Tuesday, December 23, 2014

Oil Crash Slams Buyout Funds?

Oil Crash Wipes $11.7 Billion From Buyout Firms’ Holdings:
Oil’s plunge makes energy a great investment for the coming years, according to Blackstone Group LP (BX)’s Stephen Schwarzman and Carlyle (CG) Group LP’s David Rubenstein. For private equity firms, it’s also been painful.

More than a dozen firms -- including Apollo Global Management LLC (APO), Carlyle, Warburg Pincus and Blackstone -- have lost a combined $11.7 billion in 27 publicly traded oil producers since June, when crude prices reached this year’s peak before beginning their six-month slide, according to data compiled by Bloomberg. Stocks of buyout firms with exposure to energy have slumped, and bond prices suggest some closely held oil producers may struggle to pay for their debt.

“It’s been a really volatile period, and frankly that’s how Saudi Arabia wants it,” said Francisco Blanch, head of global commodity research at Bank of America Corp. “This is a battle of endurance.”

Brent crude oil slumped 47 percent to about $61 late last week from its high this year of $115 a barrel, dragging down energy stocks, as the Organization of Petroleum Exporting Countries sought to defend market share amid a U.S. shale expansion that’s adding to a global glut. The group, responsible for 40 percent of the world’s supply, will refrain from curbing output, U.A.E. Energy Minister Suhail al-Mazrouei said on Dec. 14.

Kosmos Energy Ltd., Antero Resources Corp., EP Energy Corp. (EPE), Laredo (LPI) Petroleum Inc. and SandRidge Energy Inc. (SD), each of which is backed by a buyout firm as its largest shareholder, fell by an average of 50 percent in U.S. trading from oil’s peak through Dec. 19 in New York. Warburg Pincus is the top stakeholder in Kosmos, Antero and Laredo; Apollo is the largest investor in EP Energy; and Carlyle, with a partner, owns the biggest piece of SandRidge, according to data compiled by Bloomberg.
Apollo, Carlyle

Apollo has $5 billion invested in energy debt and equity, including companies that are closely held. Carlyle has directed 10 percent of its $203 billion in assets into the industry. Blackstone, the second-biggest shareholder in Kosmos, has backed drilling projects off Ghana’s coast and in the Gulf of Mexico.

The deals highlight private equity’s role in the debt-fueled shale push, as hydraulic fracturing in search of oil and gas leads to higher production. After investing billions of dollars, the firms are preparing to step in with more cash to fund development when prices stabilize.

Carlyle increased its exposure to the industry in December 2012 when it invested $424 million to share revenue from NGP Energy Capital Management, an Irving, Texas-based investment firm that has stakes in at least six publicly traded exploration and production companies. NGP’s holdings include Memorial Production Partners LP, which declined 39 percent; Rice Energy Inc. (RICE), which fell 21 percent; and RSP Permian Inc., which dropped 17 percent.
Laredo, Kosmos

Warburg Pincus, the New York-based investment firm that hired former Treasury Secretary Timothy F. Geithner as president last year, saw its holding in Laredo decline 66 percent, while Kosmos, a West Africa-focused exploration and production company, has held up better, dropping 26 percent.

EP Energy was bought by New York-based Apollo and others for $7.15 billion in May 2012 and taken public early this year. Apollo and its clients, which put in about $1.8 billion of equity, are down about 20 percent on their initial stake, based on the latest closing share price. Apollo cited EP as a key contributor to a 2 percent decline in the firm’s private equity holdings during the third quarter.

“It could be worse from here,” Greg Beard, who oversees Apollo’s energy investments, said of oil producers at the firm’s investor day on Dec. 11. “When the market has been in excess like it is now, you see price declines. With a change in the stance of OPEC from one of price protection to the protecting of market share, we’re in excess for at least the next 12 months.”

Samson’s Bonds

The bonds of some closely held buyout-backed companies are falling as well.

Samson Resources Co.’s $2.25 billion of bonds due in 2020 dropped to 43.5 cents on the dollar from a peak of 103.5 cents in August. KKR & Co. and its partners acquired Samson in December 2011 for $7.2 billion, the most ever paid in a leveraged buyout of an energy producer, including $4.1 billion of equity.

