DALLAS—Some private equity (PE) sponsors are charting a course that runs counter to recent public E&P trends, attendees heard at the recently held Energy Capital Conference hosted by Oil and Gas Investor. The trend is seen in PE investments targeting growth rather than the capital discipline increasingly espoused by public E&Ps, as well as a natural gas perspective that looks beyond near-term pressure on prices.

Regarding the pressure to show capital discipline, “fortunately it’s on the public companies,” said Sean O’Donnell, managing director with Quantum Energy Partners. “While public companies have to zig, private capital can zag. We’re not burdened with having to be free cash flow positive in 2018—it’s quite the contrary. We’re full speed ahead.

“Now is the opportunity for private capital to get in and create some scale at attractive prices, while the public E&Ps are having a lot more discipline instilled on them by the public investors,” O’Donnell continued.

In addition, cheaply priced assets in the natural gas sector warrant attention, according to O’Donnell, who said Quantum-backed companies have been buying sub-top tier assets, particularly in gas.

“You can buy them at very good value right now, particularly PDP (proved developing producing assets). If you pay PDP, and get inventory for free, you’re cash flow positive within approximately two years,” he said. “A private company buying today’s second tier assets and applying new technology could have tomorrow’s first tier assets in 2020-2021—and with positive cash flow and all the metrics that the public markets are likely to want by that time.”

While assets prices may be attractive for those PE sponsors with cash to put to work, the outlook for exits by their portfolio companies has certainly become more complex, according to the conference’s PE panel. Hold periods tend to be longer, as exits are “getting murky” and the market for initial public offerings (IPO) has been “significantly down,” he said.

Murphy Markham, managing partner with EnCap Investments, said about 95% of the firm’s exits have historically taken place through sales into a cash market, with the IPO route chosen only occasionally “for the right team and the right asset.” But the IPO market “has been significantly down over the last couple of years. The result is we’re just happy to hold portfolio companies a little bit longer.”

According to Murphy, the universe of buyers for oil and gas assets has undergone a significant change.

“We’ve seen a big change in that, historically, we were building assets and selling them to public companies that were primarily looking for a growth vehicle,” he said. “With the public [equity] markets being down, five of our last seven sales have been to other private equity sponsors. In two of those sales, the buyers actually took over the management teams.”

Markham noted that EnCap had sold some $13 billion of assets over the last two and a half years, although “the current pace is significantly less.” The two transactions he cited—in which the larger PE sponsors purchased not only the asset, but also the team operating it—were each about $2 billion or more in size, with plans to expand further and potentially go public. “As a result of the public market being out, we’ve sold to private equity, we’ve bought from other private equity,” Markham said.

The viewpoint from Quantum is that “you need to be prepared to stay private longer. Exits are murky,” O’Donnell said. But at some point “growth will come back into the picture,” and IPOs will re-emerge as “a more distant necessity.”

“It’s not what we aspire to do when we get out of bed in the morning, but we’re prepared for that as an outcome,” he continued.

Chuck Yates, managing partner with Kayne Anderson Capital Partners, contrasted how “out-of-basin buyers”—those seeking entry into a new basin—were common prior to the critical 2014 Thanksgiving OPEC meeting, but such buyers have recently been few and far between. “We’re telling our limited partners that they have the least amount of predictability in terms of a sale,” he said.

As a result, Kayne Anderson has focused attention on the most likely buyer, or “strategic buyer.” This may be an E&P with adjoining acreage, for example, or one poised to share in an improving cost structure due to synergies and lower general and administrative expenses. And, in the event of a sale to a publicly traded E&P, the relationship may be one where Kayne is willing to accept stock, which would avoid pressure from future financings needs on the acquirer’s stock price.

“It’s almost more important today to know what’s going on with the buyer than it is necessarily with our own assets,” Yates said. “We’re engaging with the strategic buyers when they want to talk. We spend a lot of time talking about ‘manufacturing a buyer,’ figuring out what the concerns are for the buyer and what we can do to get a deal done. It’s almost like a jigsaw puzzle these days in terms of making it happen.”

In terms of new developments on the technical side, Yates pointed to trials to test 200-mesh sand for use as a proppant. If 100-mesh sand is like talcum powder, he said, 200-mesh sand “is so thin and fine that you basically have to transport it to the drill site in liquid or else it will just blow away.”

For Quantum, O’Donnell said the firm’s latest Fund VII has a $100 million side-pocket for venture capital investments in energy technology, primarily comprising “low capital-intensive, high impact businesses with technology applications.”

Chris Sheehan can be reached at csheehan@hartenergy.com