The largest IPO of first-quarter 2016 was Silver Run Acquisition Corp.—a special-purpose acquisition company (Spac), no less, and, even more surprisingly, one focused on becoming an oil and gas operator. Some of the units’ buyers are longtime E&P investors but had never bought a Spac before, said Stephen Trauber, head of global energy investment banking at Citigroup Inc., which was a book-running manager of the February offering. “There was a tremendous amount of interest,” he said.

A great deal of the buy-in was based on Silver Run’s management—led by retired EOG Resources Inc. chairman and CEO Mark Papa—and its sponsor, private equity firm Riverstone Investment Group LLC. Neil Shah, Citigroup head of alternative capital markets, said of the offering, “The investors believe in Mark Papa, Riverstone and the potential rebound in the energy markets.”

Another upstream-focused Spac IPO this year was done by KLR Energy Acquisition Corp., underwritten by EarlyBirdCapital Inc., whose co-founder led the earliest Spacs in the 1990s. KLR Energy co-founder and CEO Gary Hanna’s most recent experience had been as CEO of EPL Oil & Gas Inc., which operated in the shallow Gulf of Mexico.

His and his partners’ plans don’t include the Gulf, though. “As much as I love the Gulf, I think it is a very difficult environment to be in today,” he said.

Instead, KLR Energy is looking to merge with a private, onshore U.S.-focused operator. With $82 million raised in the IPO, including overallotment, it is seeking a merger candidate in the range of $300 million to $1 billion, said CFO T.J. Thom, who was CFO of EPL until its merger with Energy XXI Ltd. in June 2014.

The target will be an operator in a known basin with quality rock, Hanna added. “Obviously, that would steer you toward anything in the Permian—the Midland and Delaware basins—and the Eagle Ford, D-J and Bakken. We’re not limited to those plays; we’re looking at others. But our focus is on oil and wet-gas opportunities,” he said.

Spac structure

Energy XXI was launched in 2005 as a Spac on the London AIM. While it successfully completed an initial business combination, many other Spacs met with challenging circumstances. One reason was that, in the past, the warrants accompanying units were full warrants. In the Silver Run deal, however, each unit comes with one-third of a warrant, Shah said.

Also, in the old format, according to Reuters and other reports, unitholders could greenmail management by withholding a “yes” vote on the initial combination, which is needed to release the Spac’s cash that is held in trust. Today, Shah said, “the warrants are struck out of the money, so it is less dilutive to investors.”

Another significant change has been in securities redemption and shareholder voting. Buyers of Silver Run units, for example, can get their money out if they don’t like the merger candidate. They can still exercise their warrants if they are no longer participating in the security after the merger is closed.

“In the old days, you had too many moving parts,” Shah said. “It was very difficult to close a transaction due to the dilution and structure of the Spac itself. In the past, if 30% of the investors—individually or as a group—voted against a transaction, it would prevent a transaction from closing.”

In Silver Run’s structure, a simple majority “yes” from a quorum of shareholders is needed. If a group of stockholders does get together, no more than 20% of their shares count in voting. This “will reduce their influence over our ability to complete our business combination,” Silver Run added in its S-1. If the group is still successful, the Spac’s share price is likely to decline anyway, thus the shares may have to be sold at a loss.

‘Godfather’ of shale

Among buyers of Silver Run is Michael Dell, whose MSD Capital LP and managers control 3 million units (6%), according to an SEC filing. In addition, Wellington Management Group LLP controls 5.1 million, or 10.6%.

“Historically, there had been a much smaller universe of investors who would look at Spacs,” Trauber said. “But there was a tremendous amount of interest in Silver Run. They love Mark Papa. They love Riverstone.”

Papa became chairman and CEO of EOG in 1999 upon its roll-out from Enron Corp. He retired as an officer in 2013 and as a director in 2014. He joined Riverstone as a partner in 2015 and formed Silver Run in November.

Although EOG didn’t drill the Barnett, Fayetteville, Marcellus, Bakken, Eagle Ford and other shale plays’ horizontal discovery wells, it has been viewed as an innovator. The Motley Fool described Papa recently as “the ‘godfather’ of U.S. shale.” It reported, “The shale industry is decimated and the ‘Godfather’ … has returned … . Given the current distress in the energy patch, it seems hard to imagine that any transaction Papa chooses to act on could come at a bad price.”

Shah said, “A lot of these [Silver Run] investors knew Mark Papa from EOG. Their view was ‘I worked with Mark Papa before. I made money with him before.’”

Silver Run sold 45 million units at $10 each and an overallotment of 5 million units. Each unit (SRAQU) consists of one common share (SRAQ) and a one-third warrant (SRAQW) to purchase a common share at $11.50 per. Separately, Silver Run sold 8 million warrants at $1.50 each to its sponsor, Silver Run Sponsor LLC. These can’t be sold until 30 days after Silver Run completes its initial merger.

Placed in trust was $500 million. Proceeds can’t be released until there is an initial combination. If there isn’t one within 24 months of the IPO’s pricing, the cash is to be returned to the unitholders.

