The U.S. onshore deal market took a curious turn November 25th when Kohlberg Kravis Roberts & Co. L.P. knocked down the pillars of Tulsa-based Samson Investment Co. in a $7.2-billion leveraged buyout, the second largest private-equity transaction globally in 2011 (after Blackstone's takeout of Australian retail giant Centro in March).

The transaction, which is expected to close by year end, is the latest--but certainly not the last--in a rapidly heating fourth-quarter 2011 oil and gas market that shows ample promise of the same aggressive end-of-year deal flurry that capped a record-setting 2010.

KKR/Samson features several elements pointing to an evolving domestic transactions market as costs rise sharply for tight formation oil and gas development.

Those elements include four general characteristics. First, relationships matter. Secondly, consortiums are coming to the fore as a way to amass the capital necessary to unlock unconventional onshore oil and gas potential. This element signals that onshore tight formation oil and gas development is reaching the same investment threshold as deepwater offshore or international programs where operators must spread costs and risk among multiple partners. Furthermore, these new onshore consortiums often feature an international component.

Third, capital is readily available for mega-deals despite a wobbly global economy, even as rising capital requirements for domestic unconventional development programs approach levels that only the IOCs or investment consortiums can match. As an example, nearly a dozen investment banks participated in the KKR/Samson deal.

And fourth, it's just as much about "human" resources as it is "natural" resources as tight formation oil and gas requires ever-greater technological prowess.

While these individual themes have been present in one form or fashion during the last half decade in every onshore unconventional transaction, all four are part of the KKR/Samson LBO.

Live by the deal, die by the deal

Samson evolved into a $10-billion company the old-fashioned way. The 40-year old Tulsa-based firm pursued an acquire-and-exploit strategy that combined expertise in deal making with a professional staff that utilized cutting edge technology to extract full value out of acquisitions.

Samson used acquisitions to develop a presence in every major U.S. basin from Appalachia to California, with holdings in the Bakken shale, Wyoming's Powder River Basin (Niobrara), and the ArkLaTex, including the Haynesville and Bossier shales, along with the Cotton Valley. Furthermore, Samson was an early player in the Granite Wash and Cana Woodford plays in the Anadarko Basin of western Oklahoma. Over the years Samson acquired acreage in conventional settings that later featured a substantial unconventional component. That unconventional portfolio is now, fortuitously, held by production, which turned out to be a deal sweetener for KKR.

Examples of Samson's domestic transactions during the last decade include the purchase of Dominion Exploration and Production properties in East Texas and Arkansas, Contour Energy Co.'s holdings in Louisiana and the Gulf, and the 2007 acquisition of PYR Energy Corp., which had holdings in the Rockies, the ArkLaTex, and the Gulf Coast.

Samson's deal making penchant is also evident in joint venture agreements over the years with companies such as Aurora Energy Ltd to explore for the Antrim Shale in Michigan, and with Noble Energy Inc. and Chevron Corp in the deepwater Gulf of Mexico. The Chevron joint venture culminated this past September in the announcement of a lower Tertiary discovery at Moccasin in Keathley Canyon Block 736.

While KKR may be the Delilah that cut the locks of Samson's strength onshore, those locks can grow back as Samson's family-based owners pivot from onshore tight formation oil and gas to offshore oil by retaining Samson's deepwater portfolio (and Gulf Coast conventional properties). The offshore portfolio will most certainly require a significant chunk of the cash infusion from the KKR LBO.

Or, the Schustermans may elect to sell the offshore component for $2- to $3 billion and exit the oil and gas business entirely.

Most shale deals during the last half-decade involved asset purchases or joint ventures with a company specializing in a single basin. However the KKR/Samson deal mirrors ExxonMobil's XTO Energy acquisition in December 2009 in which the buyer gained access to a basin-diverse portfolio.

Like XTO, Samson found itself in a challenging capital predicament. After spending big on acquisitions, Samson, like XTO, faced investing billions more on the treadmill of tight formation development where capital from existing production must finance ever-expanding drilling efforts in wells characterized by annual production declines steep enough to slay an army of Philistines.

Those massive future capital requirements then become the major driver forcing tight formation property owners to seek outside help in the form of joint ventures, or through sales of legacy properties and midstream assets. Consequently, tight formation oil and gas development remains a deficit industry at this point in the evolutionary change sweeping the onshore market as participants, typically publicly held oil and gas companies, routinely outspend their cash flow.

