January 22, 2013
Interviewed by: David Snow
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Oil and Gas Deal Dynamics

The oil and gas business is attractive in part because “with volatility comes opportunity” for private investors, according to Ronald Montalbano, Senior Managing Director and Group Head in the U.S. Oil & Gas M&A Capital division of EY Capital Advisors. In an interview with Privcap, Montalbano discusses the role of private capital in the space, the growing interest in master limited partnerships, and why oil and gas investing is a natural fit for emerging markets private equity. Sponsored by EY.

The oil and gas business is attractive in part because “with volatility comes opportunity” for private investors, according to Ronald Montalbano, Senior Managing Director and Group Head in the U.S. Oil & Gas M&A Capital division of EY Capital Advisors. In an interview with Privcap, Montalbano discusses the role of private capital in the space, the growing interest in master limited partnerships, and why oil and gas investing is a natural fit for emerging markets private equity. Sponsored by EY.

Privcap: How is private capital shaping today’s oil and gas industry

Ronald Montalbano, EY: Private capital plays a key role in the oil and gas sector. It has for quite some time, and we certainly expect it will going forward. When you think about the oil and gas industry, it’s very capital intensive, first and foremost. And it drives a lot of the need for private capital. And secondly, the number underlying fundamental in the business is dynamic. And by dynamic, that’s my nice way of saying it’s volatile. Because it’s in a less attractive word. But with volatility comes opportunity. So when you’ve got a capital intensive business that has risk associated with it, and private capitalist’s in the business of taking risk for appropriate return. It’s a perfect marriage.

Privcap: How much more competitive is the private equity space for oil and gas?

Montalbano: There certainly are more players now. If you go back 15 or 20 years ago, you had a relative handful of private equity providers. And they were specialized in the energy space– the oil and gas space. Over the past decade or so you’ve seen more of those pop up, number one, but also many of the generalist funds, especially the large generalist funds, who want exposure now to oil and gas. So with that, if you’re out to raise capital, you do have a broader audience. And as such it is more competitive for those parties who do want to invest in that space. But that’s because when there’s competition, that also means that there are attractive opportunities.

Privcap: What characteristics do energy companies need today to make it to a public listing?

Montalbano: I think there are a number of characteristics that a company would need or want before tapping into the public markets. If we just focus on maybe the top three or four. First and foremost, I think you’re going to want a solid backdrop. So that the fundamentals in the sector need to be solid. Secondly, a good growth story. Good growth strategy. That will include a quality use of proceeds, a good reason for going public, and a good use for that money. Third, management team. Again, a seasoned group that knows how to find oil and gas. And you also need a team that can articulate that story to Wall Street.

The fourth point I would probably put in there in the top would be size. You really want to be of a certain size to tap the market and have the multiple that you ultimately desire. Because at the end of the day, it is about having access to capital at a lower cost of capital. If you get out and don’t have the multiple that you desire, then you really don’t have what you want by going public.

And that really feeds well into the private equity conversation, because that’s where private equity has a role. A company may have three of those four characteristics, but don’t have the size yet. And private capital can come in and help them get to that next size, either through an acquisition or organically. And then they can tap the IPO market.

Privcap: What is behind the increased popularity of the master limited partnership for oil and gas properties?

Montalbano: Well, what’s driving that is the quest for yield. By the retail investor, let’s say by the public. With interest rates where they are, there is a desire for investors to find yield. MLPs are a yield product. They have a higher yield than typical bonds or treasuries. As it should, because it is an equity security at the end of the day. But that drives it. You’ve got many, many more MLPs in the marketplace today, and many that are filed with the SEC to go public. So we expect that trend to continue as well.

It’s a good marriage with private equity there as well. You’ve seen several private equity funds form and take public their own MLPs. So in this case they own the GP and own a big piece of the limited partnerships. But take it public. That allows the private equity group to go make an acquisition of an asset that may be too risky for an MLP or publicly traded company to take on.

Which is what they do. Remember, they are in the business of taking on risk for appropriate return. They make that acquisition, de-risk the play by spending money and drilling wells, and then take that when it’s de-risked and a of a yield product, and sell to the MLP. So it’s worked out very, very well. And it works out for the public investor as well as for the PE group.

Privcap: What role is private equity playing in emerging markets oil and gas opportunities?

Montalbano: When I think about emerging markets, certainly the GDP growth in those areas are expected to be higher than mature markets. But that’s true in any industry, so anyone who’s looking at that would find that attractive. They have increased country risk, political risk. But again, that’s going to be true across industries as well. What I think is interesting on the emerging market side for oil and gas companies is that the commodity that you pull out of the ground, basically is, for the most part, a universal product.

Without getting too technical, a barrel of oil out of South America, for all practical purposes, is the same as the barrel of oil out of Australia or Canada or the US. So that lends itself easier to an investment. You don’t have the other cultural issues and language issues if you’re opening up a different type of business. The other issue is that there’s less competition and capital in many of those emerging markets. So from that standpoint, private equity has an opportunity in a less competitive environment which could make the emerging market stand out as opposed to North America.

Privcap: What is unique about the M&A market for oil and gas companies?

Montalbano: Well a, I think the oil and gas businesses is– I’m a little biased, of course, because it’s my sector– the ultimate transaction business. No one’s emotionally attached to a barrel of oil three miles under the surface of the earth. It is a transaction play. It’s a model. If it all works and everyone can make money involved, then there’s a deal there to be had.

With respect to our group. We have chosen oil and gas as a very important industry for our firm. And as such, we’ve got a large, large number of professions that are dedicated to the oil and gases space. Me and my group only work in oil and gas, but within that transaction advisory services group that I referred to earlier, just in Houston alone there are approximately 80 professionals that are doing nothing but transaction work in oil and gas. When you include the audit and global, you’ve got thousands of professionals at the firm that are really dedicated to the oil and gas sector.

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