With energy-stock valuations so high today, is this the right time for seasoned E&P management teams to take their private companies public through an initial public offering? Or, with so much private-equity money flowing into the E&P space, is it better for those teams to continue growing independently in the private sector? Both paths to profitability clearly have upside-and downside-attached. On one hand, the public sector affords access to greater amounts, and more diverse forms, of growth capital. Also, the management of public companies typically retain a bigger slice of their corporate pie than would be the case in the private arena. On the other hand, a lot of teams recently coming out of large, publicly traded companies have little taste left for all the headaches associated with running such entities. Many eschew the burdensome spate of regulatory and compliance issues-and added costs-associated with the Sarbanes-Oxley Act of 2002. Some have had their fill of slavishly trying to hit quarterly-reporting numbers, in terms of production and reserve targets, just to satisfy Wall Street estimates. One now-private producer observes that even when it makes financial sense to sell an asset, it's hard to do so as a public company due to the perpetual pressure of having to meet these targets. Given these tradeoffs, does a private-sector strategy trump going the IPO route? To find out, Oil and Gas Investor talked with four upstream managements-two in the private arena, and two in the public arena. They have successfully grown shareholder value in both the public and private sectors, so they bring rounded perspective to the debate. Private hunters With the ink barely dry on the $2.7-billion sale of their public company to EnCana Corp., former Tom Brown chairman Jim Lightner and four other senior executives from the firm huddled last summer with private-capital providers to raise seed money for a private E&P start-up. The result: State Farm Insurance and Wellington Management put up the lion's share of $50 million in private equity to kick-start Orion Energy Partners, the brainchild of Lightner and his Tom Brown partners. The new upstream entrant will focus on drillbit and acquisition opportunities in the U.S. and Canadian Rockies, from New Mexico's San Juan Basin to the Alberta Foothills. It will also concentrate on the greater East Texas area, including the Bossier, Cotton Valley and Barnett Shale plays, and on the West Texas Permian Basin. "When Tom Dyk, Dan Blanchard, Doug Harris, Rod Mellott and I left Tom Brown, we could have parachuted into another public E&P company looking for seasoned management," says Lightner. "But we really wanted to start from scratch as a small private team, build a company, ultimately sell it to a larger company, then repeat the process-all the while creating value for shareholders." This approach carries less baggage than operating in the public sector, he contends. "Unlike a public company, you don't have to constantly talk about what you're doing and hence, put yourself at a competitive disadvantage." Also, a private operator doesn't have to deal with an investment community fixated on constant production and reserve growth versus real value creation, he says. Lightner notes there are many times when it may make more financial sense for an operator to sell a field before it begins to decline. Yet that's often hard to do in the public model because of the pressure to meet quarterly production and reserve targets set by Wall Street. In addition, public E&P companies these days face all the regulatory and compliance issues surrounding Sarbanes-Oxley. "Although important in some respects, this act has nonetheless thrown onto public entities large accounting and governance costs, much of which are nonproductive in terms of creating value for shareholders," says Lightner. "By being private, nearly all of our costs go into economically finding oil and gas and creating value for investors." With 12,000 to 15,000 nonproducing acres currently under lease in the Rockies, Orion Energy Partners isn't relying solely on an acquire-and-exploit strategy to propel its growth. "We're also very focused on grass-roots exploration plays where we can lease early on all the nonproducing acreage in a prospective area before other operators get into that play," says Lightner. In addition, Orion is seeking to form joint ventures with larger producers where it can use its reservoir-characterization expertise, operating experience and lower cost structure to help those producers grow production volumes on properties they don't have the time to work. Says Lightner, "Selling Tom Brown was a great way to create value for shareholders in the public market. That's what we'll be trying to replicate at Orion, this time privately." More capital access When Marc E. Bruner formed privately held Dolphin Energy in June 