That financial reality prompted Samson to seek strategic alternatives earlier this year, including partnering with another company, or raising funds through selling assets. Notably, a clue to Samson's future may have been evident at this same time last year when Samson began marketing its legacy Permian Basin holdings, which sold to Three Rivers Operating Company LLC in January 2011.

Samson subsequently hired Jefferies & Co. to begin the strategic alternative process. That effort brought bids from Korean National Oil Corp, Apache Corp. and another unidentified European oil and gas firm. The efforts narrowed to KKR in October and the $7.2-billion deal was announced on the day before Thanksgiving.

Getting By With a Little Help From My Friends

What matters is who you know rather than what you know. That old bromide is a crucial element in understanding how KKR beat out Apache, KNOC and a European player to be named later for the mighty Samson.

The "what" is this: Tulsa, Oklahoma, was an early center for oil and gas development as the industry's center of gravity shifted out of Appalachia in the first two decades of the 20th century. The legacy of that transition was evident in the large number of oil and gas operators and contractors who called Tulsa home in the 20th century.

In recent years several Tulsa companies have exited Tulsa for Houston, or sold to other firms, as is evident in Occidental Petroleum Corp's 2005 $3.5-billion acquisition of Vintage Petroleum Inc. Tulsa still remains home for Williams Cos., Helmerich & Payne IDC, and Laredo Petroleum Inc. among others, but the city is clearly sensitive to its waning status as a bastion for the energy business in the southwest United States.

Samson Investment Corp. was one of the remaining pillars in Tulsa's oil and gas temple. The firm was founded 40 years ago by Charles Schusterman, a Russian émigré, and eventually grew to international proportions following acquisitions of properties in Russia and Latin America during the 1990s. That international effort was superseded by the push for onshore domestic natural gas assets in the first decade of the 21st century.

Samson was known for a strong internal culture that valued employees and community involvement among its 700 workers at the Tulsa headquarters. Charles Schusterman passed away in 2000 at the age of 65 and was succeeded as CEO by his daughter, Stacy. When the decision was made to sell, the Schusterman family looked for a partner who would value both the human assets and the tight Samson corporate culture.

The "who" is this: KKR's Henry Kravis is a Tulsa native who spent his early years in the city before eventually becoming a co-founder 35 years ago of famed LBO specialist Kohlberg Kravis And Roberts. The "R" in KKR is George Roberts, Henry's cousin. Both shared a grandfather who was a petroleum engineer in Tulsa and reportedly a personal friend of Charles Schusterman. It took a personal visit by KKR's Henry Kravis last summer to Stacy Schusterman to ease concerns about an acquirer moving Samson’s headquarters out of Tulsa and that moved KKR to the front of the pack.

Of interest, Kravis later visited Tokyo to promote participation in the potential deal to eventual partner Itochu Corp.

In the end, personal relationships played a significant role in cementing the KKR/Samson deal, which was as delicate at crucial stages as the "ins and outs" surrounding the biblical relationship between Samson and Delilah.

Personal relationships are also a factor in the deal making acumen at Jefferies & Co., the silent instigator behind KKR/Samson and a number of joint ventures and other onshore tight formation oil and gas transactions over the last few years. Maybe the best single illustration occurred when Jefferies arranged the marriage between Atlas Resources Inc. and India's Reliance Industries, who came together in a $1.7-billion Marcellus joint venture in May 2010. Less than a month later, Jefferies instigated the negotiations that led to Chevron’s $4.3-billion purchase of Atlas Resources who, as it turns out, was the number two bidder for the original Atlas joint venture.

One notable aspect of the Samson transaction involves KKR's recent hire of two former heads of Jefferies & Co. energy transactions division. In fact those two had formed RPM Energy LLC, which partnered with Hilcorp Energy Co. in KKR's original Eagle Ford shale investment in 2010. Basically KKR brought RPM into the KKR fold in November 2011.

Thus, it was no surprise that Jefferies was the lead player when Samson decided to seek strategic alternatives in 2011, or that Jefferies shopped the idea to a KKR firm with prior Jefferies connections.

Going to Try With A Little Help From My Friends

The Samson deal is interesting on several levels. The first is that tight formation players are invariably publicly held companies. Samson, however, was one of the few remaining privately held firms with substantial unconventional holdings in a portfolio that includes 10,000 wells (4,000 operated), and 1,200 employees in Tulsa, Midland, Denver and Houston.

