(Bloomberg) -- A booming market to inject fresh money into hard-to-sell energy assets owned by private equity firms is drawing interest from hedge funds and other investors, leading to big wins and steep losses.
Oil and gas and other energy assets snapped up over the past decade are increasingly being rolled into so-called continuation funds, backed by opportunistic investors such as Baupost Group and Elliott Investment Management — with volatile commodity prices, ESG concerns and shrinking asset values making it harder to sell aging investments.
Continuation funds, a type of financial engineering that moves assets from one private equity vehicle to a new one backed by fresh capital, have grown in popularity in recent years as a way for firms to hold onto assets for longer.
Kayne Anderson Capital Advisors redistributed its ownership in energy producer Kraken Resources across three funds into a $911 million continuation vehicle led by Baupost, according to people with knowledge of the matter. The fund priced at a 10% discount, the people said, asking not to be identified discussing confidential information. Jefferies Financial Group Inc. is advising on the transaction.
Ridgewood Energy rolled Gulf of Mexico energy assets held in its second fund into a roughly $500 million continuation vehicle backed by Elliott, according to the people. Elliott also served as a lead investor on Riverstone Holdings’ roughly $815 million continuation fund for ILX Holdings and a Quantum Capital Group fund for natural gas producer HG Energy, the people said.
Representatives for Baupost, Elliott, Jefferies, Kayne Anderson and Quantum declined to comment. Ridgewood and Riverstone didn’t reply to messages seeking comment.
Energy continuation vehicles are a growing niche within the broader market for extending ownership on fund assets that are nearing the end of their lives, which generated more than $50 billion of deal volume last year, according to Jefferies.
About a decade ago, massive energy private equity funds were raised to chase deals when oil traded for about $100 a barrel and investors were eager to bet big on US energy production.
Since then, however, volatile commodity prices and fewer oil-and-gas investors have left firms with assets that are difficult to sell — just when they should be winding down their funds. In addition, pensions and endowments that invest in the funds are starved for returns. Higher interest rates also contributed to a slowdown in dealmaking, compounding the pain.
“Over the last several years, exit opportunities have been hard to come by,” Mike Suppappola, co-head of secondary transactions and liquidity solutions at law firm Proskauer Rose, said in an interview.
Many traditional secondaries investors have avoided energy continuation vehicles because of the riskier nature of the assets or limitations on investing in the sector due to ESG considerations. Existing limited partners may also be constrained from committing to an energy-focused private equity firm’s next fund.
Capital raised by private equity firms in energy, which averaged $21 billion a year from 2010 through 2019, has tumbled since, averaging about $3 billion annually, according to data compiled by Quantum.
Stepping into the void are opportunistic investors looking for ways to get exposure to oil and gas and who have a higher tolerance for the cyclical, boom-bust nature of energy investing. Because of the risks and lack of robust demand, they’re able to negotiate steeper discounts than is typical for private equity buyouts. Sponsors, in turn, get much-needed cash to hand back to their investors and to shore up assets that might need a little more work before they’re ready for sale.
“The biggest thing that we’ve seen over the last few years is the emergence of a new set of investors to pursue the deals,” said Spencer Gyory, a managing director in Lazard Inc.’s private capital advisory group. “That’s unlocked deal flow that was there but wasn’t actionable because the investor base wasn’t there.”
BlackRock, Goldman
In July, Amberjack Capital Partners raised $415 million for a continuation vehicle for eight existing investments, led by BlackRock Inc., Banner Ridge Partners, LSV Advisors and Goldman Sachs Group Inc.
There are gains to be had for buyers willing to finance the assets. Last year, Goldman backed a roughly $350 million Riverstone-led continuation vehicle for Meritage, a midstream company that helps producers move oil and gas, according to people with knowledge of the matter. That investment has already led to a two-times multiple on invested capital, meaning investors doubled the money they put in, the people said.
But the strategy isn’t without its risks.
Riverstone rolled Enviva, a supplier of wood pellets for energy production, into a continuation vehicle in 2020 as part of a recapitalization with more than $1 billion of equity commitments. The fund was anchored by Goldman, Abu Dhabi’s Mubadala and BTG Pactual. Enviva filed for bankruptcy in March.
In 2022, Amberjack moved Innovex Downhole Solutions, a maker of oilfield equipment, into a continuation vehicle backed by LSV Advisors. Innovex merged with Dril-Quip Inc., a publicly traded firm, in September. In connection with the deal, Innovex shareholders were paid a $75 million cash dividend. Shares of the newly combined company, Innovex International Inc., closed Wednesday at $15.54 apiece. That’s down 35% from Dril-Quip’s stock price at the time the deal was announced in March.
Goldman, Mubadala, BTG and Amberjack declined to comment. LSV didn’t reply to messages seeking comment.
Continuation vehicles are also controversial with private equity’s traditional investor base such as pension funds and endowments over the perceived conflicts of interest that can arise when a fund is both the seller and buyer of an asset. Some investors would like to see their sponsors hold onto assets and wait for better conditions to sell the old-fashioned way.
Still, the market for divesting energy investments through mergers and acquisitions could improve following Donald Trump’s re-election. He nominated industry executive Chris Wright as energy secretary and prioritized increasing US energy production during his second term. Debt that greases the wheels of transactions is also getting cheaper as the Federal Reserve cuts interest rates.
While it’s difficult to say exactly how the energy industry will fare under Trump, “there is at least a sense that the regulatory environment will cool off a little bit,” said Proskauer’s Suppappola.
--With assistance from David Wethe.
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