The equity markets have seen signs of recovery within the past five to six weeks, and the debt market can be attractive for investment-grade and near-investment-grade companies, says Maynard Holt, co-president, upstream investment banking for Tudor, Pickering, Holt & Co.

However, “we don’t anticipate a lot of near-term equity issuance in this market,” and for BB or B-rated or lower companies seeking public debt, “it’s not available yet.”

Holt spoke in the webinar, “Unconventional Resource A&D: How To Fund It,” available at A-Dcenter.com. To hear the one-hour program, go to https://video.webcasts.com/events/pmny001/viewer/index.jsp?eventid=30699.

“The debt and equity markets have signs of hope, but are not really there for unconventional players to finance in yet.”

Most companies are trading below a value of their proved reserves and do not get credit for their probable and possible reserves, he said, compared with last year when the stock market gave credit for probables and possibles. “It makes the equity market a difficult place to sell stock and get value for what you’re funding, which is your unconventional.”

In the present marketplace, asset transactions larger than $75 million are finding a limited audience and few cash buyers. “It’s difficult right now to take money out of your existing portfolio and put it into unconventional.”

Holt said that while the public debt and equity markets are showing life, in the short-term better ways to fund unconventional plays are via corporate mergers and joint ventures. “We’re seeing a lot of activity around combinations of companies with cash flow and another with opportunity.”

Joint ventures in particular are “interesting and exciting” as well-capitalized companies lacking opportunity team up with companies holding acreage but without capital to drill. And, “they’re happening across borders,” he said.

“Canadians, Asian and Europeans have a desire to get into U.S. unconventional basins and haven’t been able to because it’s been so competitive. They can find a partner and help a U.S. player fund an opportunity. We spend a lot of our time on things like this.”

According to Lynn Bass, co-founder of GasRock Capital, the market for mezzanine financing “probably feels broken,” but mezzanine lending survives albeit in a different form than last year.

Return expectations by investors is a “huge impediment” to mezzanine financing right now. The energy downturn has driven project returns down and the financial crisis has driven investor’s return expectations much higher, Bass said.

“In a $9-gas environment, almost any project created acceptable returns.” But the downturn of commodity prices has driven returns of projects down to the point many are uneconomic. Meanwhile, investor return expectations have gone higher. “Funds are expected to return 20% or higher in the current financial market.”

Also, investor appetite has changed. “Investors have almost a singular focus of financing acquisitions of distressed assets at bargain prices and prefer target returns be achievable with little or no drilling.” And while these dream investments have not materialized so far, “regardless, investors have in mind that they soon will and every potential investment is compared with this dream deal rather than true investment alternatives at the moment.”

Bass emphasized that a mezzanine lender’s portfolio comes first in priority, and this has greatly reduced the time any fund can spend evaluating new transactions. As a buyer seeking capital, try to understand the fund’s portfolio to find opportunities—it may have a similar company with similar assets to yours.

“Perhaps a merger makes sense,” says Bass. “You can achieve better access to capital by helping a fund out of a tough spot. Consolidation may improve your economics.”

Mezzanine investors are seeking higher returns, more equity, and are more sensitive to downsides. “Try to bridge that gap. Think of ways to spread risk. Deploy hedging in ways to reduce risk. Think creatively about the wants and needs of your financial partner.”

Wil VanLoh, president and chief executive of private-equity firm Quantum Energy Partners, says because of the capital intensity of resource plays, experience of management is crucial in gaining private-equity funding.

“There is a huge premium on intellectual capital. The learning curve is always steeper, longer and more expensive than you hoped they would be.”

The required experience and depth of management teams is so much greater for resource plays, he said. “We don’t like paying people’s tuition.” These teams sought by private-equity investors typically come from large public companies with experience drilling many in resource plays.

And the amount of equity required is exponentially greater, but leveragability is much smaller. This puts a lot of pressure on generating acceptable rates of return on equity, “especially considering they are front loaded—you’ve got to spend material dollars on acreage, and acreage doesn’t cash flow.”

An obstacle for private-equity funds investing into resource plays is “you can’t hedge land,” VanLoh says. Instead, “you’re investing those dollars expecting to be able to produce hydrocarbons at a certain price deck. For people that bought land last year, they’re having a rude awakening right now at $3.50 gas.”

A mistake many private-equity companies make is to think they will have a great package to sell after 10 or 20 wells are drilled, when in fact, it may take 200 to 300 wells before the economics of the play are optimized. “Don’t go into these undercapitalized. The magnitude is 10 times what you need for a conventional play.”

VanLoh emphasizes that if you are going to own the asset for a long time, ask, “Can I access the capital?” and “How much will I really need?” “There are private companies we’ve seen spend more than $1 billion of private equity in resource plays, and still need more.”