Forthcoming Energy Equity Great Battle

Dan Denning - Tue 30 Jan, 2007

... there are two factors which make more private equity bids for energy assets more likely. The first is that the supply of well-managed energy companies with good balance sheets. Private equity is keen to buy scarce and quality assets, wherever it can find them. The energy sector presents compelling value ...

- The "Great Battle for Energy Equities" will begin heating up very soon. Major oil companies around the globe will find themselves directly competing with private equity firms and their ultra-rich clients for the energy assets of publicly-listed stocks.

- It’s worth noting that four of the five largest merger and acquisition deals in 2006 were private equity deals. And private equity firms already have $146 billion stockpiled for a new round of acquisitions in 2007, according to PriceWaterhouseCoopers.

- With such a sizeable war chest, private equity firms will continue what is nothing less than, "a significant privatization of the American capital system," according to William Krisch at private equity law firm, Paul, Hastings, Jansofsky and Walker LLP.

- Because so many cash-laden private equity firms are prowling the financial markets, appetizing prey has become scarcer. But many of the oil services and oil exploration stocks remain extremely enticing acquisition prospects.

- Private equity analysts must do the same thing you and I try to do each day as investors: buy a dollar's worth of value for less than a dollar. The private equity world has added a twist: lots of leverage. By using lots of debt to acquire a company, the returns on the actual cash invested can be much higher. But the risks of debt-financing are also higher.

- That kind of leverage means you don't want to enter into just any sort of deal. The target acquisition must either have lots of cash per share, sell at a deep discount to sales or book value, or be in a sector in which demand is growing buy supply is scarce.

- At first blush, energy exploration and production companies would not seem to have the attributes of a typical private equity target. Exploring for oil and gas involves a large capital cost which must be financed through either cash flow, debt, or equity.

- But there are two factors which make more private equity bids for energy assets more likely, though. The first is that the supply of well-managed energy companies with good balance sheets. Private equity is keen to buy scarce and quality assets, wherever it can find them. The energy sector presents compelling value.

- The second factor that puts energy assets on private equity’s radar is the long-term underlying scarcity of oil and gas that’s driven energy stocks higher since 2004. Oil and gas are getting harder to find.

- Publicly traded energy conglomerates and nationally run firms are finding it harder to replace annual production with new reserves, especially because demand keeps rising and discovery of new reserves keeps falling. Therefore, private equity investors see the fundamental picture for energy assets being very bullish and would like to get in now, while credit remains cheap, energy prices remain high but stagnant, and before other bidders start arriving.

- There WILL be other bidders, however. That is the third and final factor leading to higher prices for energy assets in 2007. Private equity buyers will find themselves engaged in bidding wars with major oil companies, flush with cash but desperate for new sources of production, as well as countries like China and India, flush with cash from trade, but also in desperate need of secure energy supplies.

- It will be a great energy equity rush. And as an investor, the obvious question is which companies will be most coveted? Oil service companies and oil exploration and production companies seem particularly attractive.

- The epic bull market in energy stocks is about to enter a second phase. As private equity funds battle the world’s major oil companies for control for scarce energy assets, the prices of most oil stocks should move considerably higher, especially if crude oil itself, stages a modest rebound. It all adds up to a continuation of the epic bull market in energy stocks.

- Let the battle, and the profits, begin. 

Regards,
Dan Denning,
for The Daily Reckoning

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