Apollo Management LP Managing Partner Leon Black speaks at the panel discussion "Global Opportunities in Private Equity" at The Milken Institute Global Conference in Beverly Hills, California May 2, 2011.Fred Prouser/Reuters
Everyone's buying the hype.
With energy prices in the gutter, private equity players are angling to score assets on the cheap. Boatloads of cash have already been raised, with The Carlyle Group drumming up $9-billion (U.S.) and Blackstone Group LP hauling in $6-billion. "I think it's a very good time to be getting into it," Apollo Global Management's Leon Black told a conference in Berlin, according to a New York Times report Tuesday.
It seems like a sure bet. Much like how private equity funds invested heavily in real estate right after the financial crisis, the world's largest buyout firms are now piling into energy, hoping to secure some distressed assets.
Some funds will doubtlessly generate big returns. But there's no way they all can. There are just too many players chasing the same glory.
To put their chances in perspective, let's not forget that reputable energy companies lost significant sums during the bull market. Just one example: Shell wrote off $2-billion worth of its liquids-rich North American shale assets in 2013. Early movers can make big money, but after a certain point, there just isn't enough to go around.
Energy assets are rather fickle. You might be in the same basin as some top tier players, but the exact land you own is what really matters. And the distressed companies that are selling assets don't want to give up their crown jewels. They would much rather sell their crap.
The PE time-line is also troublesome. The funds typically look for exits within five to seven years. Who knows how long energy prices will be subdued? Even if they start to rebound, the chances of every private buyer being able to sell their holdings at a profit are slim.
And if private equity firms use leveraged buyouts to buy these companies, as they often do, it won't take much volatility to knock their turnaround plans off course. Energy services players are particularly vulnerable; while oil producers generate cash flow, even at weak prices, services firms can see their contracts cancelled quickly. If that happens, and the company has been purchased with a lot of debt, the chances of success are even lower. Just look at Tervita Corp., which is still struggling seven years after the financial crisis, thanks to a leveraged buyout that left it saddled with repayment obligations.
Big returns can be made. Apollo cashed in more than 600 per cent on its investment in Athlon Energy Inc. – a company that was ultimately sold to Encana Corp.
But private equity players keep proving they are susceptible to sizable energy losses, too. In 2012 and 2013, they struck $51-billion worth of deals in the energy sector and a number of them aren't doing very well.
In its latest quarter, Apollo's earnings plummeted 79 per cent from the year prior, while Kohlberg Kravis Roberts & Co.'s profits dropped 94 per cent, mostly because of weak energy valuations. KKR paid $7.2-billion for Samson Resouces Co. in 2011, a record price for an energy leveraged buyout, but in January Bloomberg noted that Samson's bonds that mature in 2020 were trading at 28.5 cents, down from 103.5 cents in August.
Because private equity is subject to time-line limitations, the safest bet in the sector might lie with pension funds, whose time horizons can span decades. From what we hear, they know it, too.
Tim Kiladze