When Ken Hersh was in his last year at Stanford Graduate School of Business in 1988, he had an idea: to create a private equity firm that invested only in oil and gas companies and assets. He wrote a letter to Richard Rainwater -- the man who helped the Bass brothers make billions -- to see what he thought of the plan, and Rainwater liked it. So did Gamble Baldwin, a former natural gas analyst at First Boston. Hersh put the plan together in his dorm room, Rainwater invested, and Baldwin joined the firm, which was called Natural Gas Partners.
Baldwin passed away in 2003, and Rainwater -- who stepped out of the firm early on -- has been suffering from a debilitating neurological disease. But Hersh is still at the firm, now known as NGP Energy Capital Management LLC, which has $13 billion under management. In May he closed on the firm's 10th fund, raising $3.6 billion out of a targeted $4 billion.
"This one took us longer," Hersh says matter-of-factly, noting that the combination of the financial crisis and the Bernie Madoff scandal had even established investors spooked. "Dollars are precious, allocations are precious, and firms got overexposed, so there's been a general push for fewer, higher-quality relationships. We were the beneficiary of that because we had good results."
Indeed, Irving, Texas-based NGP claims it earns gross returns north of 31%, with net returns of 20% -- pretty sweet for a private equity firm operating in an industry that is rife with commodity risk. But Hersh says the firm doesn't play commodity prices. "People who equate energy investing with commodity prices don't understand the business," he says. "The success of the industry doesn't correlate with energy prices. Those who have made that assumption have been wrong."
The firm's principles are simple: align with great management teams who understand the drivers of their niche; make small bets (on average, $50 million to $100 million); and keep a keen focus on the risk and reward. "Before our money is spent, we understand where the capital is going, and we understand the risk," he says.
It hasn't always been easy. A severe drop in oil prices in the late '90s led one of the firm's portfolio companies, Canada's Sunoma Energy Corp., which had taken on a lot of debt to finance takeovers of Barrington Petroleum Ltd. and Orbit Oil & Gas Ltd., to go into receivership. The firm's other investments, however, kept its returns in the midteens. "The 1990s taught a lot of people the dangers of leverage," Hersh says.
The firm's latest headache: affiliate NGP Capital Resources Co.'s purchase in July of $25 million worth of overriding royalty interests in certain Gulf of Mexico properties owned by ATP Oil & Gas Corp., which filed for bankruptcy Aug. 17. NGP claims such royalties will be treated as production payments in bankruptcy court and won't be halted, but restructuring experts aren't so sure.
"All the debate in the case is around the interests [and] I've never seen case law on point," comments one restructuring source.
Still, NGP has had many successes over the years (it boasts a 90% success rate), starting with its 1996 acquisition and recapitalization with Rainwater of T. Boone Pickens' ailing Mesa Petroleum Co., which later became Pioneer Natural Resources Co. (Pickens had some not-very-nice things to say about Hersh in his autobiography.) But several observers -- and Hersh himself -- point to oil and gas pipeline operator Energy Transfer Partners LP as NGP's crowning achievement: It invested $35 million in the company in 2002 and by 2007 had pulled $1 billion out of it. "It was one of the greatest private equity investments that one could ever have," says Jeff Zlotky, a partner at Thompson & Knight LLP in Dallas who has worked on capital raisings and investments for the firm.
The 49-year-old Hersh, who has been called smart and numbers-driven but also impatient and a little arrogant ("One thing that was pretty obvious was that Hersh felt he didn't have anything to learn from any of us," Pickens wrote in his book regarding Hersh after the Mesa takeover), fell into the energy business by chance. The son of an economics professor and a podiatrist, the Dallas native went to work as an analyst at Morgan Stanley after graduating from Princeton. " 'You're from Texas, go to energy,' " he remembers his bosses saying. "But that's where the action was. I enjoyed it."
John Goodgame, an attorney at Akin Gump Strauss Hauer & Feld LLP who has worked with NGP on the restructuring of Eagle Rock Energy Partners LP and the structuring of Memorial Resource Development LLC in order to take Memorial Production Partners LP public, says one of the keys of NGP's success is building long-term relationships and keeping on good terms with management teams. "They don't try to squeeze them," he says. "They want them to be successful over and over again."
Latham & Watkins LLP attorney Michael Chambers gives the example of Houston oilfield equipment maker CRC-Evans Pipeline International, which NGP funded, sold to LG&E Energy Corp. in 1999 for $45.6 million, took private in 2003 by backing a $40 million management-led buyout and then sold to Stanley Black & Decker Inc. in 2010 for $445 million. "In every transaction, they made money," he says.
NGP placed its latest big bet when it acquired family-owned oil and gas explorer Samson Investment Co. with Kohlberg Kravis Roberts & Co. LP and other investors last fall for $7.2 billion, one of its largest investments ever. More recently, in June, it agreed to back Calgary, Alberta, oil and gas investor Petrus Resources Ltd. in its purchase of oil and natural gas assets in the Peace River area of Alberta for $58 million. (NGP had invested in Petrus CEO Kevin Adair's previous company, Spry Energy Ltd., which was sold last year to Whitecap Resources Inc. for $226 million.)
So what's next? A new industry focus. NGP had hoped to raise a water and agriculture fund called Global Adaptation Partners led by former Archer Daniels Midland Co. executive Mark Zenuk. But when investor interest wasn't as brisk as expected, it folded it into its latest energy fund, which will be 10% invested in those areas. It's already made one small investment, in an agricultural logistics business. "Water and agriculture are areas that have been severely underinvested in, but the world hasn't had to worry," Hersh says. "But as the population grows, climates change, and industrial uses and demands have shifted, there have been real pitch points. We saw a highly fragmented industry structure and the need for capital."
Still, NGP's bread and butter is oil and gas, which are hot areas right now to invest in. But Hersh says it's a boom-and-bust business and even he doesn't know when the music will stop: "Anytime that people say, 'This time is different,' I tend to bite my lip."