On the up ..

The oil & gas sector, traditionally dominated by specialist funds, has attracted some generalists keen to secure deals in the segment. The all-time-high oil prices, driven by increased demand in China and India, supply disruptions in Nigeria and Iraq and declining production in Russia, have added to the appeal of the sector. The key beneficiary of this increased spending is the oil field services and equipment sector. Even the credit crunch hasn't decreased appetite for the industry.

The value of downstream deals more than doubled from $3.7bn in 2006 to $8.4bn in 2007, according to PricewaterhouseCoopers. Private equity is a big part of this, with three of the 10 largest deals last year containing private equity financing. In addition, according to research by Private Equity Insight, two of the three ever largest deals in the sector were completed in 2008 (See table opposite for an overview of the three largest oil & gas deals in Europe).

"We have definitely seen a stronger appetite for the oil & gas sector, in particular the oil field services & equipment sector, among generalists," says Lars Saunes, director of Simmons & Company, who runs Simmons' recently established office in Norway.

The energy investment bank held a EUR87.5m first closing for its private equity co-investment fund Simmons Parallel Energy in April, which will focus on buyouts and growth capital opportunities across the energy sector. Bank of Scotland is the fund's cornerstone investor.

3i has been an active investor in the segment since the 1970s, and has an oil & gas portfolio worth $1.4bn. 3i's team has also seen a surge of financial backers entering the market. "The large buyout funds are well capitalised after a strong fundraising environment over the past few years, so they are well equipped to make investments in the sector," explains Hans Middelthon, director of 3i's oil & gas team in Aberdeen.

But not all aspects of the sector appeal to financial sponsors. Middelthon distinguishes between two sub-segments in the industry: Oil field services, which produce services to petroleum exploration, and exploration and production (E&P). "The E&P segment is more sensitive to oil prices and therefore more volatile, and has historically been less sought after by financial sponsors, while oil field services has a less cyclical nature," Middelthon says. However, even if oil field services has been a more popular segment, it has experienced rising costs and staff shortages of late. "In the years after 1999, many people in the industry were laid-off due to the exceptionally low oil price, meaning that there is a shortage of qualified staff, driving up costs," says Middelthon. However, 3i was invested both in E&P and oil field services with a strong track-record; a success more generalists are now keen to replicate.

Risks and success factors

Owing to the complexity of the sector, oil & gas investments have long been the remit of specialist funds with sector expertise, not so much generalist financial investors. "It is a tough industry to be successful in, and it is vital that investors understand the sector and the people in it since it is a small industry where there are many pitfalls," says Middelthon. With these risks, what can ensure success in this sought after sector? "Know the industry, be disciplined in bidding processes, go for high quality companies, ensure understanding of the competitive landscape and finally invest in companies where you have a deep understanding of the products and services," answers Saunes.

Some are also highlighting the similarities of the sector to the dotcom bubble. Oil prices have risen 697% since 2001, much more than NASDAQ rose during the IT heyday. So is the massive increase in prices sustainable, or is investing in the sector like betting on a horse that has already won? "I don't believe we are seeing an oil bubble. The fundamentals in the sector remain strong and I expect the oil supply cushion to remain thin for the years to come," Saunes says. He also points out that the world's oil companies are struggling to keep up with demand, driving up prices more than financial speculators, which have been given the blame for the increasing costs since they have used the oil prices as a hedge against inflation due to the weakened dollar. But not only are prices driven up by production shortages, refining capacity also remains an issue, further pushing prices.

Cash-rich trade buyers

As consumers suffer the ill effects of increasing prices, the large oil conglomerates are getting stronger balance sheets by the day. This means they can effectively compete with private equity houses for target companies, especially in today's credit environment where liquidity-starved investors are struggling to assemble competitive finance structures to support deals. "There are many consolidation opportunities in the market that private equity houses are keen to get their hands on, but so are the large, integrated oilfield service providers, creating fierce competition," says Saunes.

Thus, in the uncertain financial markets, deal-hungry private equity houses will struggle to effectively compete with the rich oil companies that are benefiting from a golden age due to the rocketing oil prices. However, as the activity in the sector has shown; where there's a will there's a way, and if oil prices continue to reach new records, the sector will only continue to become even more important for private equity sponsors in the time to come.

Case study

Montagu Private Equity-backed Logstor, a Danish manufacturer of pre-insulated pipe systems, has been a true buy-and-build case for the GP. Since Montagu resumed ownership in 2006, after Polaris Private Equity and Axcel sold the company (May 2006, page 40), it has made a number of add-ons and expanded into the oil & gas sector. The strategic move into the sector has proven successful.

The company's CEO, Preben Tolstrup, explains the company's outlook for its oil & gas activities: "There is an underlying demand in the market and we see no signs of it slowing down." He believes that the high oil prices are driven by consumption rather than speculation, and the brisk demand is set to continue. "New services and products that can reduce costs for the large oil conglomerates are well received in the industry," Tolstrup explains.

Logstor has some new products due to be launched this year in the oil & gas segment of its operations.

"A financial backer has played an integral part in our development. The transfer of ownership from a local private equity house to an international one was a positive step in our global expansion. We felt that Montagu was the right partner to get on board in order to transfer our focus from the Danish market to being a true multinational company," says Tolstrup.

Logstor was founded in 2005 by the merger of Logstor Ror and Alstom Power FlowSystems in 2005 and today has subsidiaries in Denmark, Sweden, Finland, Germany, Poland, the Netherlands, France, Italy, Austria, Switzerland and Lithuania, and joint ventures in Dubai, China and Korea. But the company has roots dating back to 1999. Axcel and Polaris first provided expansion capital to one of the companies in the Logstor group in January 1999 (November 1999, page 15). The two investors also participated in a second round of funding as part of a buy-and-build strategy in 2005. When the company was sold to Montagu, it marked one of the best mid-market exits of the year, and the exit deal was shortlisted for best mid-market exits of the year for the Nordic unquote" Awards 2006.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Investments
• Nordics