During the final months of 2010, industry watchers were paying special attention to E&P announcements, reading between the lines for insight about development strategies and revised sentiments about natural gas. A year previous, just as energy reporters were starting to think about the holidays, the surprise was the flurry of M&A deals that suddenly came across the wires. Near the end of 2010, however, the markets saw a different surprise when two well-known, gas-weighted E&Ps, Quicksilver Resources Inc. and Exco Resources Inc., announced plans to take the companies private.

"While each potential transaction must be considered on its own specifics, they represent a maturing of the downcycle and a natural consequence of plentiful financing," Stephen Richardson, analyst, Morgan Stanley & Co. Inc., wrote in an early November research note.

"For E&Ps, available funding levers have proven key to financing development and growth in a low commodity price environment. Buyouts represent another alternative to weather the downcycle. This highlights a disconnect between required return and view of commodity upside in the public vs. private markets.

"While likely related to the perceived duration of the downcycle, we view the transactions as expressions of a common view; natural gas fundamentals have bottomed, and its cyclical nature will reassert itself for those willing to take a multiyear view," he said.

Quicksilver's announcement was made in mid-October, when the board received a letter from Quicksilver Energy LP indicating that it, along with members of the Darden family, wanted to explore strategic alternatives for Quicksilver Resources Inc (see Gas Processors Report 10/07/10).

On the heels of the Quicksilver announcement, in November, Exco Resources Inc.'s chairman and chief executive, Douglas H. Miller, offered to purchase all of the outstanding shares of stock of the company for $20.50 per share, a 38% premium over the October 29 closing price.

The proposed Exco acquisition would merge the company with a newly formed acquisition vehicle. In his letter to the board, Miller wrote that he'd "discussed this proposal with Oaktree Capital Management LP, Ares Management LLC, and (major shareholder) Boone Pickens, and each has expressed an interest in pursuing the acquisition with me."

Betting on the Assets

"…This isn't a bet on gas," Miller said during a conference call in November. "I'm betting on the assets and the people. I'm also a believer that gas is going to be cheap for at least the next 12 to 18 months, and I think it's an opportunity to get private and be ready to go, make some acquisitions."

It's not entirely surprising that select gassy companies are making this move now, said Kim Pacanovsky, a managing director at New York-based McNicoll, Lewis & Vlak LLC, a boutique investment bank and institutional broker-dealer. From a political standpoint, while there were many good pieces of pro-gas legislation written that could have improved gas demand, they were never passed and gas-weighted companies are pressing onward.

"Many management teams have taken a company public, then regretted it, because of all of the pulls of the public market," Pacanovsky said. "But at some point, if you're running a company and you have a large insider ownership position, if you see your work and the value you've created are not being represented in the stock price, selling the company or taking it private can be a reasonable solution.

"The one disadvantage is not being able to tap the public markets for capital, but with the amount of private equity available now, this isn't the big issue it used to be."

The appeal of going private has also grown during the past two years as the public finance markets have changed. Jack Aydin, analyst, KeyBanc Capital Markets, said, "During that time period, the way many E&P assets were being valued was a very haphazard process. Companies saw a lot of volatility in their stock prices and, ironically, there was a disconnect between stock prices and company asset values in the ground."

And the investment landscape has evolved. Exchange-traded funds, the increase in the number of foreign buyers interested in U.S. assets, zero interest rates – all of these things have changed asset valuations and the way the investment culture works. The turmoil in the financial markets also played a role, Aydin said, and the new environment, along with the rules, regulations and compliance inherent in the public markets, probably became too cumbersome for some companies.

"Private companies still have investors to answer to, but the time horizon to see returns is different and as long as management is executing on its business model, near-term hiccups are viewed as bumps in the road."

Why Go Private?

Also, in line with staying flexible, Aydin said companies considering the take-private scenario shouldn't be highly leveraged. To go private, unless a company has an investor contributing equity, the money has to be borrowed. Companies with a smaller debt load are better positioned to implement such a strategy.

"Quicksilver is asset-rich, but it has somewhere north of 60% in leverage, so the question is how much more leverage does management want to assume. They could actually get more value if they sold assets in a piecemeal fashion. In this scenario, maybe it's worth paying a greater premium and taking on the additional leverage."

Companies with assets that have a good, long-term development horizon can be good take-private candidates, but management teams and private-equity firms have to be positioned to take risk near-term, as it relates to natural gas prices, Aydin added.

"It's actually surprising that so many private-equity shops, flush with cash, haven't moved more aggressively in the gas-focused areas of the E&P sector. While each take-private announcement is a case-by-case situation, the outcome can be a good indicator of asset valuations in a specific area. And as those valuations continue to be examined, we're going to see more foreign interest in the E&P sector going forward, especially during the next year."

For gas-weighted companies that have fairly high insider ownership, a take-private proposal in the current environment may be a logical step. But the take-private model doesn't work for every company. It's also not something most management teams would encourage if they don't own a large chunk of the stock, because they probably don't want a group of money managers running the company, Pacanovsky said. – Bertie Taylor, from Hart’s Oil and Gas Investor