Independents Profiting, But Financiers Wary
Flush with profit from surging natural gas prices and a stock
rise across the board this year of about 85%, North American
independents still appear to be in no rush to secure financing for
more exploration and production activities. And unless you've got
equity or a strong balance sheet, lenders still may be wary before
jumping into any financing deals.
Instead, the independents --- especially the smaller ones ---
are rebuilding the bloody balance sheets devastated in the bust two
years ago, and cautiously looking for ways to secure shareholder
value and regain investors' confidence. Despite the hesitation, it
is falling more and more to the smaller independents to exploit the
natural gas reserves in North America, as the majors turn more
attention toward exploration in the deep Gulf of Mexico and
overseas. Soon, say analysts, some independents may announce
significant investments in North American E&P.
"For the blue chip companies, like the Apaches, investment
opportunities have already opened up and actually never stopped,"
said David Khani, senior energy analyst with Friedman, Billings
Ramsey & Co. "The smaller guys are just starting to look for
investments. I think later this month and into October, we'll see
five to 10 offerings by some of the smaller independents."
Because about 70% of most independents' portfolios is in natural
gas, "if the independents can't find financing now, they'll never
find it," said Fahnestock & Co.'s Fadel Gheit, an energy
analyst and research director who covers a lot of independents.
"It's now or never."
Still, Khani pointed out that investors have to be confident
that the high natural gas price cycle will last. "It's starting to
settle in that gas prices will remain high," he said. "The lenders
are starting to gain confidence."
Investments will be easiest to come by for those companies with
equity, said Khani. "Equity is the first way to obtain financing.
The next is when the high-yield market opens up, and finally, the
commercial banks start to increase their lending. Equity financing
is just opening up now. But it's just starting."
For an independent looking for financing, it has to have had
some drilling success, a focused strategy and a balance sheet
repaired from the last bust two years ago.
"No one wants to lend to companies with damaged balance sheets,"
Khani said. "They want to see a good, clear view of drilling
Drilling inventory, though, is certainly not the most important
thing anymore, said Gheit.
"We're not seeing a rush to glory like we did a few years ago,"
said Gheit. "We're not seeing a rush to spend money. The
independents got wise. They are looking for shareholder value and a
return on the capital employed."
Gheit, who covers Mitchell Energy and Development Co. among
other independents, said companies no longer are rewarded for
drilling holes, but for "drilling holes that produce." Before the
last bust, independents would book all of the drilling rigs they
could and when they went to the bank, the lenders would look at the
drilling program and make the loans based on that information.
"Amazing," he said. "It's not that way anymore." He even knows
of companies that until two years ago, would drill in areas they
knew would not produce. "My view, and we can joke about it now, but
those companies could have been sued by shareholders. At the time,
the exploration programs were geared toward a big noise and not
necessarily a result. Nobody cared." Two companies that
participated in dry hole drilling, which he would not name, are
near bankruptcy today.
"In the last bust, a lot of companies lost their credibility,
and their investors dropped out and are not coming back," said
Gheit. "Making promises and not keeping them...that's a killer."
Irene Haas of Sanders, Morris Mundy said it's still "tough for
the small guys." She said the market is "warmish," but the
independents have to have one of three things to gain financial
backing these days: a good balance sheet going in, a healthy
company with excess cash flow or minor problems with the balance
sheet that are in the process of being fixed. "Those with even
minor problems are still having difficulties obtaining loans," she
Another problem is with the lending institution itself. Since
the last bust two years ago, many of the commercial banks have been
restructured and many no longer service loans for less than $100
million, she said. "The need for financing comes from the equity
side in those cases."
Analysts said that some of the smaller companies that are
setting an example for other independents to follow include
Comstock Resources, based in Frisco, TX, Spinnaker, based in
Houston, and Nobel Affiliates.
"Comstock Resources is very small and very focused," said Gheit.
"It has 97% of its holdings in natural gas, and there's no hedging.
This is the kind of company that's in a dream position today."
Haas said that Houston-based Spinnaker recently completed some
successful financing because it improved its balance sheet and
focused its attention on specific properties in the shallow water
Gulf of Mexico.
And Khani pointed to Nobel Affiliates, which had been down to
1/3 of what it is today after the last downturn. "Now they've
turned the corner after waiting and cutting back on production. A
lot of investors had given up on Nobel, but this is the kind of
independent that took its time."
Other areas where analysts expect to see independents shine in
North American exploration, specifically the United States, will be
in East and South Texas and the Powder River Basin in Wyoming.
Khani said it may be surprising, but many of the best priced
stocks today are the highly leveraged independents, who were "so
beaten up in the last downtown and now the stock prices are
performing." He said that with the commodity prices up, the cash
flow is helping even highly leveraged companies with their balance
To improve domestic natural gas production, expect to see more
of the smaller independents merge. "The best ones will be the
prospect-rich company combining with the cash-rich company," said
Khani. "The small guys have a second shot at life because commodity
prices are strong. We've seen companies on the brink of going
under, already in Chapter 11 and then come out. Those are the ones
who go out and make the deals."
Carolyn Davis, Houston