October 14, 2016
Interviewed by: Andrea Heisinger
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Why a Rise in Energy Bankruptcies is Good for PE

As low oil and gas prices persist, energy companies trying to avoid bankruptcy are reorganizing, looking for buyers, or, ultimately, filing for bankruptcy and cleaning up their balance sheet. That’s where private equity comes in. EY US Energy Transactions Advisory Services Leader, Mitch Fane explains what energy companies are doing to survive, and why a bankruptcy may make them more attractive to PE.

As low oil and gas prices persist, energy companies trying to avoid bankruptcy are reorganizing, looking for buyers, or, ultimately, filing for bankruptcy and cleaning up their balance sheet. That’s where private equity comes in. EY US Energy Transactions Advisory Services Leader, Mitch Fane explains what energy companies are doing to survive, and why a bankruptcy may make them more attractive to PE.

Why a Rise in Energy Bankruptcies is Good for PE
With Mitch Fane of EY

Q1: What happened in upstream over the summer that affected people’s strategies?

Mitch Fane, EY:
There was a little bit of an uptick in commodity prices and oil prices over the summer, though, and all of a sudden a lot of the banks and a lot of the lenders started to push back and say, well, look, if this commodity increase really stays, and we do see a modest recovery, why would I want to write off my investment in these businesses? And so, they started pushing back on some of the plans of reorganization, they started slowing down the bankruptcy process a little bit,

As more economic data comes out, you find out that, actually, inventory’s increased in oil prices. The summer driving and everything else did not consume as much oil and gasoline as was hoped. And so, as a result, oil prices started to come back down a little bit. So you’re starting to see operators and lenders kind of converging again on the plane of, all right, let’s go through with the bankruptcy, let’s go through with the financial reorganization, so that by the fall we can actually be in a better position to emerge and move forward.

Q2: Does bankruptcy make an energy company more or less attractive to a PE buyer?

Fane: Absolutely more attractive. The biggest challenge we have right now is that when a company has more debt than they have assets, it’s very hard for potential investors or private equity to come in and to acquire the business.

So what you see is a process where companies would go in, go through the bankruptcy process, bring in or convert the existing debt to equity, and give them a chance to then come out either with a clean balance sheet to go do acquisitions on their own, or to maybe sell some non-core assets without having to worry about the existing creditors, and then so incoming capital can acquire those assets. So it’s absolutely key to M&A activity.

Q3: Are there are other trends you see now, or that we’ll see in the near-term?

Fane: The amount and the volume of bankruptcies right now is a bit unprecedented. Okay? We had a lot of banks and a lot of private equity extend capital with very, very loose lending policies when commodity prices were high. Companies were borrowing at $100 a barrel, and it collapsed at $30 a barrel, so 70 percent of the value went away within a three to six-month period. So there are a lot of companies that are still struggling with what does that mean for me, and can I survive, and they survive because they use hedges, which are very short term in nature. They’ve survived because they turn capex off. But now they’re finding themselves, over the next 6 to 12 months, in a situation where they will run out of liquidity.

We’ve talked about all these liquidity cliffs for the past 18 to 24 months; we’re now going to see that. And we’ve seen it because of already the high number of bankruptcies that have already been filed. I would think from a private equity standpoint, if I was trying to increase my assets, that I would want to be very aggressive in screening all those companies that are out there to find out which management teams I really thought were doing a good job. I’d also want to leverage every resource I could to understand where the better operators were located.

While M&A activity has been light in energy for the past 18 to 24 months, I do anticipate that they’ll pick up quite a bit in the next 6 to 10 months or 6 to 12 months.

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