Tuesday, January 3, 2017

Oil Companies That Sold Shares During Collapse Are Now Riding High

The stock offerings allowed companies to pay down debt, buying the firms time until oil prices rebounded.

By Ryan Dezember 
The Wall Street Journal
January 3, 2017

Energy companies that took the risky step of selling shares in the last two years to survive the vicious collapse in oil prices finished on top in 2016, rewarded as U.S. oil prices closed 2016 up 45% and with many investors betting crude could rise even higher.

More than 70 North American energy companies sold about $57 billion worth of shares in so-called follow-on stock offerings during the past two years. Many of these shares spent stretches trading below their offering prices, hurting investors who wagered on companies that failed to find footing as well as investors who sold out before shares rebounded. A handful of the stock sellers went bankrupt as the price of oil fell by more than half.

But most survived, defying widespread predictions that the plunge in crude and high levels of debt would force many more producers out of business.

Instead, these stock offerings allowed them to pay down debt and hold on long enough for oil prices to recover and their shares to rebound into a rising stock market.

Collectively, shares sold over the past two years ended 2016 more than $13 billion above their offering price, according to a Wall Street Journal analysis of Dealogic data and securities filings.

Oil-and-gas companies were star performers in 2016. Energy shares in the S&P 500 rose 23.7%, tops in the index of big companies. They also led the broader Russell 1000 index, up 22.4%. More than 40 U.S. oil producers gained at least 30%, including Parsley Energy Inc. and RSP Permian Inc., which reached all-time highs, and Cimarex Energy Co. and Concho Resources Inc., which came close. Shares of Resolute Energy Corp., a Denver company that drills in Utah and Texas, shot up 847%.

Selling stock to pay down debt “breaks a lot of rules in corporate finance” because it swaps cheap capital [debt] for more-expensive funding, said Ira Green, head of capital markets at energy-focused investment bank Simmons & Co. “It was survival mode.”

Many of these oil-and-gas companies had few options. The bond market became unavailable to them as crude prices plunged. Banks, which lend to energy producers against the value of their untapped oil-and-gas reserves, also cut back credit lines as the value of this collateral fell.

Private-equity investors, meanwhile, were generally hesitant to invest until they were sure commodity prices had bottomed. These firms also often insist on a level of control that many oil and gas companies were unwilling to give.

Some analysts say oil is poised to rally further, which could extend the recent gains. The Organization of the Petroleum Exporting Countries in November agreed to production cuts, helping to send crude prices to their highest level this year. The election of Donald Trump , who has pledged to reduce regulation and promote more drilling, could provide another boost to the industry.

Companies’ fortunes could reverse if they produce too much oil and leave markets out of balance, or if OPEC fails to implement its output cut.

Yet many North American producers have also spent the past two years wringing costs to help them drill profitably at current prices. U.S. crude ended the year at $53.72 a barrel, up about 45%.

Even so, more than 110 U.S. and Canadian oil producers declared bankruptcy over the past two years. By contrast, only a handful companies that raised capital through the stock market filed for chapter 11.

The busiest month for follow-ons was February, when oil prices bottomed at $26 a barrel. Oil and gas producers raised $7.4 billion selling stock to investors eager to buy at the bottom. All of those shares are trading higher, and those sold in four of the 14 offerings have more than doubled in value.

“That low of a price was unsustainable,” said Matthew Stephani, senior portfolio manager at Cavanal Hill Investment Management, which manages $7.3 billion and bought new shares sold by Encana Corp. and three companies that sell services and supplies to producers. “It’s not so much what you do in booms that creates wealth, but more how you act in busts.”

That bust began in mid-2014, when oil prices fell from above $100 a barrel. OPEC pushed them lower that autumn when it decided to keep pumping freely, and a global crude glut dragged prices down below $30 before they recovered.

The energy stock offerings started even as prices were in retreat. A January 2015 deal from Diamondback Energy Inc., which wanted to reduce debt, helped jump-start these sales. Credit Suisse Group AG bankers suggested that the Midland, Texas, company sell shares—and do so in a few hours before the stock market opened to lessen the impact volatile oil prices would have on an offering conducted in the typical manner over a few days.

Diamondback sold about $100 million of shares and its stock rose 9% that day. The outcome, unusual because adding stock typically pushes down the price as earnings are spread over more shares, touched off a wave of follow-on offerings. Diamondback’s move, which reduced its bank debt by about half, ensured it could continue to drill its prized prospects in West Texas and allowed investors to buy into a less-indebted company at a discount. Bankers, starved for business amid a dry spell for initial public offerings, enticed companies with favorable terms.

‘The capital markets were there for us again.’ -- Callon Petroleum CEO Fred Callon

Rob Santangelo, the Credit Suisse banker who led the Diamondback offering and dozens of subsequent deals, told executives and investors that he believed many oil producers would emerge from the bust stronger. “We found a lot of public capital willing to make that bet, and so far it’s been a good bet,” he said.

John Goff, a Texas real-estate magnate, bought much of his roughly 10% stake in Resolute when the Denver company’s shares traded below $1 and were at risk of being removed from the New York Stock Exchange.

He said he sensed opportunity similar to three decades ago when he sought bargains after the 1987 stock-market crash and in the beaten-down property market. Resolute stock he bought for $7.6 million is now worth more than $63 million, and he took a similarly sized stake in another of the year’s big winners, Mid-Con Energy Partners LP, which more than doubled. Mr. Goff bought another 100,000 Resolute shares two weeks ago for $38 apiece in 2016’s final follow-on offering from an oil producer.

Eventually, defensive stock offerings to pay down debt gave way to sales that funded acquisitions, particularly in the Permian Basin in West Texas, where stacked layers of oil-bearing rock help make drilling profitable even at low prices.

Diamondback sold so many shares in six offerings that it held a special shareholder vote to double the number of shares it is allowed to issue before its latest deal, a $1.2 billion offering in December to help pay for its purchase of rival Brigham Resources LLC.

Callon Petroleum Co. began the bust with a stock-market value of about $333 million. Six offerings later, the Natchez, Miss., company has roughly five times as many shares as it started out with and a market capitalization greater than $3 billion. On a call to discuss its December purchase of West Texas drilling land, paid for by a $656 million offering, Chief Executive Fred Callon said: “The capital markets were there for us again.”

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