DALLAS—When capital markets are challenged and the other traditional methods of financing projects don’t appear as attractive, investors have been known to turn to mezzanine funding.
Mezzanine appeals to investors because of the flexibility it can provide and that can be essential in this climate after the turmoil that hit the world markets late last year.
Stuart Page, the managing director of The Carlyle Group, Ronald Gajdica, who is the managing director of EIG Global Energy Partners and managing director of GSO Capital Partners Larry Tharp discussed the re-emergence of mezzanine funding during a roundtable discussion during the Energy Capital Conference presented by Oil and Gas Investor in early March.
Page’s group is a leader in the sector with about $212 billion of capital, of which $50 billion is on the credit side. He oversees the energy mezzanine opportunities fund, which is a $28 billion fund that was raised toward the end of 2016. The Carlyle Group is global with 31 offices in 19 countries, but every deal it has done so far has been in the U.S.
“So we have the ability to expand our borders and barriers but we find the best risk-adjusted are found to be in the U.S. in the upstream at the moment,” Page said.
Gajdica, meanwhile, says EIG is most interested in providing seed money for established teams and established assets to help companies build acquisition financing or to finance development plans. EIG has about $22 billion in assets under management and so far has invested about $30 billion in 345 transactions in 36 countries.
“We’re not really working with new startups,” Gajdica said. “We’re working with existing entities.”
The three-member panel discussed mezzanine funding and their respective company’s approach to what projects they fund and how those decisions are made. Here is a look at their answers to questions about the mezzanine sector.
RELATED: See the entire panel on video here.
RELATED: See the entire panel on video here.
What is the squeeze point that brings a producer to mezz?
Gajdica: “Companies, if they have enough production to have reserve-base lending—a revolver, a bank group—that is certainly the first part of their financing. That’s the cheapest capital around and everybody will try to do that first. Often thought that is not enough for the capital needs that they have. They want to grow. They want to hold their acreage. There is pressure to not let acreage expire. There is pressure to keep rigs running. There is pressure to grow. So you need extra capital for that.
“Often times you have a choice between raising more equity, which is hard to do today with the capital markets being the way they are. Also, often there is not an incentive to raise equity because it dilutes the existing equity owners and they don’t like that. If you can possibly do it with another source of financing that’s a good way to do it so that drives you to the mezz market. Secondly, mezzanine or whatever you want to call it,…The cost of doing that is certainly high but maybe it’s good if you really believe in your investments and you think you are going to make money, you think that your portfolio is going to generate good positive returns then it’s a smart thing to do. Right now that’s one of the few ways to get capital.
“As far as deal flow across my desk right now, we’re seeing a very high level of deal flow, lot of opportunities coming through. We have a whole group of people that does business development and tries to bring in deals and they are having a very easy time of bringing deals in to evaluate. We have the enviable position of getting to pick and choose how we deploy that capital.”
Page: “The whole panel here, we think about mezz as an infinite variety of different vehicles. IBL is at one end of that spectrum, we’re pretty much everything until equity. There are so many different ways to create alignment. And the goal is to match the risks in the state of the project and the need for the capital with the cost of the capital and we can do that in so many different ways to try and make that work. As an operator, you can go and try to raise equity but it’s tight right now, it’s tough. Or you can look for ways to creatively advance your cause with the least dilution possible.”
How aggressive do you get on your evaluations?
Page: Says his company has a group of engineers internally and almost certainly conservative.
“We like to confident with the rock, we like to be confident with the expectation in what we will see. We don’t tend to listen to what the company is showing us and their interpretation. That’s obviously one of the inputs but to say we have a start of aggression or we are purposely biased in a direction that’s not the case. We try to read it as best we can, we have great engineers and they do the most honest job they can.”
Gajdica: “There is a fine line between being aggressive and conservative. If you are too conservative you are never going to make a mistake on investment and you will always come out with a good positive return, but if you are too conservative you are not in the game because my competitors will offer better terms and they will win all of the deals and we won’t. On the flipside, if you get too aggressive you stand to have an underperforming asset relative to your investment assumption, so you have to be careful not to get too aggressive so it’s a fine line to be in the game but not be too aggressive at the same time.
“When we are looking at deals I think it’s important to look at each unique asset that underlies the value of the deal and to look at where the risk opportunities are and where the upside opportunities are so that the risk-reward and the upside all have to be acknowledge and possibly quantified. If you have a bit of experience in it you can structure a deal around the risks and still give yourself an opportunity to capture the upside if that scenario were to manifest itself. So looking at all of the intrinsic parts of the deal is important to try to figure out how to structure it so that the combination of the technical understanding with the deal structure understanding and putting it all together really works. I once had an experience manager who said, `Ron, the next year I don’t want you to drill any dry holes. Drill only the discoveries, please.’ That’s obviously a tongue and cheek comment but it’s the same way when you are running an investment portfolio. Simply I want to say yes to the good deals and I want to say no to the bad deals. If I can do that consistently the fund as a whole is going to perform very well. That’s what we are trying to accomplish.”
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