2002, it wasn't with the intention of keeping that Miami-based entity private very long. Indeed, by November of that year, he completed the reverse merger of Dolphin into a then publicly traded shell, Galaxy Investments. The E&P company was renamed Galaxy Energy Inc. (OTCBB: GAXI) in May 2003 and is currently headquartered in Denver. "From the start, we felt that unless we could raise $50- to $100 million of private capital-something that would have been hard to do when all we had were some options on coalbed methane (CBM) concessions in Wyoming's Powder River Basin-a public company was the best vehicle to raise capital incrementally from different investors wanting the liquidity of public stock and clarity of value in their investments," explains Bruner. With this public-market view, Galaxy Energy proceeded to raise $5.6 million through an October 2003 convertible-debenture offering, $3.5 million through a December 2003 offering of common stock with warrants, and $11.9 million through a similar January 2004 offering. The latter two transactions were handled by the Shemano Group, a San Francisco investment-banking firm that caters to micro-caps. During that same period, the company was also able to acquire-for stock, notes and cash-a 100% working interest in some 12,000 gross acres of Powder River CBM leases held by a group of private Wyoming-based operators. Meanwhile, it acquired, through a stock-and-cash deal, interests in an additional 15,000 gross acres of Powder River leases, this time from Pioneer Oil LLC, another private Wyoming operator. "The fact that we were a public company, that our stock was trading up, and that we were able to use that stock, in part, as currency for these acquisitions was largely the reason we were able to complete nearly $30 million worth of transactions in a four-month period," says Bruner. To round out the funding for its CBM drilling program for 2004 through early 2005, Galaxy completed a $20-million, convertible-debenture offering last August, again through the Shemano Group. "With all this capital-raising in the public markets during 2003 and 2004, we were able to drill, through last fall, more than 100 Powder River wells-all of which we expect to have on production during the next 60 days," says Bruner. This funding will also allow Galaxy to drill and complete another 80 wells by the end of first-quarter 2005. As a result, its natural gas output will rise from about 400,000 cubic feet per day-from only eight wells online last November-to 20- to 30 million cubic feet per day. While there are extra costs associated with being public versus private, there are major tradeoffs for management, the Galaxy head says. "One of them is being able to retain a much bigger piece of the company than would be the case if all the money came from major private-capital investors who typically insist on owning larger pieces of private entities." Recycling privately Randy Foutch, chairman, president and chief executive officer of Tulsa's Latigo Petroleum Inc., knows a thing or two about growing private upstream companies. In 1991, with just $50,000 in hand, he started Colt Resources, a Tulsa-based E&P company focused on the Anadarko Basin. Three years later, he brought in First Reserve Corp. as a private-equity partner, and in 1996, sold Colt to JN Exploration and Production for slightly north of $30 million. The following year, with $20 million of initial private-equity funding from Warburg Pincus, Foutch formed another private Tulsa start-up, Lariat Petroleum, which targeted drillbit growth in both the Anadarko and Permian basins. Through an added $54 million in funding from Warburg during the next three years, Foutch grew Lariat steadily from a company with zero reserves to one with proved reserves of 256 billion cubic feet equivalent (Bcfe). On New Year's Day 2001, he sold the company to Newfield Exploration for $333 million. Not finished with replicating this successful upstream business model, Foutch formed another Tulsa start-up, Latigo Petroleum, in late 2002 with $300 million in private-equity commitments from Warburg Pincus and JPMorgan Partners. Its focus: drillbit opportunities in the Anadarko, Permian and Arkoma basins. "We're almost boring in our methodology, but it's our belief that if you're good at exploration, that's going to allow you to make better acquisitions and enhance your overall rate of return on them, versus just drilling the development wells that initially come with those acquisitions," says the Latigo head. By pursuing this boring methodology, Latigo within the past two years has increased its proved and probable reserves from zero to 200 Bcfe and 100-plus Bcfe, respectively. Meanwhile, its production has grown from zero to 30 million cubic feet per day. Notably, 25% of this output is from new, exploratory wells. Explains Rodney Myers, Latigo's chief operating