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Riverstone, Carlyle will reap hefty profits from Dynamic Offshore

by Claire Poole and David Holley | Published February 3, 2012 at 9:31 AM

Riverstone Holdings LLC and the Carlyle Group deferred an initial public offering of portfolio company Dynamic Offshore Resources LLC in favor of an outright sale to strategic buyer SandRidge Energy Inc., and it's easy to see why.

Oklahoma City oil and gas explorer SandRidge said Wednesday it is paying $680 million in cash and 74 million shares of SandRidge stock valued at $8.02 per share for the Houston oil and gas company. The deal, valued at $1.275 billion, was announced a day after Dynamic was due to price an IPO.

Riverstone and Carlyle together will receive $355.6 million in cash and 38.7 million shares of SandRidge stock worth $310.39 million. The cash and stock payments equate to a 2.96 times return on the $224.9 million in equity that regulatory filings showed the sponsors have invested since 2008. With $136.8 million in distributions paid to the two sponsors since 2008, the total return from Dynamic is about 3.6 times their cost.

If the IPO markets weren't so problematic, the company might have gone ahead with an IPO, which, based on its proposed $17 to $19 per share target range, would have conferred the 52.3% majority owners a much smaller cash realization with a promise of bigger gains down the road.

A full exit is generally preferable to a partial one.

A source close to the matter said Dynamic Offshore deployed $202 million of the $450 million that Riverstone and Carlyle committed to invest in 2008. The company also deployed modest borrowings and internally generated cash flows to finance 10 material acquisitions valued at about $850 million, the source added.

Dynamic Offshore has been one of the more aggressive acquirers and operators on the Gulf of Mexico shelf since its 2008 buyout. Last year it bought nearly all of the Gulf of Mexico properties of Exxon Mobil Corp.-owned XTO Offshore Inc. and related assets for $182.5 million, and Beryl Oil & Gas LP in 2009 for around $200 million. It was in the running to buy Devon Energy Corp.'s assets in the area in 2010, but Apache Corp. picked them up for $1 billion.

SandRidge said Dynamic Offshore's oil-rich assets will add reserves, production and cash flow at an attractive valuation that is consistent with its three-year plan to triple Ebitda and double oil production while lowering its debt-to-Ebitda ratio.

Analysts at Tudor Pickering Holt & Co. Securities Inc. applauded SandRidge in a Tuesday note for being "as tenacious as a honey badger" with its defensive-driven acquisition to secure future cash flow and shore up its balance sheet. They said that multiple compression, strategy shift and net asset value dilution will outweigh the positives, including the price paid and the free cash flow, leading them to downgrade the stock. "Our concerns outweigh the positives," they wrote.

Global Hunter Securities Inc. analyst Dan Morrison was more positive about the move, saying the implied price per share for Dynamic came in at the lower end of its IPO price talk. The deal should generate $150 million to $200 million per year of surplus cash flow, which should improve the visibility of its funding for the popular horizontal Mississippian play, he said.

During a conference call with analysts and investors, SandRidge management said more bolt-on acquisitions might be coming in the Gulf of Mexico.

SandRidge and Dynamic have a history together: SandRidge CFO James Bennett knew Dynamic's management when he was at GSO Capital Partners LP, which had invested in the company. SandRidge management said they began technical due diligence on Dynamic after its S-1 document was filed with the Securities and Exchange Commission in August.

One retail broker on the conference call said he had put some of his clients into the company because of its conservative, deleveraging strategy. Now the company would have "lots of leverage" and more risk, he commented. "You're destroying value," he added.

CEO Tom Ward responded that management did see the transaction as deleveraging and lowering risk, adding producing oil properties in the Gulf of Mexico to ones it already has. "We think over the course of time this will be proven to be a good acquisition," Ward said.

Asked by an analyst whether the impetus was to buy cheap assets or diversify, Ward answered, "both."

"The assets were too inexpensive to pass up. It was opportunity driven," he said. "Plus, the Gulf of Mexico is being classified with too much risk going forward, and the price for oil there is too cheap. It's like looking back at the Permian Basin in 2009 that other companies didn't want to be in that we chose to buy production in."

Even so, SandRidge is taking on debt to finance the transaction. SandRidge secured $725 million in committed financing from Bank of America Merrill Lynch, SunTrust Robinson Humphrey Inc. and Royal Bank of Scotland Group plc that the company may use to fund the cash portion of the purchase price. It can also tap its $790 million borrowing base facility, which remains undrawn.

SandRidge Energy bonds have been trading down since Wednesday on news the company is raising the $725 million in committed financing, according to Standard & Poor's Leveraged Commentary & Data.

The company's 7.5% notes due 2021 are trading around 99, down from 101/102 yesterday, LCD said. The 8.75% notes due 2020 are at 101.75/102.75, while the 9.875% notes due 2016 are at 107, sources told the service. Shorter-tenor LIBOR plus 362.5 notes due 2014 are marked at 96.5/97.5, said LCD.

Dynamic Offshore operates primarily in water depths of less than 300 feet, producing 25,000 barrels of oil equivalent per day.

Its year-end proved reserves were 62.5 million barrels of oil equivalent per day and are valued at $1.9 billion using Securities and Exchange Commission net present value discounted at 10%, or what's known as PV-10. Of these reserves, 80% of the value and the quantity are proved developed and about 50% of Dynamic's production and proved reserves consist of oil.

SandRidge expects to close the deal in the second quarter.

BofA Merrill Lynch's Scott Van Bergh and Andrew Castaldo, as well as SunTrust Robinson Humphrey's Jim Warren and Tom Gerlach, advised SandRidge. Covington & Burling LLP provided legal counsel with a team led by Scott Smith and Stephen Infante and including Matthew Fox, Mirra Levitt and Jeffrey Katz (M&A); John Gourary and Andrew Hyman (financing); David Engvall and Matt Franker (capital markets); Steven Rosenbaum (federal offshore oil and gas leasing); Rob Heller and Sarah Burnham (tax); Mike Francese and Michael Chittenden (employment and benefits); and James Dean (antitrust).

Vinson & Elkins LLP assisted Dynamic with a team including James Hanna (M&A); David Peck and Shane Tucker (tax); and associates Christina Tate, Lanchi Huynh, Pete Vranderic and Lina Dimachkieh. V&E capital markets partners Mark Kelly and Matt Pacey and associates Will Burns III and Randi Revisore were representing Dynamic in its IPO.

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Tags: Carlyle Group | Dynamic Offshore Resources LLC | IPO | private equity | Riverstone Holdings LLC

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Riverstone, Carlyle will reap hefty profits from Dynamic Offshore

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