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Mezzanine Finance for Independents:
How to Keep Your Project Moving
SIPES
Houston, TX
August 22, 2013
About Five States
Why Review Financing?
What is Mezzanine?
Cost of Capital
Case Studies
Overview
ABOUT FIVE STATES
Five States Energy Capital, LLC
1985
•Five States Energy Company, Inc.
•Acquires operated and non-operated working interests
1985
• Five States Operating Company, Inc.
• Operates Five States’ interest properties
2004
• Total Energy Asset Management Services (TEAMS)
• Oversight of portfolio asset properties
2007
• Five States Energy Capital, LLC
• Provides mezzanine capital to independents
Independents % Allocation of Time
Why Review Financing?
Activity % of Time
Research & Culling Data 35 - 65
Project Development 10 - 20
Project Financing 20 - 50
Administration 10 - 20
Independents’ Sources of Development Capital
Why Review Financing?
• Available Cash
• Cash Flow from Previous Activities
• Sell Down of Promoted Interest
• Cash Flow from Current Project
• Convert Working Interest to Override
• Bank Loans
• Convenient Sources
• Mezzanine Financing!
WHAT IS MEZZANINE?
Fills Gap Between Senior
Debt and Equity
Subordinate in Priority of
Payment to Senior Debt
Senior in Rank to Equity
Stretch Debt
As With Banks, Advances
Usually Based on Proved
Reserve Base
What is Mezzanine?
MEZZANINE
Senior Asset Backed Debt
Equity
Development drilling programs
Acquisition financing
Infrastructure financing
Bank clients that are over extended (but
typically still solvent)
Mezzanine typically fits:
Capital Structure in Oil & Natural Gas Transaction
• Advantages – Not a sale of equity
– No loss of control of
company
– No requirement to sell on a
schedule
– Puts up majority of
development capital with
minority stake in project
– Appears as debt; can be
financed from pre-tax
revenue
– No board position required
Companies with Efficient Capital Structures
5% - 12% Senior Debt 50% - 75 %
Mezzanine 20% - 30%
Equity 15% - 30%
13% - 25%
25% +
Typical Private Equity Structure . (% of total Assets)
Expected
Returns (%)
Source: Management Magazine, Bond Capital
COST OF CAPITAL
Relative Costs of Financing Options
Banks
Mezzanine
Private Equity
Lowering Cost of Capital
Case 1: Traditional Case 2: Typical Debt Case 3: High Leverage
100%
50%
20%
20%
50% 60% Equity
Mezzanine Bank Debt
Company Capital Structure. (% of Company Value)
80% of company
value can be
released in Cash
Return on Equity
Weighted Average Cost of Capital
35 %
19 %
11%
12 % 21% 40% Source: Management Magazine, Bond Capital
Underwriting Process
1 • Initial Investment Criteria Check
2 • Engineering Analysis
3 • Financial Analysis
4 • Operations / Legal / Land Analysis
5 • Term Sheet Issued
6 • Final Due Diligence
7 • Close Investment
Oil, gas, and midstream deals are
sourced in the marketplace through
industry contacts and intermediaries
~50% pass initial screening for further
evaluation
~5-10% pass due diligence
and term sheets are issued
~2-5% are
closed and
become part
of the portfolio
Typical Term Sheet
Interest • ~12% coupon
• ~25% WI Back-in at Payout
Term 3-5 years
Facility Determined
By:
• 90-100% PDP
• Discounted PDNP and PUDs
• Land/Leases
Structure Very fluid
What Do Lenders Look For In A:
Borrower?
Deal Structure
Business Plan
Track Record
Equity Participation
Collateral (PDP, PUDs, Leases)
Reputation/Character
Collateral
Higher Risk
• “PUD” Proved Undeveloped
• Leases
Moderate Risk
• “PDNP” Proved Developed Non-Producing
Lower Risk
• “PDP” Proved Developed Producing
~10% ~25% ~90%
CASE STUDIES
Financing Package – Bakken
Appalachian Acquisition Package
Pipeline Construction – West Texas
$85mm Mezzanine Debt Financing for Development of 14,000 Acres in North Dakota • $16.2mm initial advance
with remaining funding to occur over time
• 45 producing wells and need for funding to keep pace with rapid development of the area
• Senior note @ 6.25% – bank revolver structure (30%)
• Junior note @ 12.50% – mezzanine structure w/ BIAPO* (20%)
24
Financing Package - Bakken
Note: Photo for illustration only. *BIAPO: Back In After Pay Out
Appalachian Transaction (WV & OH)
Collateral
PDP and PUDs
Term 5 years
Interest Rate 12%
Origination Fee 1.0%
Equity Component 25% at term or repayment
• Option to purchase 25% of assets for cash
equivalent of loan amount at closing
Hedging 75%
Advantage Pipeline – West Texas
Pipeline Construction
Advantage Pipeline – West Texas
Pipeline Construction
• Location: Pecos, TX to Crane, TX
• Length: 75 miles
• Cost: $60 MM
• Deal Structure: $17.5 MM equity financing
Mezzanine can be a good fit for:
– Companies focused on acquisition and development
– Especially when there is existing production
– Companies needing to pay down bank debt
At end of term:
– Company is left with majority of equity
– Greater profit potential
Summary
Five States Energy Capital, LLC
Mezzanine Finance Market
