Nestled between private equity and MLPs on the energy investment spectrum is Cornerstone Acquisition & Management Co. The company’s energy hedge funds, The Caritas Funds, invest in mineral, royalty and nonoperated working interests. Derren Geiger, portfolio manager, heads a team of seven from Rancho Santa Fe, Calif. While low commodity prices have put the E&P universe in a tailspin, for an investment vehicle like Caritas, which divested a majority of its portfolio this past September and now is redeploying that capital, the downcycle looks appetizing.
Chicago native Geiger spent much of his childhood in California. Joining the Air Force after high school, he worked in conjunction with the U.S. Drug Enforcement Administration searching for drug-trafficking aircraft from locations within Honduras. After his service he earned a finance degree from Arizona State University, where a hedge fund internship developed his expertise in capital markets and asset management.
After college he took a job with Barrington Consulting Group in Chicago, focusing on private company valuation, and earned his CFA. Desiring a return to the capital markets, he joined Preservation Capital, a commodity-focused hedge fund. In 2005 he moved his young family to San Diego and became lead acquisitions analyst for newly formed Cornerstone. He took over management of the fund’s portfolio in March 2009, in the depths of that crude price downcycle.
In a recent interview, Geiger discussed Cornerstone’s strategy in 2015 and beyond.
Investor: You’ve described Caritas as a hedge fund/private-equity hybrid.
Geiger: Yes. The funds allow investors conservative private oil and gas exposure, albeit in a relatively liquid (semi-annual) investment vehicle. The liquidity profile of the funds matches that of the underlying assets.
Investor: What returns have you generated?
Geiger: Caritas has generated 19% net annualized returns since inception (2004), with a 31% return in 2014. Approximately 10% of that was through yield generation, with the remainder a gain from the sale of a majority of our portfolio to Haymaker Minerals & Royalties LLC for $162.5 million. We retained our nonoperated working interests.
We sold at attractive prices, locked in the gain and are now deploying that capital at a materially lower price threshold with less downside risk exposure for our investor base. Acquisition opportunities will increase the longer prices languish, providing an optimal scenario for investors possessing a positive long-term energy outlook.
Investor: Factors in your success?
Geiger: We’ve been very timely over the past decade in creating alpha for investors. We patiently wait for outlier events, and subsequently put significant conviction behind our positions. Examples include hedging aggressively in the aftermath of weather events (2005), price peaks (2008) and geopolitical strife (2011). Acquisitions and divestments follow the same methodology—actively adding during downturns and monetizing when rational.
Investor: You mentioned three tenets.
Geiger: Yes. First is property discipline—acquiring high-quality assets with stable cash flow. We attempt to create an ideal blend of long-life, low-declining properties with proven high-growth opportunities. Second is acquisition discipline— essentially, paying the right price, recognizing value at troughs in the cycle and not overreaching in a strong commodity price environment. Third is prudent hedging—locking in yield at price extremes.
Investor: How will E&Ps manage this cycle?
Geiger: It’s an opportunity for those that are financially stable and have capital to deploy. The longer prices stay low, the more pressure that builds on smaller, highly levered E&Ps to raise capital. Asset sales will be a large part of that process.
Private-equity firms will be very active, with several launching new funds to take advantage of this price decline. MLPs will increasingly be forced to slash distributions amid cash flow shortfalls. The two are aligning in certain instances; Linn Energy has teamed up with Blackstone to fund some of Linn’s drilling. It will be interesting to see how the upstream MLP sector ultimately fares during this downturn. Some are better positioned financially, strategically and geographically than others; however, one has to be cognizant of contagion risk in the sector.
Investor: Size and timing of your deployments?
Geiger: As long-term investors, we’ll leg in when and where we see pockets of value. Prices could drop into the lower $40s before capex cuts have an impact.
Cornerstone has approximately $300 million to currently deploy on a moderately levered basis, but could ramp that up further depending on the asset type. In terms of royalties, I’m confident we can tackle nearly any size portfolio. We typically limit nonop interests to a minority percentage of the overall portfolio, so the size is capped at $25 to $50 million per transaction.
Investor: Your outlook for crude prices?
Geiger: I believe the supply overhang will moderate in second-half 2015. That being said, the market is completely discounting any potential global supply issues. The world is a much more dangerous place with crude at $40 than at $80. Investors, by and large, were exceptionally bullish with WTI in the $90s and are now decidedly bearish with prices in the $40s. Cornerstone has the opposite mindset.
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