E&P IPO: Can TPG Keep Pace With This Energy Offering?

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Includes: CDEV, KAACU, SRUNU, VEACU
by: Raw Energy

Summary

TPG Pace Energy Corp., a "blank check" company or special purpose acquisition corporation, recently completed its IPO, raising $600 million in the process.

TPGE.U priced 60 million units at $10/unit, each unit comprised of one share and 1/3 warrant with each whole warrant exercisable at $11.50 per share.

TPGE is backed by TPG Capital, an alternative investment manager that has over $74 billion in assets under management.

Similar to Centennial, Silver Run II, Kayne Anderson and Vantage , units offer investors a "nearly free look" at the initial transaction to be proposed.

In a "lower for longer" environment, the units may be a good speculation on management's ability to perform; a portfolio approach for any or all five companies may make sense.

And ... they're off! Although it's not exactly the Kentucky Derby, this "horse race" may prove to be even more interesting to investors in the E&P sector. This race is for investor dollars, and it pits nearly all of the major E&P investment management firms against each other, each attempting to outdistance the others in raising money through SPACs ("Special Purpose Acquisition Companies").

First out of the gates back in Feb., 2016 was Silver Run I, now called Centennial Resource Development (NASDAQ:CDEV), with Riverstone as its jockey/sponsor. After the success of that offering, Riverstone followed up with Silver Run II (NASDAQ:SRUNU) and was joined by Kayne Anderson Energy Acquisition (NASDAQ:KAACU) in Mar., 2017. Vantage Energy Acquisition (NASDAQ:VEACU), with Natural Gas Partners as its jockey/sponsor, then followed in April, 2017. Those companies have raised over $3 billion for future acquisitions in the SPAC format, also known as a "blind pool."

As the companies head down the initial stretch, they are being joined by a 5th major IPO, TPG Pace Energy Acquisition (NYSE:TPGE.U). TPGE went public on 5/5, probably just a coincidence for the 5th offering, but horse race betters are a superstitious bunch. The company raised $600 million by issuing 60 million units at $10/unit.

For those who have followed along with my prior articles on Centennial, Silver Run II, Kayne Anderson and Vantage, the structure in TPGE closely parallels those deals. You may know the structure of the deal, but those who are only just now tuning in to this race may not be aware; bear with me if as I repeat the setup.

In a "blind pool" or "SPAC" (special purpose acquisition corporation), a new company with no existing assets raises money to invest in future opportunities, in this case in the energy business. Investors are asked to trust that the founders will identify and act to acquire attractive assets/businesses, while at the same time investors are also given the right to get almost all of their money back if the SPAC does not close on a business combination within 24 months of the IPO or when the initial transaction is proposed by the founders/management.

The Offering

TPGE, as well as the others mentioned above, structured its offering much like a private equity fund, in which its founders purchase very cheap initial shares and obtain a 20% share ownership. They also invested $15 million to purchase 9.3 million warrants to purchase stock at $11.50/share.

Investors who contributed the $600 million get shares entitling them to the remaining 80% of common shares. Of the total contribution, $5 million is specified as common equity, while $575 million is specified as "Common stock, subject to redemption." The balance of net proceeds ($21 million) is designated as deferred underwriting commissions.

The units consist of one share and 1/3 warrant to purchase one share at $11.50. Only whole warrants (3 X 1/3) may be exercised. Only the units will trade until 52 days from the IPO, at which point they may be separated by holders into common stock (TPGE) and warrants (TPGE WS). The warrants become exercisable on the later of the date on which the initial business combination occurs and 12 months after the IPO, and they expire 5 years after the date of its initial business combination transaction. The warrants can be redeemed, at the option of TPGE in its discretion, at any time after which the common stock trades at $18 for 20 days out of a 30-day trading period. Such calls for redemption typically result in warrant owners converting their warrants into common stock, which can require additional cash consideration (i.e. $11.50 per share) or, as has recently been the case in CDEV, by allowing a "cashless" exercise in which investors receive additional shares based on the difference between $11.50 and the then-market price.

The "nearly free look" nature of the transaction is intended to lessen the risk of entrusting funds with no specific usage initially. Assuming a deal is identified, the specifics are set out in detail and investors are given 30 days in which to decide whether to continue to hold their common shares or to require the company to redeem them for what amounts to 95%+ of their investment. In that respect, the initial investment acts more as an option to take advantage of a potentially attractive future acquisition; time will tell whether the market cooperates with the hoped-for result.

The underwriters for the offering included Deutsche Bank, Goldman Sachs, Citigroup, Credit Suisse and Tudor Pickering. Readers may recognize many of these for having served as underwriters in the previous E&P SPAC offerings.

