SIPES Houston Meeting: August 2013

1. Mezzanine Finance for Independents:
How to Keep Your Project Moving
SIPES
Houston, TX
August 22, 2013

2.  About Five States
 Why Review Financing?
 What is Mezzanine?
 Cost of Capital
 Case Studies
Overview

3. ABOUT FIVE STATES

4. Five States Energy Capital, LLC
1985
•Five States Energy Company, Inc.
•Acquires operated and non-operated working interests
1985
• Five States Operating Company, Inc.
• Operates Five States’ interest properties
2004
• Total Energy Asset Management Services (TEAMS)
• Oversight of portfolio asset properties
2007
• Five States Energy Capital, LLC
• Provides mezzanine capital to independents

5. Independents % Allocation of Time
Why Review Financing?
Activity % of Time
Research & Culling Data 35 - 65
Project Development 10 - 20
Project Financing 20 - 50
Administration 10 - 20

6. Independents’ Sources of Development Capital
Why Review Financing?
• Available Cash
• Cash Flow from Previous Activities
• Sell Down of Promoted Interest
• Cash Flow from Current Project
• Convert Working Interest to Override
• Bank Loans
• Convenient Sources
• Mezzanine Financing!

9. WHAT IS MEZZANINE?

12.  Fills Gap Between Senior
Debt and Equity
 Subordinate in Priority of
Payment to Senior Debt
 Senior in Rank to Equity
 Stretch Debt
 As With Banks, Advances
Usually Based on Proved
Reserve Base
What is Mezzanine?
MEZZANINE
Senior Asset Backed Debt
Equity

13.  Development drilling programs
 Acquisition financing
 Infrastructure financing
 Bank clients that are over extended (but
typically still solvent)
Mezzanine typically fits:

14. Capital Structure in Oil & Natural Gas Transaction
• Advantages
– Not a sale of equity
– No loss of control of
company
– No requirement to sell on a
schedule
– Puts up majority of
development capital with
minority stake in project
– Appears as debt; can be
financed from pre-tax
revenue
– No board position required

15. Companies with Efficient Capital Structures
5% - 12%
Senior Debt
50% - 75 %
Mezzanine
20% - 30%
Equity
15% - 30%
13% - 25%
25% +
Typical Private Equity Structure .
(% of total Assets)
Expected
Returns
(%)
Source: Management Magazine, Bond Capital

16. COST OF CAPITAL

17. Relative Costs of Financing Options
Banks
Mezzanine
Private Equity

18. Lowering Cost of Capital
Case 1: Traditional Case 2: Typical Debt Case 3: High Leverage
100%
50%
20%
20%
50%
60%Equity
Mezzanine
Bank Debt
Company Capital Structure.
(% of Company Value)
80% of company
value can be
released in Cash
Return on Equity
Weighted Average
Cost of Capital 35 % 19 % 11%
12 % 21% 40%
Source: Management Magazine, Bond Capital

19. Underwriting Process
1
• Initial Investment Criteria Check
2
• Engineering Analysis
3
• Financial Analysis
4
• Operations / Legal / Land Analysis
5
• Term Sheet Issued
6
• Final Due Diligence
7
• Close Investment
Oil, gas, and midstream deals are
sourced in the marketplace through
industry contacts and intermediaries
~50% pass initial screening for further
evaluation
~5-10% pass due diligence
and term sheets are issued
~2-5% are
closed and
become part
of the portfolio

20. Typical Term Sheet
Interest • ~12% coupon
• ~25% WI Back-in at Payout
Term 3-5 years
Facility Determined
By:
• 90-100% PDP
• Discounted PDNP and PUDs
• Land/Leases
Structure Very fluid

21. What Do Lenders Look For In A:
Borrower?
Deal
Structure
Business
Plan
Track Record
Equity Participation
Collateral
(PDP, PUDs, Leases)
Reputation/Character

22. Collateral
Higher Risk
• “PUD”
Proved
Undeveloped
• Leases
Moderate Risk
• “PDNP”
Proved
Developed
Non-Producing
Lower Risk
• “PDP”
Proved
Developed
Producing
~10% ~25% ~90%

23. CASE STUDIES
Financing Package – Bakken
Appalachian Acquisition Package
Pipeline Construction – West Texas

24.  $85mm Mezzanine Debt
Financing for
Development of 14,000
Acres in North Dakota
• $16.2mm initial advance
with remaining funding to
occur over time
• 45 producing wells and
need for funding to keep
pace with rapid
development of the area
• Senior note @ 6.25% –
bank revolver structure
(30%)
• Junior note @ 12.50% –
mezzanine structure w/
BIAPO* (20%)
24
Financing Package - Bakken
Note: Photo for illustration only.
*BIAPO: Back In After Pay Out

25. Appalachian Transaction (WV & OH)
Collateral PDP and PUDs
Term 5 years
Interest Rate 12%
Origination Fee 1.0%
Equity Component 25% at term or repayment
• Option to purchase 25% of assets for cash
equivalent of loan amount at closing
Hedging 75%

26. Advantage Pipeline – West Texas
Pipeline Construction

27. Advantage Pipeline – West Texas
Pipeline Construction
• Location: Pecos, TX to Crane, TX
• Length: 75 miles
• Cost: $60 MM
• Deal Structure: $17.5 MM equity financing

28.  Mezzanine can be a good fit for:
– Companies focused on acquisition and development
– Especially when there is existing production
– Companies needing to pay down bank debt
 At end of term:
– Company is left with majority of equity
– Greater profit potential
Summary

29. Five States Energy Capital, LLC
Mezzanine Finance Market