A Spac’s sponsor pays the fees associated with the IPO and neither it nor management is paid until a deal is done. Each Silver Run unit in trust retains a cash value of $10. Shah said, “What you see [in mid-April] on the screen [of $10.35 a Silver Run unit], the cash value is $10. It’s trading above its cash value.”

Buyer’s market

Silver Run priced on Feb. 23, while Papa was speaking at IHS CERAWeek. Papa said, according to a FuelFix report, “The next six to 12 months [are] going to be a decimation for [the E&P] industry—bodies all over the place.”

Tom Edelman, managing partner of private equity firm White Deer Energy LP, said in an IPAA-hosted program in April that, at the end of this cycle, between 30% and 50% of the industry “will be unrecognizable” after asset swaps, restructurings, bankruptcies and other revisions to portfolios and capitalization.

“I think it will be a two- to two-and-a-half-year process to clear away all the rubble,” he said. Operators with access to any type of capital “are going to be in the best position to be able to participate in this market.”

KLR Energy sold 8.2 million units at $10 each in March. The units (KLREU) include one common share (KLRE) and one full warrant (KLREW) to buy a share at $11.50. Its sponsor is a KLR Group LLC affiliate. Buyers of 5% or more of KLR Energy units are The K2 Principal Fund LP, Weiss Asset Management LP and Polar Asset Management Partners Inc., according to SEC filings.

“The KLR founders saw a need in the marketplace for companies that aren’t distressed or broken,” said T.J. Thom at KLR Energy Acquisition Corp.

Hanna and the group are offering their Spac as an avenue for a private operator with a decent balance sheet to access the public market. The merger candidate won’t be in bankruptcy proceedings, Hanna said. KLR has up to 18 months after pricing the IPO to close a deal or the capital raised will be returned to the unitholders.

“We need surety of close,” he said. “In bankruptcy, you can’t control the timeline. It’s too difficult to get all of the players to a common solution.”

Thom said the KLR founders saw a need in the marketplace “for companies that aren’t distressed or broken. They’re good companies that simply missed the IPO window, and access to the high-yield market is no longer an option. At the same time, they are being squeezed by their [bank revolver]. They’re stuck, but they have decent balance sheets.”

Candidates may be private, family-operated E&Ps. “They see opportunities to efficiently deploy capital for strategic acquisitions and simply can’t access capital,” he said.

Hanna said, “We are a merger vehicle to inject capital into a company to come out as a fast-tracked, public entity with a very strong balance sheet. In selling to us, a private operator is selling to themselves. Once they are in the public market and well-capitalized, they will be in a position of strength.”

Re: Leverage

Law firm Skadden, Arps, Slate, Meagher & Flom LLP reported in April that 25 U.S.-based Spacs raised more than $5 billion in 2015. Silver Run’s and KLR’s IPOs were among only 11 U.S. IPOs of any type in the first quarter of this year.

“The rise in popularity comes at a slow time for the IPO market,” the firm reported, “and is in part due to the fact that well-known private equity firms increasingly are serving as Spac sponsors as a means to expand their potential sources of equity capital outside of the traditional private equity model. The presence of respected private equity sponsors, with their significant expertise, makes Spacs more attractive to would-be targets and potential investors.”

The cash value of KLR’s units is $10.40 each. Hanna said, “We wanted to offer our investors the ability to offset some of the cost of parking their money in our trust for up to 18 months. We thought a 4% return was fair and made our investment a bit more attractive.”

“On a fully baked basis, when you take into account land-acquisition costs, we think the cost of supply in the U.S. is $60 to $70,” said KLR Energy president Ed Kovalik.

Except for having a bank line of credit, KLR doesn’t plan to leverage acquisitions with debt. Hanna said, “We want the resulting business transaction to have a very pristine, clean balance sheet.”

Ed Kovalik, KLR Energy president, is CEO and a managing partner of its sponsor, KLR Group, which he co-founded in the spring of 2012. Kovalik said that, “on a fully baked basis, when you take into account land-acquisition costs, we think the cost of supply in the U.S. is $60 to $70. On a go-forward basis, companies are making money at $40 in some parts of the Permian and D-J, but those are in the core, sweet spots.

“Outside of there, you really need realized prices of $50 or more to make money in most areas. I don’t think there is any place exciting for development from a commodity-price perspective, which is why our [KLR Energy] strategy is more on acquisition than on development.”

Hanna said a merger candidate could continue to run the company. “We’re not necessarily looking to displace a management team. We would make their growth less expensive.”

Citi’s Trauber said there could be more energy-focused Spacs this or next year. “It’s not a deep market, so there would have to be an awfully compelling thesis and management team to raise the funds,” he added.

After Silver Run completes an initial business combination and “is successful, as we expect it will be, there might be some others that follow. We don’t expect a rush to do a lot of these, but I won’t be surprised if there is one or a couple in the next year or 18 months.”

Twenty-five U.S.- based Spacs raised more than $5 billion in 2015, according to law firm Skadden, Arps, Slate, Meagher & Flom LLP.