Management

Obviously, with structures that are largely identical, investors are being asked to place their bets on management, and more specifically on the sponsors. TPGE is sponsored by TPG Capital, one of the largest alternative investment managers in the world, with $74 billion in assets under management.

Headquartered in Fort Worth, TPG was founded in 1992 by David Bonderman and James Coulter. Mr. Bonderman had earned his reputation initially as COO of the Robert M. Bass Group, the vehicle for one of the Bass family members who are among the wealthiest individuals in the U.S.

Shortly after leaving Bass to form TPG, the company had a major financial success in its pursuit of Continental Airlines in bankruptcy, ultimately selling out for roughly 10X what it paid to establish the stake. Since that time the company has participated in several other major transactions in many different industries, including Ducati Motor Holdings, S.p.A., Armstrong World Industries, Inc., Burger King Holdings, Inc. and Seagate Technology plc, among others Many of those were successful, while the company also notably failed in its efforts to turn around Caesar's Entertainment, and it was an investor in the failed Energy Future (TXO) LBO. Bonderman himself was recently named as one of the investors in the NFL's new Las Vegas stadium.

From the prospectus.

"TPG's investment activities include discrete investment platforms focused on a range of alternative investment products and a series of funds across the private equity spectrum, including ("i") TPG Capital, TPG's private equity business for equity investments over $100 million, which focuses on global investments across all major industry sectors predominantly in North America and Europe; (ii) TPG Asia, TPG's Asian-focused private equity business; ("iii") TPG Growth, which invests in small- and middle-market growth equity and corporate opportunities in all major industry sectors in North America and in other developed and emerging markets; (iv) TPG Biotechnology Partners, which invests in early- and late-stage venture capital opportunities in the biotechnology and related life sciences industries; and ("v") TPG ART, which invests in alternative and renewable technologies. Beyond its private equity platform, TPG has opportunistically established (vi) TPG Special Situations Partners, which is the special situations and credit platform of TPG; ("vii") TPG Real Estate, which is the real estate platform of TPG; (viii) TPG Public Equity Partners, which invests in the public equity market; and ("ix") TPG Strategic Infrastructure, which invests in large scale infrastructure opportunities in growth markets. TPG has over 1,000 employees and advisors, including 527 investment and operations professionals."

Keen observers will note one missing item in the above description of TPG's experience: energy. While TPG has management experience across a broad range of industries, its experience in energy is not as extensive. More information about TPG's various investment platforms can be found {here}.

The company does note, though,

"TPG has successfully taken several of its energy and energy related portfolio companies public, including Kraton Performance Polymers and Northern Tier Energy. Additionally, TPG has successfully provided growth capital for publicly traded energy and energy related companies, including Copano Energy and EnLink Midstream Partners. TPG also has substantial experience acquiring large scale energy and energy related divisions and assets from large publicly traded energy companies, including CenterPoint Energy, Marathon Oil and Encana."

The historical transactions show TPG's main focus to have been in the midstream and refining businesses, which may indicate the direction that TPGE will take. It has a very broad mandate, however, that would allow it to pursue energy transactions in upstream, midstream or downstream operations.

TPG's most well-known foray into upstream/E&P was its investment in Jonah Energy, which owns a significant development project in Wyoming. Just this past week, Jonah acquired interests in that area from Linn Energy (OTCQB:LNGG) for $580 million. Other development joint ventures have been entered into by one of its credit platforms to finance drilling with Legacy Reserves (NASDAQ:LGCY), Hunt Oil and others.

Like the other SPAC entrants, TPGE has a retired energy executive to head its efforts, Stephen Chazen, formerly CEO of Occidental Petroleum. According to the prospectus,

