From The Wall Street Journal
Apollo Global Management APO -0.73% LLC and a group of other big investors had black gold in mind when they acquired oil-and-natural-gas producer EP Energy Corp. in a leveraged buyout seven years ago. Instead, the debt-fueled deal has delivered black eyes.
Last month, EP warned in a securities filing that its ability to remain a going concern is in doubt because of a looming payment on some of the $4.25 billion of debt it shouldered to help Apollo and its partners buy the company for $7.15 billion. EP also wrote down the value of its West Texas drilling fields by $1.1 billion. Since January, its shares have been trading below $1—giving the company a market value of about $67 million—and are at risk of being removed from the New York Stock Exchange.
The tumbling stock, which closed at 26 cents on Tuesday, has reduced the value of the buyout group’s controlling stake to about $50 million. That is a sliver of the $3.3 billion of cash the group put toward acquiring the Houston company.
It could be worse for the investors, though: They extracted about $750 million in fees and dividends from EP before taking it public in a 2014 stock offering. But even after that haul, Apollo and its partners face a potential loss of about $2.5 billion, which if realized would cement the EP buyout as one of private equity’s great whiffs.
EP has struggled to produce oil profitably, particularly in the West Texas fields on which it had staked its future, after the Organization of the Petroleum Exporting Countries initiated a price war with U.S. shale producers in late 2014 that sent crude-oil prices plunging.
“It just wasn’t a good recipe for survival given the tectonic shift in the macro picture,” said Arun Jayaram, a JPMorgan Chase & Co. analyst. “The debt load became something that was too high for a company with its asset base.”
EP executives didn’t respond to requests for comment and didn’t take questions on their recent earnings call. Apollo and its partners in the EP investment either declined to comment or didn’t respond to requests for comment.
Barring a reversal of EP’s fortunes, it will become private-equity investors’ latest multibillion-dollar misstep in the oil patch.
Private-equity firms acquire companies using a combination of cash from their fund investors—including pensions and endowments—and borrowed money. These firms have invested with zeal in the U.S. shale boom. Shale producers, which release oil and gas through horizontal drilling and a rock-cracking process called hydraulic fracturing, have a chronic need for cash.
The domestic drilling boom began more than a decade ago, around the time financial markets seized up in 2008. Private-equity firms, which had plenty of their investors’ money locked up in long-term funds, stepped in and scored some big profits on early shale deals. Apollo pocketed a profit of more than $2 billion selling a Permian Basin explorer that it funded with seed money in 2010.
Yet the heavy doses of debt these firms use to boost their returns have proven a poor fit for several energy producers, whose earnings and ability to make interest payments whipsaw with commodity prices.
Two big oil-and-gas funds that Stamford, Conn., energy specialist First Reserve Corp. raised over a decade ago have suffered multiple bankruptcies and lost roughly one-third of their value, or about $5 billion combined, according to public pension documents. Meanwhile, investors in a $2 billion drilling fund raised by EnerVest Ltd. of Houston were essentially wiped out.
The shale boom’s signature boondoggle has been the buyout of Samson Resources Corp. The family-owned, Tulsa, Okla., energy producer buckled under more than $4 billion of debt and filed for bankruptcy about four years after KKR& Co. and partners bought it for $7.2 billion. KKR and its partners, including oil-focused investment firm NGP and Japanese trading house Itochu Corp. , put $4.1 billion of cash into the deal and were wiped out except for about $175 million in fees they had extracted from the company.
Samson’s prospects became so grim that Itochu didn’t bother to learn whether any of its $1 billion investment would be left after bankruptcy proceedings. It sold its 25% stake back to Samson for $1 beforehand and its two board members resigned, according to a securities filing.
EP was sold to the highest bidder in February 2012, about three months after the auction for Samson. EP parent El Paso Corp. was merging with pipeline rival Kinder Morgan Inc.and scotched plans to spin off its exploration-and-production unit in favor of a sale. The day the sale to the private-equity group was announced, oil traded at nearly $110 a barrel. It now trades just above $60.
Apollo, a New York City firm that manages $280 billion, was joined in the purchase by Korea National Oil Corp., energy investment firm Riverstone Holdings LLC, Len Blavatnik’s conglomerate Access Industries and Singapore sovereign-wealth fund GIC.
For acquiring it, EP paid the buyout group a $71.5 million transaction fee. It also sold bonds to pay Apollo and its partners a $337 million dividend and agreed to hand the investors a $25-million-a-year management-consulting fee.
The buyout group took EP public in early 2014. The company raised $704 million and used the proceeds to cover payouts to the buyout group. EP paid its private-equity owners an $83 million termination fee so that it could stop paying the annual management fee. It also used $395 million to retire the 2012 dividend debt and put the remainder of its initial-public-offering proceeds toward paying down debt it took on to make a $205 million dividend payment to the Apollo group in 2013.
Known for shrewd debt deals, Apollo collected smaller—sometimes six-figure—fees for its role in several of EP’s bond sales, according to securities filings. It made $2.5 million on bonds that are due in May 2020. Those are the notes coming due that EP warned would trigger default before summer unless commodity prices rise significantly.