Heavily reliant on natural gas, the Tulsa, Oklahoma-based company suffered big losses after the deal when prices for the commodity slumped. Standard & Poor’s and Moody’s Investors Service downgraded Samson’s junk credit ratings in the last two weeks.

Large buyout firms are emphasizing the opportunities that lower oil can ultimately create, rather than any immediate damage.
Few ‘Difficulties’

Blackstone, based in New York, is raising its second energy-focused fund with a $4.5 billion target. The firm, which owns stakes in startup Vine Oil & Gas LP as well as Kosmos, is weighted more toward natural gas and electric power than oil, Schwarzman said at a financial conference this month. The price drop “has not created a lot of difficulties for us,” Schwarzman, Blackstone’s chief executive officer, said at the New York event.

Henry Kravis, co-CEO of New York-based KKR, said at the same conference, on Dec. 10, that he welcomes the decline as a chance to fund cash-starved producers. Carlyle co-CEO Rubenstein said the next five to 10 years stack up “as one of the greatest times” to invest in energy.

“If you have an asset you already own, it’s probably going to go down in value,” Rubenstein said. If you have a lot of untapped money to invest, “it’s a great time to buy,” he said, adding that Washington-based Carlyle has about $7 billion to spend in energy.
Igniting Deals

Warburg Pincus raised $4 billion for energy in less than a year for its first fund dedicated to energy deals, which started investing this year. The firm, which had targeted $3 billion for the vehicle, has deployed more than $9.5 billion in energy-related companies since its founding in 1966.

“Dislocations create interesting investment opportunities, and we’re fortunate to have plenty of available capital,” Peter Kagan, who leads energy investing at Warburg Pincus, said in an e-mail.

Oaktree Capital Group LLC (OAK), the world’s biggest distressed-debt investor, is sizing up the bonds of struggling oil producers, Howard Marks, the Los Angeles-based firm’s co-chairman, told the conference. Marks sees the potential for oil’s decline to ignite a new debt crisis, he later told clients in a Dec. 18 letter.

“We knew great buying opportunities wouldn’t arrive until a negative ‘igniter’ caused the tide to go out, exposing the debt’s weaknesses,” Marks wrote. “The current oil crisis is an example of something with the potential to grow into that role.”
You should all take the time to read a note Oaktree's Howard Marks recently put out to clients, The Lessons of Oil. It's excellent and he rightly notes that DoubleLine's Jeffrey Gundlach was one of the few who got rates right in the last few years. (Interestingly, Bill Gross, the fallen bond king, loves TIPS while Gundlach hates them. I'm with Gundlach on that call).

Howard Marks is one of the best distressed debt investors in the world but I have to disagree with him, while I see the surging greenback and global deflation continuing to pound energy and commodity prices next year, I don't see the plunge in oil crashing markets. Markets will decouple from oil and melt up in 2015, led by tech, biotech, healthcare, financials and retail, but the biggest gains will be in tech and biotech.

However, as the article above demonstrates, there will be pain in the energy portfolios of public and private funds. Buyout funds are not immune to macroeconomic developments. They have suffered huge losses investing heavily in energy which is why you see their big wigs come out to state they see tremendous opportunities in energy.

Unfortunately, as Gundlach and others have explained, this time it's different, and there won't be any big rebound in energy and commodity prices. And god forbid deflation hits America, then it's going to be a bloodbath for energy and commodity related investments, regardless of whether it's in public or private markets. 

Importantly, all the risk departments at every pension and sovereign wealth fund should carefully tally up their exposure to public and private energy and commodity investments, including emerging markets like Russia, Venezuela and Mexico, as well as countries like Canada and Australia (Sober Look just wrote an excellent comment explaining why if energy prices remain at current levels, Canada's economy is in big trouble).

Public pension funds are feeling the pain of the plunge in energy and commodity prices through their public and private investments. Some will get clobbered while others who minimized their exposure to these sectors and understood the macro environment, will fare better.

Below, Mike Harrowell, Director of Resources Research at BBY, says oil prices could fall to $15-20 a barrel unless Saudi Arabia cuts output to restore market balance.

Also, take the time to read Gary Shilling's Bloomberg comment, Are You Ready for $20 Oil?. Clearly most of you aren't! Shilling recently discussed how the fall in the value of the ruble impacts the Federal Reserve and his call for global deleveraging. He spoke on “Bloomberg Surveillance.”

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