At the start of this year, a number of secondaries professionals believed 2019 could be a big year for energy, particularly when it came to GP-led deals.
A series of steep oil price declines over the past 15 years led many energy fund managers to hold onto assets until they could work a more profitable exit. Today, there are several vintages that have blown past their 10-year lives with plenty of net asset value remaining.
The HarbourVest Partners-led $1.9 billion GP-led deal on Lime Rock Partners IV last year and GCM Grosvenor’s backing of a restructuring on Denham Capital’s 2005-vintage fund suggest that energy managers are exploring their options. According to research by secondaries intermediary Setter Capital, energy fund transaction volumes were up 38 percent last year at $1.7 billion, from $1.23 billion the year before.
“There’s a global phenomenon of private companies staying private longer,” says Holcombe Green, head of secondaries advisory at Lazard.
“Energy firms [in particular] have the need to find non-traditional routes to liquidity in order to deliver cash back to investors in what has been a relatively illiquid underlying market in recent years.”
It is in the energy sector that the first ever multi-billion GP-led secondaries deal may occur. In February, Private Equity International’s sister publication Buyouts reported that The Energy & Minerals Group, a Houston-headquartered GP with $16.2 billion in assets under management, was working with advisor Park Hill on a secondaries deal that could be worth between $4 billion and $5 billion in NAV.
The assets are out there and the need for liquidity is real. Still, energy remains a risky bet.
GP-led secondaries processes tend to come with a degree of diversification. Even though all assets are managed by the same GP, there is likely to be a mix of sectors and geographies to hedge against negative macro effects.
In energy, most assets are to some degree correlated to the price of oil. This can be useful as it makes the value of an energy fund relatively transparent. It can also mean the buyer is making a binary bet on fluctuating oil prices. As of early June, Brent crude was down around 18 percent compared with a year prior.
“What appetite do buyers have to go into an asset class that has seen two crises in the last 10 years?” asks a London-based managing director at an advisory firm. The transparency of the price of energy funds also takes away a useful advantage for the secondaries buyer – the lag between when a deal is priced and when it completes.
In 2016 energy-focused private equity firm First Reserve attempted to restructure its 2006-vintage fund. The deal was priced off a March NAV date and by the time the offer went to limited partners in the vehicle, the price of oil had risen. LPs who were once keen to sell were now eager to stay. The secondaries buyers lined up to back the deal – Pantheon and ICG – could not acquire a big enough chunk to justify doing the deal.
For larger deals, such as that involving EMG, a consortium of buyers that includes non-traditional institutions such as sovereign wealth funds and pensions, who have longer term return horizons, can help to spread the risk. GP-led transactions that contain some midstream assets, such as pipelines, have a weaker oil price correlation, so their inclusion can also help make a portfolio less risky.
“When a GP goes out with their projection on a deal it will probably look very attractive because with oil, if you get the price right, you nail it,” says one secondaries buyer who has bid on an energy GP-led deal in the past year.
While energy GP-leds can be a risky basis for a portfolio, small amounts of exposure to this deal type can be the pop in returns some secondaries funds are seeking.