PRINT THIS PAGE

Active target – energy plays in private equity

At the peak of the liquidity and credit crisis three years ago with capital markets closed to speculative energy firms, one of the few places for financially battered companies to turn was non-traditional sources such as private equity and hedge firms, says David Haarmeyer and George Givens of Global Energy.

These active investors and other financial entrepreneurs were and continue to be major buyers of the assets energy companies sold to pay down debt and exit non-core business lines. Today, the electric power and gas industry are firmly on the road to recovery. The S&P Utilities Index ended the year up almost 18% - more than twice the S&P 500. The industry’s financial recovery is also reflected in the growing number of companies that are returning money to shareholders rather than handing it over to creditors, or ploughing it into potentially value-destroying investments. The proposed Exelon-PSEG merger is also a clear sign of renewed industry confidence as well as the need for industry rationalizing.

With the recovery under way, confidence and share prices up, companies are beginning to turn their attention to real and perceived growth opportunities. At this point in the business cycle, re-investment risk, the risk shareholders face when surplus cash is redirected into ventures that may fail to meet a firm’s cost of capital, becomes a real danger.This may be especially true in mature industries such as utilities, with steady predictable revenues and limited long-term growth opportunities.

These new market conditions present another role for active investors, which is to address the conflict between shareholders and managers over the payout of free cash flow. As the siren sounds of growth become louder so too will the temptation to roll the re-investment dice. By impairing a company ’s strategic vision about what its realistic growth options are, too much cash raises the risk of over-investment and uneconomic diversification.

In direct contrast, private equity groups must return capital back to their limited partner investors over the 5-7 year life of their funds.

Click here to view the full article (pdf 218kb)

You need Adobe Acrobat to read this document. If you do not have it, you can download it free from www.adobe.com/products/acrobat/readstep.html

Global Energy is a leading provider of integrated software, data and consulting solutions for the energy industry. David Haarmeyer is director of strategic consulting at Global Energy, while George Givens is a vice president at the firm.

This article originally appeared in the Americas Energy Review of PFI magazine - Project Finance International is the authoritative and unbiased guide to new deals, pipeline deals and all aspects of project finance activity each week. For more details visit http://deals.thomsonib.com