Stephen Chazen has served as our Chief Executive Officer and President since February 2017 and will serve as Chairman of our board of directors following the completion of this offering. Mr. Chazen retired as Chief Executive Officer of Occidental in April 2016 and remains a member of the company's board of directors. Mr. Chazen began his career at Occidental in 1994 as Executive Vice President-Corporate Development. He was named Chief Financial Officer in 1999 and served as Chief Financial Officer until 2010. Mr. Chazen was appointed President of Occidental in 2007. He was then named Chief Operating Officer in 2010 before being appointed Chief Executive Officer in May 2011. Mr. Chazen was elected to the Board of Directors in 2010. Before joining Occidental, Mr. Chazen was Managing Director in Corporate Finance and Mergers and Acquisitions at Merrill Lynch. He worked as Director of Project Evaluation and Reservoir Engineering at Columbia Gas Development Corporation from 1977 to 1982. Mr. Chazen began his career at Northrop Corporation in 1973 as Laboratory Manager at the Johnson Space Center, where he worked until 1977. Mr. Chazen is a former Chairman of the American Petroleum Institute. He also serves on the Board of Advisors of Rice University's Baker Institute for Public Policy and is a member of the Senior Cabinet of the President's Leadership Council at Houston Methodist Hospital. Mr. Chazen is a Director of Ecolab Inc. and The Williams Companies, Inc., and Chairman of the Board of the Catalina Island Conservancy. Mr. Chazen holds a Ph.D. in Geology from Michigan State University, a master's degree in Finance from the University of Houston and a bachelor's degree in Geology from Rutgers College. Mr. Chazen is well-qualified to serve as a director because of his significant directorship experience, as well as his substantial and broad experience in the energy sector, as an executive, advisor and director.

At this point I would be remiss if I did not point out that, unlike the other SPACs which hired their executives from among the independent E&P sector, Mr. Chazen's experience was in leading an integrated semi-major company, one typically not thought of when it comes to aggressive action and decision-making. While that experience and TPG's own background suggest to me that the focus of TPGE's activities might lead it more to the midstream or refining businesses over the E&P business, the flexibility that TPGE has to pursue any energy-related field does give broad discretion.

Fortunately for investors, they have the right to put shares back to TPGE after having been given all the details of the initial business combination proposed by the company, a significant detail that substantially de-risks the investment. TPG's reputation and desire to expand its footprint in energy undoubtedly incentivizes them to present an attractive initial deal, and the analytical support that TPGE, Mr. Chazen and others will receive from TPG, its private equity, credit and other platform connections should prove valuable. That is a probably a major reason that the offering was upsized from its original $460 million level to $600 million.

TPGE's mandate is very broad and flexible, allowing it to take advantage of whatever energy transaction comes along that meets its acquisition criteria. It obviously thinks that the market for assets will be active, what with companies restructuring their own asset bases to take advantage of their best assets, as well as potentially distressed situations. The nice thing is that there is no need to speculate (much) now, since the redemption feature allows investors to react at the time of an initial proposed business combination. My own opinion is that leveraged companies will have a difficult, if not impossible, time surviving in a pricing environment of $50-60/bbl.

How should readers differentiate the SPACs that have come to market recently? SRUN and VEACU are very similar, with strong sponsors, experienced managements and forward commitments for additional equity capital to be employed largely in upstream companies. I believe KAACU may focus more on midstream opportunities, and it does not have the same size or commitment level the other two have. TPGE is a bit tougher to read, but hopefully it will not just end up competing for the same deals as CDEV, SRUN and VEACU. Without seeing what each company will propose as their initial business combination, it is tough to know which one will do better (or worse), and my approach will be to invest in several companies as "options" to invest in their identified deals in the future. By sizing positions to avoid putting all eggs in one basket, investors may reap those benefits and still achieve diversification of risk based on the source and specifics of the deals identified.

Conclusion

In summary, TPG Pace Energy, much like its fellow SPAC companies Centennial, Silver Run II, Kayne Anderson and Vantage, offers a near ground-floor opportunity to take advantage of an investment manager's expertise without risking much on the front end. In some respects the companies function as a "put" on existing energy assets, with the hope, if not the expectation, that future reductions in asset value can be capitalized upon at lower prices. Investors certainly do not get the opportunity to invest in hedge funds directly, so this is the closest option the market offers to public investors.

So how would I handicap this horse race? Well, unlike bettors who are asked to place bets on a single horse, I am more likely to spread things around. While the cost structure of TPGE and the others (20% of ownership) is high, the ability to take that into account in assessing the initial transaction does reduce the risk somewhat. Nothing about any of the 5 companies suggests that investors need to focus on only one, and a "portfolio" approach of investing in them all might well make sense. While it is always possible that no successful business combinations will be achieved, I think the market will continue to be very active ($25 billion already in M&A YTD and another $33 billion in assets being marketed). That makes TPGE.U a worthwhile speculation for me, one I will plan to add to my portfolio at some point in the near future. In any event, it is definitely a company that should be followed by E&P and other energy investors.

Stay tuned to see if any other investment managers (Quantum, Ares/Apollo, Encap, etc.) step up with other entrants into this horse race....

ETFs dedicated to E&P companies include: XLE, XOP, IEO, PXE, GUSH, DRIP, SOP and UOP.

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Disclosure: I am/we are long SRUNU, KAACU, VEACU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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