Plexus Capital, LLC

1
Plexus Capital, LLC

• An Intricately Interwoven Combination of Elements
  or Parts in a Cohering Structure
• Navigating the Maze of Available Financing
  Options
• New York
• April 18, 2005
• Wayne Williamson 1560 Broadway, Suite 1950,
  Denver, CO 80202 www.PlexusCapital.com
• [phone]

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Plexus Capital, LLC

• Formed to design and source conforming and
  alternative financing structures, minimizing the
  cost of capital for oil and gas producers
• Will assist the producer in determining its
  capital requirements and advise alternative
  solutions for accessing it
• Will assume lead role for transaction to expedite
  execution and allow producers management to
  continue to focus on current business
• Previous transactions have been structured as
  non-recourse monetization of PDP assets,
  compartmentalizing different risks to enable a
  high advance rate at lower than market cost of
  capital, allowing the producer to retain 100 of
  the upside
• Previous transactions have been structured as
  taxable to convert ordinary income to long term
  capital gain

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CFOs Capital Formation Responsibilities

• Dont run out of money
• Forecasting
• Anticipate capital requirements
• Reduce cost of capital
• Evaluate and manage risk
• Match risk with lender risk tolerance

4
Sources of EP Capital

• Public Markets
• Debt
• Equity and equity-linked debt
• Private Markets
• Commercial banks
• Vendors (well service, seismic, pipeline
  companies)
• Individuals
• Industry partners
• Private institutions (direct or thru fund
  managers)

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Why Hire an Intermediary?

• Internal personnel available and qualified to
  handle capital formation?
• Understanding of the current market range and
  cost of available capital
• Identifying tier/type/structure of capital that
  best fits the need
• Ability to communicate to capital markets through
  written and verbal presentations
• Ability to identify strengths and weaknesses of
  the internal organization
• What has been done before? What is reasonable to
  ask for?
• Time required to
• Design and prepare information to present to
  capital markets
• Track process as the market of the cost of
  capital is determined
• Read and negotiate agreements
• Creates an improved dynamic in the negotiation
• May gain more information from the capital
  provider
• Decision maker is removed from direct negotiation
  creating protection from forced commitments

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Intermediarys Role

• Help producer design the capital type and
  structure to source
• Producer risk tolerance
• Cost of capital
• Draft a transaction memorandum laying out the
  deal for prospective funders
• Model the producer entity pro forma the capital
  being sourced
• Arrange producer presentations to prospective
  funders
• Negotiate term sheets
• Ensuring the producer understands his true cost
  of capital and risk he is either keeping or
  transferring to the funder
• Keep producer and funder from talking past each
  other
• Recommend attorneys skilled in the type of
  transaction being undertaken
• Review and negotiate documentation
• Get the deal closed
• Fund expensive extravagant closing dinner
• Start to finish can vary based on complexity,
  where it is in the bid/ask spread, deadlines
  created by other transaction, experience of
  funder

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Attributes of a Good Intermediary

• Good negotiation and communication skills
• While maintaining a good relationship with and
  respect of funders, his relationship with
  producers is paramount
• Knowledge of capital markets
• Knowledge of producer business, concerns, future
  potential tension points
• Persistent
• Imaginative
• Interest in getting the best deal for his client,
  as opposed to just getting a deal done

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How Does an Intermediary Charge for his Services?

• EVERYTHING is negotiable! Only lack of
  imagination limits what can be done
• Up front retainer
• One time
• Monthly
• Reimbursement of out of pocket costs approved by
  client
• Success fee as a percent (1-5) of dollars
  committed or funded
• Conforming debt at lower end, non-conforming and
  equity at upper end
• Higher up front retainer can be traded for lower
  success fee
• Size of deal
• Tension points in engagement
• Exclusivity of representation
• Term of tail period for additional fundings after
  initial closing
• Indemnification

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Understanding Cost of Capital

• Weighted Average Cost of Capital
• Conforming bank debt (coupon, front end fee,
  commitment fee, admin fee)
• Sub debt (coupon, front end fee, commitment fee,
  ORRI, warrants, back-ins)
• VPP (discount utilized for calculating purchase,
  additional spread on hedges)
• Preferred Equity (coupon, expected equity growth
  rate)
• Equity (new equity or current owners equity)
• Need to consider term (floating vs fixed), front
  end fees
• Subjective values
• Transaction closing risk
• Speed of execution
• Future availability of capital from funder
• Call on capital

