Thomas Weisel on PE in O&G sector

If you focus any of your brain on the private equity world, you cannot help but notice the role that buyout funds are starting to play in Canada’s oil and gas market. Funny thing, this.

Hedge funds were blamed for playing the momentum of oil from $70/barrel to $115/barrel. Now private equity is starting to deploy cash. Given that the Fortress (FIG:NYSE) and Blackstone (BX:NYSE) IPOs marked the end of the run in financial and PE shares, our Calgary friends can only hope this is not the sign of a top.

From Thomas Weisel Partners’ research:

“Insight or Development:

In the wake of yesterday’s news that Saxon Energy (SES-T: $6.99; Restricted) has been negotiating to potentially go private, we ask the larger question of why so many private equity deals are happening in this space.

Analysis:

Private equity has recently invited itself to the oil service ball, which on the face of it is surprising given the typically early-stage timing of private equity participation. That is, private equity often looks at a sector when it is down and out and in need of re-organization-focused capital, not in the middle of a global resource boom (to include the oil-levered stocks in this group). What gives? Before addressing this question, we need to look at some data points. For example, First Reserve, a sizeable private equity group specializing in energy transactions, is in the final stages of taking offshore helicopter company, CHC Helicopter (FLY.A-T: $31.79; not covered) private, for roughly $3.7 B. First Reserve also bought international land driller, the Abbot Group in December 2007 for £906 MM. A private equity consortium led by Candover Group and Goldman Sachs agreed on April 18, 2008 to pay £1.8 B for Expro International (EXR-L: £14.95; not covered) – a price that may be trumped by Halliburton (HAL-N: US$47.46; not covered), based on more recent disclosures. Finally, yesterday, Saxon announced that it is in exclusive discussions with First Reserve and Schlumberger (SLB-N: US$106.91; not covered) to take Saxon private for $7.00 per share (value of almost $700 MM, including debt), with the participation of Saxon’s current management team.

Without commenting on the individual merits of any of these transactions, we note that private equity has become much more aggressive in this space than we are used to seeing. First, we can conclude that private equity is taking a more optimistic view of the long-term growth potential of oil service companies than many in the market. With WTI oil prices steaming toward US$120/bbl and U.S. natural gas prices now above US$10.00/mcf, commodity traders and strategic investors (such as private equity) appear to be getting quite optimistic on the durability of this commodity bull run. The arguments around tight supplies of oil and natural gas are well known. Further, demand for both is being generally fed by enormous GDP growth rates in emerging economies (oil and gas) and environmentalism (gas). Second, valuations are clearly below what we have seen in past bull runs (e.g., 1995-1997, 2000-2001), which is frustrating to many observers such as ourselves who believe the problems around future energy delivery are underappreciated and systemic. These are structural problems that will take a long time to solve, opening the door for much corporate growth along the way. Private equity recognizes this opportunity. Third, individual transactions often offer unique exposure to certain areas or themes, which private equity is recognizing early.

Conclusion:

The proliferation of private equity oil service deals amidst a commodity bull run seems surprising at first blush. However, value creation opportunities remain plentiful, which private equity is clearly noticing.”

MRM