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Mezzanine Finance for Independents: How to Keep Your Project Moving by Tom Barnes of Five States

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SIPES Houston Meeting: August 2013

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Mezzanine Finance for Independents: How to Keep Your Project Moving by Tom Barnes of Five States

  1. 1. Mezzanine Finance for Independents: How to Keep Your Project Moving SIPES Houston, TX August 22, 2013
  2. 2.  About Five States  Why Review Financing?  What is Mezzanine?  Cost of Capital  Case Studies Overview
  3. 3. ABOUT FIVE STATES
  4. 4. Five States Energy Capital, LLC 1985 •Five States Energy Company, Inc. •Acquires operated and non-operated working interests 1985 • Five States Operating Company, Inc. • Operates Five States’ interest properties 2004 • Total Energy Asset Management Services (TEAMS) • Oversight of portfolio asset properties 2007 • Five States Energy Capital, LLC • Provides mezzanine capital to independents
  5. 5. Independents % Allocation of Time Why Review Financing? Activity % of Time Research & Culling Data 35 - 65 Project Development 10 - 20 Project Financing 20 - 50 Administration 10 - 20
  6. 6. Independents’ Sources of Development Capital Why Review Financing? • Available Cash • Cash Flow from Previous Activities • Sell Down of Promoted Interest • Cash Flow from Current Project • Convert Working Interest to Override • Bank Loans • Convenient Sources • Mezzanine Financing!
  7. 7. WHAT IS MEZZANINE?
  8. 8.  Fills Gap Between Senior Debt and Equity  Subordinate in Priority of Payment to Senior Debt  Senior in Rank to Equity  Stretch Debt  As With Banks, Advances Usually Based on Proved Reserve Base What is Mezzanine? MEZZANINE Senior Asset Backed Debt Equity
  9. 9.  Development drilling programs  Acquisition financing  Infrastructure financing  Bank clients that are over extended (but typically still solvent) Mezzanine typically fits:
  10. 10. Capital Structure in Oil & Natural Gas Transaction • Advantages – Not a sale of equity – No loss of control of company – No requirement to sell on a schedule – Puts up majority of development capital with minority stake in project – Appears as debt; can be financed from pre-tax revenue – No board position required
  11. 11. Companies with Efficient Capital Structures 5% - 12% Senior Debt 50% - 75 % Mezzanine 20% - 30% Equity 15% - 30% 13% - 25% 25% + Typical Private Equity Structure . (% of total Assets) Expected Returns (%) Source: Management Magazine, Bond Capital
  12. 12. COST OF CAPITAL
  13. 13. Relative Costs of Financing Options Banks Mezzanine Private Equity
  14. 14. Lowering Cost of Capital Case 1: Traditional Case 2: Typical Debt Case 3: High Leverage 100% 50% 20% 20% 50% 60%Equity Mezzanine Bank Debt Company Capital Structure. (% of Company Value) 80% of company value can be released in Cash Return on Equity Weighted Average Cost of Capital 35 % 19 % 11% 12 % 21% 40% Source: Management Magazine, Bond Capital
  15. 15. Underwriting Process 1 • Initial Investment Criteria Check 2 • Engineering Analysis 3 • Financial Analysis 4 • Operations / Legal / Land Analysis 5 • Term Sheet Issued 6 • Final Due Diligence 7 • Close Investment Oil, gas, and midstream deals are sourced in the marketplace through industry contacts and intermediaries ~50% pass initial screening for further evaluation ~5-10% pass due diligence and term sheets are issued ~2-5% are closed and become part of the portfolio
  16. 16. Typical Term Sheet Interest • ~12% coupon • ~25% WI Back-in at Payout Term 3-5 years Facility Determined By: • 90-100% PDP • Discounted PDNP and PUDs • Land/Leases Structure Very fluid
  17. 17. What Do Lenders Look For In A: Borrower? Deal Structure Business Plan Track Record Equity Participation Collateral (PDP, PUDs, Leases) Reputation/Character
  18. 18. Collateral Higher Risk • “PUD” Proved Undeveloped • Leases Moderate Risk • “PDNP” Proved Developed Non-Producing Lower Risk • “PDP” Proved Developed Producing ~10% ~25% ~90%
  19. 19. CASE STUDIES Financing Package – Bakken Appalachian Acquisition Package Pipeline Construction – West Texas
  20. 20.  $85mm Mezzanine Debt Financing for Development of 14,000 Acres in North Dakota • $16.2mm initial advance with remaining funding to occur over time • 45 producing wells and need for funding to keep pace with rapid development of the area • Senior note @ 6.25% – bank revolver structure (30%) • Junior note @ 12.50% – mezzanine structure w/ BIAPO* (20%) 24 Financing Package - Bakken Note: Photo for illustration only. *BIAPO: Back In After Pay Out
  21. 21. Appalachian Transaction (WV & OH) Collateral PDP and PUDs Term 5 years Interest Rate 12% Origination Fee 1.0% Equity Component 25% at term or repayment • Option to purchase 25% of assets for cash equivalent of loan amount at closing Hedging 75%
  22. 22. Advantage Pipeline – West Texas Pipeline Construction
  23. 23. Advantage Pipeline – West Texas Pipeline Construction • Location: Pecos, TX to Crane, TX • Length: 75 miles • Cost: $60 MM • Deal Structure: $17.5 MM equity financing
  24. 24.  Mezzanine can be a good fit for: – Companies focused on acquisition and development – Especially when there is existing production – Companies needing to pay down bank debt  At end of term: – Company is left with majority of equity – Greater profit potential Summary
  25. 25. Five States Energy Capital, LLC Mezzanine Finance Market

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