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Cost vs Risk

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Conforming Debt Attributes

• Advance 50 75 (60 - 65 is typical) risked
  proved PV10 at higher of bank pricing or hedge
  price
• Senior secured
• Payout within half life of reserves
• Maximum term 8 years
• Coupon at Prime or Libor 100 to 300
• Borrowing base review 2 times per year
• Proved non producing limited to 20 of borrowing
  base
• Single property no more than 15 of value
• Single bank hold limit 25MM - 50MM

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Private Mezzanine Attributes

• Limit total debt to 100 PV10 PDP at higher of
  institution pricing or hedge price
• Subordinated secured, requires inter-creditor
  agreement with senior lender
• No corporate governance issues
• Covenants similar to senior debt
• Cost from Libor 400 to 25 total cost of
  capital including ORRI or other equity kickers
• May allow a portion to revolve
• 1-2 months to complete financing

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Private Equity Attributes

• Investment focus is on Management
• 3-7 year investment time frame
• Active corporate governance, board
  representation, control
• Management receives 10-35 back-in after 8-25
  IRR
• Meaningful investment from management
• 3-6 months to complete financing

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Private Capital Sources(several play in both
groups)
Equity Providers Altira Group LLC ARC
Financial ArcLight Capital Partners, LLC Camcor
Capital Inc. Canfund VE II Mgmt. Ltd. Darby Latin
Am. Mezz. Fund, LP Encap Investments Energy
Spectrum Partners LP GE Capital Goldman
Sachs Greenhill Capital Partners, LLC Kayne
Anderson Capital Advisors Lime Rock
Partners Morgan Stanley Private Equity Natural
Gas Partners QUANTUM ENERGY PARTNERS Riverstone
Holdings LLC SCF Partners Warburg Pincus Yorktown
Partners LLC
Mezzanine Providers Ableco Finance LLC AIG
Financial Products Corp. Axiom One L.L.C. (a J.M.
Huber Co.) BlackRock Energy Capital Constellation
Power Source Crown Capital Partners
Inc. Foothills Capital (affiliated with Wells
Fargo) Liberty Mutual Macquarie Energy
Capital Petrobridge Investment Management
LLC Prudential Capital Group Standard Bank of So.
Africa TCW Asset Management UnionBanCal Equities,
Inc. Wachovia Capital Partners Wells Fargo Energy
Capital
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Example of Recent Unusual Transactions
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Financing Structure
Funder
Swap Counter-Party(s)
Credit Support
Secured Loan
Commodity Price Hedge
Mortgage
Interest Rate Swap
Property
Producer
Producer SPE
Insurance Company
Subordinated Note
Financial Guaranty
Cash Purchase Price
Guaranty Fee
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Structure Benefits for Producer

• Converts ordinary income to long term capital
  gain
• Lock in historically high gas prices without risk
  of margin calls
• Potentially higher advance rate than conforming
  commercial bank loan
• Financing is recourse only to subject properties
• No inter-creditor issues
• Diversifies capital structure
• Producer retains all property upside
• Vehicle for wealth transfer in estate planning

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PV Tax Savings for Various Reserve Profiles
Note Compares 15 capital gains rate to 38
ordinary tax rate.
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A Few Pearls

• Create competition for your transaction
• Dont assume a lender will not be interested in
  your type of transaction
• Ping as many lenders as you can, then focus on
  the 2 5 best fits
• Try to convince lower risk/lower cost lenders to
  move up the risk spectrum
• Lenders with minimum return will not accept lower
  return, regardless of lower risk
• Possible to get lenders to accept more risk for
  slightly higher return
• Find out what the lenders return criteria is and
  what they value

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A Few More Pearls

• Identify your assets/attributes (what you have to
  give) and find the lender that values them
• Other non-producing assets to pledge or value
  (seismic, equity in other enterprises, equipment,
  commitment of equity from VC)
• Geographic concentration of production
• Analyze and measure the risked value of your
  assets so the lender understands
• Always negotiate a detailed comprehensive term
  sheet
• Reduces legal cost
• Insures you have a deal before you invest too
  much time and legal costs to walk away
• Get senior lender to provide additional margin
  facility for hedging with non bank counterparties