?First-quarter 2008 was tumultuous, marked by an escalating debt-market meltdown from the sub-prime mortgage bubble and signs of simultaneous recession and inflation. Retail sales fell, oil prices rose as the U.S. dollar weakened and non-petroleum import prices had grown 4.5% from a year earlier, all affecting the way investors and banks prioritize business strategies.


The ongoing credit crisis moved the Federal Reserve to become a “lender of last resort” to Wall Street investment firms by offering short-term emergency loans, and it lowered the federal-funds rate to 2.25%. JPMorgan Chase & Co. offered to bail out rival Bear Stearns & Co.


Yet, investment banks focused on energy see themselves as a relatively calm port in the storm. “Once funds figure out how to put out their own fires internally, they still have to put their money somewhere, and energy looks fantastic,” says Adam Connors, an associate director for boutique investment banker C.K. Cooper & Co. in its corporate finance group.


“The discount in the deal that JPMorgan Chase offered for Bear Stearns seems to indicate that there is more trouble behind the scenes than what was initially apparent in the current credit crisis.”


Based in Irvine, California, C.K. Cooper is focused exclusively on banking oil and gas companies. “Some of the big boys we’ve worked with are rebalancing their portfolios, working on their leverage situations and attacking that chaos before further investing. In the energy sector, we are in such a high-priced commodity environment that energy investment continues to be very compelling.”


While there was a flurry of public investment-banking transactions in the fourth quarter of 2007, the first quarter of 2008 has been much quieter.


“There simply are not a lot of transactions going on in the public-equity side in 2008. It’s speculatively attributable to this current restructuring of the way the buyside does business.


“Some institutions have lost their comfort level in the markets as a whole. In combination with the tiptoeing economy and the dollar devaluation, it seems as though they have other issues they are dealing with.

They evidently are sitting on the sidelines, watching the credit issues unfold and speculating on how that affects their business. It really doesn’t have anything to do with the fundamentals of the energy industry, which are still very compelling.”


The investment bank targets smaller, independent nuts-and-bolts E&P firms. “We have to resort to our experience—partnering with issuers that will successfully attract capital, even in these times of turmoil. We find that fundamental, nuts-and-bolts companies with defined strategies, compelling assets and experienced, proven management works in any market. Our job is to keep our pulse on the markets, evaluate the appetites of the Street, and match those to opportunities they seek,” says Connors.


Two such opportunities are exemplified by the firm’s recent success with ATP Oil & Gas Corp.’s $235-million public offering, and Cano Petroleum Inc.’s $25-million private placement.

The OTC: QX
Connors is enthusiastic about a fairly new platform market from the U.S. Pink Sheets, called OTC: QX, which was launched in March 2007. The exchange is designed for small- to midsize U.S. and foreign-listed companies, in a post-Sarbanes-Oxley environment, exposing them to a large capital market.


“This platform is conducting a push to list international companies that are currently listed on other exchanges. This exchange has fewer regulatory aspects than the big boards, but more than the traditional Pink Sheets. Think of it as a hybrid of the U.K. AIM market and the Nasdaq and Amex,” he says.


Today, it costs about $1 million to be listed as a U.S., fully reporting company, whether through an IPO, reverse merger or other structure, he says. Listing on the new Pink Sheet platform is a much less expensive alternative to access needed public capital for start-ups.


“OTC: QX mirrors what the Nasdaq and Amex do, with business-plan reviews and background checks on executive managements, offering a real level of comfort to investors. They are investing in actual companies with ongoing operations, not shells, blank checks or special-purpose acquisition companies (SPACs),” says Connors.


The platform has a qualitative screening process and requires oversight administrators known as designated advisors for disclosure (DADs) and principal American liaisons (PALs). “The new platform could be a great stepping stone for some energy listings,” says Connors.


After studying the new platform, C.K. Cooper promptly submitted applications to operate as both DAD and PAL for interested E&Ps, and was officially approved for both positions on March 20. Other investment banks, such as Roth Capital Partners Inc., Sanders Morris Harris Group Inc. and Dahlman Rose are also planning to list client companies on the new exchange.

SEC rules relaxed
Another new trend, that of more E&Ps having a registration statement on file, may be promoted by the SEC’s decision to adopt three new measures to modernize and improve capital-raising, reporting and disclosure requirements for smaller companies, says Steve Landry, partner and head of corporate finance for Mandeville, Louisiana-based, boutique energy banker Pritchard Capital Partners LLC.


The final rules make scaled disclosure regulations available to smaller companies. They also shorten the holding period for restricted securities of public companies, issued in private placements, from one year to six months. Finally, the rules create two new exemptions for compensatory employee stock options so that registration requirements will not be triggered solely by a company’s compensation decisions.


“Now, with the easing of SEC rules for filing shelf registrations and the shortened hold time under Rule 144, which will reduce the cost of capital and facilitate timely access to capital, I think we will see more companies take advantage of having a registration statement on file. That will enable them to quickly, efficiently and opportunistically access capital, once the shelf is effective, without having to undergo a prolonged registration process with the SEC when capital is actually needed. Smaller companies are now able to do that,” Landry says.


Also, the rule change regarding the holding period for private placements likely will result in companies becoming involved in more private deals than in the past, he says.


“These are all somewhat new events, although there has been discussion about these changes for quite some time with public notification and commentary. These rules are finally coming into effect now. We are seeing some interest expressed by companies wanting to issue securities under the new rule regime.”


