer, smaller E&P companies looking to finance development-drilling programs with mezzanine capital." Weisser says, "Mezzanine debt has been a preferred source of capital for domestic independents for well over the last two decades. The structure doesn't have the control issues of equity and is far less dilutive." Compared with traditional reserve-based bank lending, GasRock will advance operators a greater amount of capital-usually 1.5 to two times as much-to allow borrowers to accelerate their development projects and enhance their returns, adds Johnson. The advance ratio, of course, depends on an engineering analysis of the risk profile of the project. "We'll fund proved undeveloped (PUD) drilling projects, and may even extend beyond that to funding exploitation-drilling projects, with the sweet spot of our investment in the $5- to $50-million range," he explains. "So in essence, we'll take engineering risk, not geologic risk." For this stretch, GasRock seeks returns in the mid-teens to 20% or slightly above. Currently, the firm is working on mezzanine deals for private producers in both the Gulf Coast and the Rockies, involving development-drilling funding for wells costing $2- to $5 million to drill. Says Weisser, "While our initial financing will be less than $5 million, we believe these facilities could grow to more than $30 million each." Aggressive advances With the plethora of mezzanine capital exiting the energy space during the past several years, Natural Gas Partners in 2004 also saw the opportunity to expand beyond its core private-equity business through the sponsorship of NGP Capital Resources (Nasdaq: NGPC). A new energy-focused business development company (BDC), set up under the Investment Company Act of 1940, NGPC is a closed-end, non-diversified investment entity that enjoys favorable tax treatment as long as it distributes at least 90% of its taxable income. "The BDC structure exposes individual investors to emerging E&P and midstream mezzanine-level investment opportunities they otherwise couldn't access on their own," says John Homier, NGP Capital's president and chief executive officer in Houston. For providing double-digit, mezzanine-level returns-consistent with what lenders receive for making loans with equity kickers-the firm receives a 1.8% management fee plus an incentive fee equal to 20% of net investment income above an 8% annual hurdle rate of return. Last year, upon completion of its November IPO, the company wasted no time closing a $59-million mezzanine investment in Crescent Resources, a private California-based producer, and purchasing $8 million of a $150-million 144A notes offering by Venoco Energy, another private California-based operator. Through this summer, NGP Capital has completed four other upstream-related mezzanine transactions. They include a $30-million senior secured loan for TierraMar Energy, a private Texas E&P company, which carried a Libor plus 6% coupon and an overriding royalty interest with warrants attached; another $30-million senior secured loan for C-Gas, a private Utah-based producer, carrying a Libor plus 5.5% coupon and an overriding royalty interest; a similar $15-million senior secured facility for Atchee CBM, another private Utah operator; and a $25-million senior secured bridge loan for Millennium Offshore Group, a private Gulf of Mexico-focused producer. "The recent sustained high level of commodity prices is making a lot of development projects and acquisitions very viable, so we're looking at a robust level of deal flow," says Steve Gardner, NGP Capital's director of finance. "In fact, as of early August we had in our pipeline, at various stages of evaluation and development, 51 different energy-related transactions that represent about $129 million worth of potential investments." Whereas a bank might typically lend 60% against an operator's proved developed producing (PDP) reserves, NGP Capital will consider advancing as much as 150% of their value, says Homier. "This assumes, of course, that the operator's asset base also has proved undeveloped (PUD), probable and possible reserves that can be brought to fruition in a timely manner and that we like the full development story." In these cases, the firm can evaluate, commit and close in a matter of weeks. Besides having in hand a good development story, it also helps if a potential E&P borrower has both a good track record of adding value and a knowledge edge-either in a particular region, a formation or play, or a particular technology-that can be brought to bear on the development of an oil and gas asset, says Gardner. Homier notes that NGP Capital has upwards of $450 million available today for energy mezzanine-level investments.