officer, "By adding value through the drillbit, we're taking some of the risk out of our acquisitions on the price side." As for choosing the private sector as the path to growth thus far, Foutch feels very comfortable with this strategy. "Private-equity people understand industry cycles well and often choose to be aggressive in their investing precisely at the time when there's no public money available. We view that as a tremendous advantage, in terms of being able to manage our business long term." Foutch adds that being private also allows management to run Latigo with an exclusive focus on shareholder value. "We don't have to run it to hit quarterly-reporting numbers." In addition, the private company doesn't have to contend with Sarbanes-Oxley. "If we had to adhere to that act, it would probably cost us $2- to $3 million a year in accounting, legal and public-reporting expenses," says Mark Womble, Latigo chief financial officer. "More importantly, as a public company we'd have to spend an extraordinary amount of management time on governance issues." These negatives aside, Foutch concedes that being public has an advantage. "In good times, you can access capital at a much lower cost than accessing private equity." Opportunity driven Floyd C. Wilson, president and chief executive officer of publicly traded Petrohawk Energy Corp. (Nasdaq: HAWK) in Houston, is a veteran entrepreneur comfortable with both the private and public markets as avenues for growth. In 1976, he founded Kansas Oil Corp., a private Wichita start-up with a Midcontinent focus and zero assets. In 1982, Wilson sold that firm to a private Kuwaiti partnership for more than $20 million and the assumption of debt. That same year, he formed another private Wichita start-up, Reach Oil Co., which was sold four years later to Australia's Western Gulf Resources for $20 million. Again in the private sector, Wilson in 1987 founded Hugoton Energy Corp., which grew to $100 million in asset size by 1994 when it was taken public; four years later, after the company had grown to $400 million in enterprise value, it was sold to Chesapeake Energy. "In taking Hugoton public, I felt the move would open more financing options for growth while allowing me to maintain more control over the company than would be the case if I had continued growing it through private-equity sources," says Wilson. After selling Hugoton in 1998, the entrepreneur that same year formed 3Tec Energy Corp., a private Houston independent he then took public in 1999 through a reverse merger with Middle Bay Oil Co., a then publicly traded Houston operator. "With EnCap Investments providing $20 million of equity backing and our management another $2 million, we recapitalized Middle Bay and renamed it 3Tec Energy," explains Wilson. "We saw Middle Bay, with its Midcontinent and East Texas assets, as a good fit and public platform for our acquisition and drilling strategy in those regions." A good platform, indeed. In June 2003, he sold 3Tec for $450 million to Plains Exploration & Production. Wasting no time, Wilson that same month formed Petrohawk Energy LLC, a private Houston producer focused on the Gulf Coast and Midcontinent regions. Soon after, a small, public Tulsa operator, Beta Oil & Gas Inc., caught his eye. The result: in May 2004, with $54 million of equity funding from EnCap Investments and Liberty Mutual Energy Co. and $6 million of management's money, Wilson completed the reverse merger of Petrohawk into Beta, with Petrohawk Energy Corp. the surviving public entity. "Although it had attractive properties in the Midcontinent and Gulf Coast, Beta wasn't receiving reasonable value for those properties in the stock market," he says. "We saw an opportunity to obtain those properties at a bargain price and accelerate the growth of Petrohawk-not just in terms of additional assets but also in terms of the broader array of financing alternatives typically available to public companies." Indeed, this past November, Petrohawk Energy-needing to close on the $425-million acquisition of privately held, Dallas-based Wynn-Crosby Energy Inc.-was able to raise $450 million. Of the total, $250 million was through a bank group led by BNP Paribas, and $200 million was from a convertible preferred stock offering handled by Friedman, Billings and Ramsey, an Arlington, Virginia investment-banking firm. The acquisition leap-frogged Petrohawk's proved reserves to 233 Bcfe from 33 Bcfe, and daily production to 57 million cubic feet equivalent from 11 million. "We couldn't have grown Petrohawk as fast as we have if we were still private," says Wilson. "On the other hand, it's a lot less cumbersome, from a reporting standpoint, running an oil and gas company privately. So there are merits to each strategy. I've employed both, based on which made the most sense at a particular time to seize opportunity." M