Previously the transition to tight formation oil and gas domestically has either been through joint ventures, which now total $35 billion over the last half decade, or buyouts by the IOCs who have spent approximately $25 billion in the U.S. during the last two years. Generally the IOCs have been purchasing privately held firms outright as they seek reserves in North America while the publicly held independents followed the joint venture route, often in tandem with a foreign investor.

Secondly, the deal, which ranks second in 2011 oil and gas dollar value to BHP-Billiton’s $15.1-billion July 2011 takeout of Petrohawk, involved a consortium of four players, including Japanese trading house Itochu Corp., Natural Gas Partners, a perennial oil and gas private-equity player, and Crestview Partners LP, a Wall Street private-equity firm. Actual deal terms have not been released, but the four partners combined to provide more than $4 billion for the effort with KKR responsible for 60% share. And there was another tranche involving a combination of high-yield debt and a bank credit line to reach the $7.2 billion threshold.

In structure, the KKR/Samson deal resembles the coalitions that have been put together for deepwater development where large capital obligations force operators to trade participation in future reward by offsetting significant near-term cost through the inclusion of three or more partners.

For its part, Itochu provided $1.04 billion for a 25% stake. The Itochu contribution reflects a rapidly changing energy environment in Japan following the March 2011 earthquake and tsunami that crippled the nation's nuclear power industry. Japanese firms are now scrambling to expand LNG imports in the recovery effort. Itochu's interest was likely piqued by Cheniere Energy's ability to win U.S. Department of Energy approval for changing a Sabine Pass LNG terminal into an export facility for U.S. natural gas in May 2011. Actual LNG exports are still years away, but the Cheniere facility provides a neighborhood outlet for Samson natural gas production in the Bossier, Cotton Valley, and Haynesville shales. Itochu's involvement signals that ArkLaTex gas is earmarked for the overseas market and is a concrete first step in moving the U.S. LNG export effort from concept to reality.

At least one other member of the coalition has ties to Samson. Minority participant Natural Gas Partners, which contributed $500 million to the LBO, created 15 companies over the years with former Samson employees.

Break Up or Make Up?

Usually LBOs lead to a break up as the acquirer seeks to extract value and pay down borrowed funds. That model has been a hallmark of KKR's 35-year history. Traditionally, KKR's LBO model involves using high-yield debt to acquire undervalued assets, followed by efforts to pump up the asset’s value, then capped by a quick sale to other buyers. More often than not, it entails breaking up the original company.

The KKR storyline took an uncharacteristic turn over the last two years as KKR entered a series of oil and gas investments that involved flipping unconventional properties within a year of capital investment. At first, the buy-then-flip strategy looked like an effort to overcome the challenges that grew out of KKR’s troubled $45-billion 2007 Texas Utilities LBO. That deal foundered when commodity prices collapsed in 2008, an event that knocked the legs from under TXU’s business model, since the utility was forced to cut customer electric rates and that, in turn, made it difficult to service the large debt burden that was forced on TXU through the LBO.

KKR rebounded from the TXU imbroglio by dipping into the hot new shale gas plays with a $350-million 2009 investment in East Resources, a Marcellus shale player. That investment yielded $1.55 billion upon the $4.7-billion sale to Royal Dutch Shell in June 2010. KKR then invested $400 million in a 40% share of Hilcorp’s 100,000 Eagle Ford shale acres in South Texas. That investment turned into a $1.4-billion payday when Hilcorp sold to Marathon Oil for $3.5 billion in June 2011.

Of note, both KKR deals involved private-equity infusions into privately held players followed within a year by a property flip to an IOC.

But this time may be different. KKR appears to view its Samson investment --85% of which involves natural gas properties--as a long-term play for stability in a volatile economic environment. Certainly it is an "all in" bet on natural gas of the unconventional kind during a time when gas is out of favor.

The agreement to maintain Samson headquarters in Tulsa--and add its national unconventional portfolio to KKR’s growing energy business--is one clue. Another is that KKR, in fact, has done nine energy transactions in the last two years. This time KKR appears to be looking a decade or longer down the road with Samson--if public statements can be believed. And that makes the king of the LBO genre sound a whole lot like the major IOCs it has been selling to when it comes to a contrarian bet on North American unconventional gas.

Perhaps the final surprise of the KKR/Samson transaction is that a perennial buy, flip and quick-exit private-equity player may have evolved into an oil and gas investor with a long-term fascination with unconventional natural gas. If so, KKR's strategy change recalls a time long ago when another Samson developed a fateful infatuation with the biblical Delilah.

Contact the author, Richard Mason, at rmason@hartenergy.com.