Nice niche if you got it

It pays to be a niche investor, especially when that niche is the energy sector. Denham Capital Management LP, an energy and commodities specialist, has struck a raft of deals this year even as the buyout industry has slowed dramatically. So far, the Boston firm has announced nine in 2008, investing with a new $2 billion fund that closed in May.

The sponsor was founded in 2004 by its chairman and CEO Stuart Porter, a former portfolio manager for Harvard Management Co. (Harvard is among the investors in its latest fund). Denham was created as part of Sowood Capital Management LP but split in June 2007 as the Boston hedge fund was collapsing under heavy bond and loan market losses.

The firm now has some $4.3 billion of capital under management, is expanding globally and seeking deals across the energy spectrum from oil and gas to mining to renewables. A trio of energy industry veterans founded Denham; all of them are in Houston. They include Carl Tricoli, a former Enron Corp. executive; Riaz Siddiqi, the former CEO of Houston energy investment adviser Capstone Global Energy LLC; and Bill Zartler, a former portfolio manager of Aquila Inc., a Kansas City, Mo.-based electricity and natural gas services provider.

Continue reading below

---

Denham has been riding a wave as commodity prices have soared over the past couple years. Although oil has fallen considerably over the summer to less than $100 a barrel, it's still high. And that has spurred a lot of interest among private equity firms, particularly in exploration and production as well as oil-field services.

So far this year, M&A in the oil and gas sector has reached $196.1 billion -- up 1% from the same period last year and the highest year-to-date volume on record, according to Dealogic LLC. Financial sponsor buyouts reached $10.1 billion, up 31% from the corresponding period in 2007. In July, for instance, Denham-backed Greene's Energy Group said it was buying oil-field equipment rental and services company Devin Rental Tools Inc., of Lafayette, La., for undisclosed terms.

Denham typically invests $50 million to $250 million of equity in both development-stage projects and mature companies, and it does not confine itself to domestic deals.

"We're actively looking at more things outside of the U.S. than in," says Tricoli, who heads the firm's natural resources group. That's a shift. Denham's previous $1.24 billion fund was restricted from investing more than 40% of its capital outside of North America, but the cap was lifted as possibilities surged overseas. And while most of the firm's 63 investment professionals are in the U.S., it is making an international push.

In October 2007, it opened an office in London to target deals in Europe, Russia, the Middle East and Africa and Asia. It intends to expand its four-person London team to as many as 10 to 12 people. It also has its sights set on South America. This October, it plans to open shop in São Paulo, Brazil, initially with two investment professionals, but eventually six. In the U.S., Denham has 28 people in Boston, 27 in Houston and four in Short Hills, N.J.

The competition is lighter abroad, Tricoli says. That is partly because the perception of political risk in the Middle East tends to be greater than it actually is, he adds.

Denham has an independent team in place to weigh the risks of all its energy investments. "We're probably one of the few private equity firms that have a formal risk management function," says Siddiqi. A designated group of four enters the process as soon as Denham's deal team decides a target is worth pursuing. "They opine on every aspect of the transaction," he says.

Once Denham has formulated an investment thesis, it sets out looking for deals to match it. "We spend a majority of our time researching market dislocation," says Tricoli. For instance, after Canada announced in 2006 that it was planning to end tax advantages for income trusts, Denham saw an opportunity for profit. It bet the market would overact to the change, creating a diminution in the value of trusts. With this in mind, it sank $100 million in Canadian oil and gas explorer Fairborn Energy Ltd. in October 2007, helping the then-trust to reorganize into a corporation.

While the persistent credit crunch has dealt a blow to the buyout world, lenders have stayed supportive of energy deals thanks to the sector's strong fundamentals, notes Harris Williams & Co. banker Drew Spitzer. "There has been long-term underinvestment by and large across the various sectors, and that plays out well for private equity," he says.

Nuclear is one such area that Denham is now eyeing. The U.S. hasn't built a new nuclear plant in more than 30 years, notes Siddiqi, who heads the firm's power and carbon group. It's not the first sponsor to see opportunity there: In late August, energy-focused private equity firm First Reserve Corp. said it had created Accord Nuclear Resources to buy businesses in the nuclear power generation sector.

"The world is short power," says Siddiqi. One way of solving this problem is to generate more of it, without adding greenhouse gases, through new nuclear plants or wind farms. But, there's so much energy being wasted that more can be done to capture that "free fuel," he says.

In November 2007 Denham struck a deal with Recycled Energy Development to develop a $1.5 billion portfolio of waste-energy recycling projects that will help industrial production and electricity plants to reduce costs and greenhouse gas pollution. As part of that partnership, Denham is backing Silicon producer West Virginia Alloys, a unit of Globe Specialty Metals Inc. with $500 million of equity, helping it turn a process that was 33% efficient into one that is 80% efficient, says Siddiqi.

Denham's business model is distinct from most buyout firms in its willingness to tackle early-stage projects. For instance, EthylChem Ltd. announced in May the sponsor was supplying it with funds to build a 100-million-gallon-a-year ethanol dehydration plant in the Republic of Trinidad and Tobago.

There have been a few other renewable energy deals for Denham this year.

In July, it agreed to sink $145 million in geothermal power developer Vulcan Power Co. In April, it committed $200 million to Malta's SunRay Renewable Energy Ltd. to develop solar parks and rooftop installations in Europe. And in February, it teamed with StormFisher Biogas of Toronto to develop a C$350 million ($354 million) portfolio of biogas projects.

As the world seeks ever more innovative ways to become green, the firm is considering a newer technology that coverts algae into energy, says Siddiqi. It has also explored deals where waves are used to generate power. "One day, I have no doubt that it's going to play a very important role in the production of electricity," he says.

Comments

Post a comment

Name:

Email Address:

URL:

Remember personal info?

Comments: (you may use HTML tags for style)

Please only click "Post" once. It may take a few moments to process.