Since 2005, Pritchard Capital has been involved in some $7 billion of capital markets transactions in E&P, oilfield services, coal, tankers, utilities and clean energy. Its role has been in IPOs and secondary offerings, equity-linked securities, debt and equity private placements, and M&A advisory.


Consolidation may occur, he says, among both large and small investment-banking firms. “I think the fall-out of the Bear Stearns failure will not be fully appreciated for some time to come. I don’t think anyone could have predicted just how fast and how hard that firm came down.


“It just goes to show what a lack of confidence in liquidity can do. This was essentially a run on the bank, so to speak. We will have to wait and see what happens when the dust settles.”


Such an event causes unintended consequences, he adds. “There will be quite a few talented investment bankers, research analysts, institutional equity salespeople, equity and debt capital-markets people, as well as corporate-finance guys, who will need to find a new home. There will be a fair amount of talent transitioning in the marketplace, and we may see some new, smaller firms come out of all of this.”


Many energy companies are generating significant cash flow due to high commodity prices, and may choose to avoid the debt or equity markets at this time.


“The market hasn’t seen as many transactions this year as we would ordinarily expect to see at this point in time. To some extent, excess internally generated cash flow and the volatility in the market has kept some potential issuers on the sidelines.”


How institutional investors react to the volatility of the marketplace will affect how much investment-banking business gets done. “There is a lot of interest in oil, gas and service companies, given the current level of commodity prices. We haven’t seen energy share prices deteriorate to the same extent as the broader market. They generally move in tandem with commodity prices, which have been on a tear.”


Companies with a lot of running room include Chesapeake Energy Corp., Range Resources Corp., Arena Resources Inc., Petrohawk Energy Corp., PetroQuest Energy Inc. and BPZ Resources Inc., he says. On the service side, there are T-3 Energy Services Inc., Flotek Industries, OYO Geospace Corp., Hercules Offshore Inc. and Hornbeck Offshore Services Inc.


“Also, offshore companies are bound to do well, given the near-record amounts bid on lease blocks at the recent lease sales, even if we see some diminution in commodity prices over the near- to mid-term,” Landry says.


The weakening dollar may affect U.S. independents in the M&A marketplace, says Landry, in competing against foreign energy companies for assets or companies. This has especially been true in the Gulf of Mexico.


“They are able to bid higher than domestic companies, due in part to their relatively stronger currencies. This makes it more difficult for U.S. companies to compete for assets,” he says.

Commodity prices
“We believe, as many economists surveyed in recent news reports believe, that we are currently in a recession,” says James A. Hansen, Houston-based managing director of energy investment banking for Broadpoint Capital Inc., formerly known as First Albany Capital Inc.


The firm is a subsidiary of Broadpoint Securities Group, formerly known as First Albany Cos. Inc., and co-subsidiaries are Broadpoint Securities Inc. (formerly Descap Securities Inc.) and FA Technology Ventures. The investment bank has raised more than $7 billion in capital since 2003.


Regardless of the spiraling economic contraction, the price of oil continues to hover at record-breaking prices. According to Tom Covington, Broadpoint managing director and lead E&P research analyst, prices are responding to the declining dollar, easing monetary policies and surging commodity investment. At this point, supply, demand and inventory data are not primary causes.


“This really is more about the lack of demand for dollars than about any difficulty of oil supply,” says Covington. “It’s hard to recall a time when oil’s physical-market fundamentals were so seemingly divorced from price reality.” Covington recently increased Broadpoint’s forecast for oil and gas for 2008 to $88.50 and $7.80, respectively.


“With the overall world economy slowing, we expect volatility to continue. In fact, there is further room for the dollar to move down,” says Hansen. Still, some economists seem much more comfortable predicting a near-term market bottom than they were a month or so ago, he says.


Despite that, energy capital markets and M&A activity should be robust for 2008 because, first, oil and gas stocks currently represent a “defensive strategy” versus other sectors and a relatively large proportion of the S&P 500 (13% now versus 10% a year ago). Secondly, the U.S. equity market may offer relative gains, versus absolute gains, compared with international markets.


Overall, investors have not priced in the robust current and long-term commodity prices into most E&P names, suggesting a view that both oil and gas will “roll over,” says Hansen.


“We believe there are still compelling E&P stories, even with lower commodity prices. These stories possess excellent management teams, organic growth prospects and low operating costs.”


Hansen says NGAS Resources Inc., BPZ Energy Inc., Cano Petroleum Inc., Rex Energy Corp. and Newfield Exploration Co. should do well in 2008. While geographically and geologically diverse, each has strong management and offers substantial upside, he believes.


“A trend we see developing is that many micro-cap companies that benefited from the run-up in commodity prices several years ago have actually fallen within the last 12 to 18 months. We see this as a direct result of capital flight to larger, more liquid names. Those with quality assets may increasingly seek merger partners to provide scale, diversified assets and shareholder bases,” he says.


The M&A market will thus be strong in 2008, with more than $30 billion in property transactions by the end of the year, he predicts. This is in addition to expanded capex budgets that result from more drilling opportunities and slightly higher drilling costs than in 2007.


“The bank credit market has tightened, but it’s still available to support financing. Although the spread on both high-yield and investment-grade paper has jumped considerably, both markets should be more attractive by the end of the year,” Hansen says.