KKR Digs Into Natural Gas

Target: East Resources Inc.

Price: $350 million

Sponsor: Kohlberg Kravis Roberts & Co.

Kohlberg Kravis Roberts & Co. recently made its first investment in the energy exploration and production industry since 1985. In early June, the New York-based mega firm invested about $350 million of convertible debt in East Resources Inc., a private company that owns about 650,000 acres atop the Marcellus Shale, which is said to be one of the most promising sources of natural gas.

The deal for KKR comes after a lengthy search for a natural gas play. “We have spent a significant amount of time—almost a year now—looking at opportunities in the Marcellus Shale,” Jonathan Smidt, an executive in KKR’s private equity group focused on energy, told Buyouts. The Marcellus Shale is basically an enormous sub-surface rock that runs through Tennessee, Kentucky, West Virginia, Maryland, Ohio and Pennsylvania. Natural gas companies drill into shale to fracture the rock and release the gas that gathers in its pores.

The firm zeroed in on East Resources for a number of reasons: It operates in a fragmented market that isn’t dominated by one large player; the vast amount of land it owns; and its proximity to the Northeast energy markets, Smidt said. KKR was also drawn to a new horizontal drilling technology the company is using, previously used to great effect by Mitchell Energy in the Barnett Shale, which is located in Texas. KKR’s investment in the company will help it reduce debt, drill for gas and develop its infrastructure.

Though this is KKR’s first investment in an E&P company in more than 20 years, the firm has ample experience with companies whose fortunes depend, in part, on natural gas prices. In 1985 the firm bought Union Texas Petroleum Holdings Inc., the oil and gas subsidiary of Allied Corp., for $1.4 billion. In 2004, the firm participated, along with TPG, The Blackstone Group and Hellman & Friedman, in the successful $3.6 billion buyout of Texas Genco Holdings, which the group subsequently sold to NRG Energy Inc. in 2006 for $8.3 billion. And in 2007 the firm participated in the $32 billion buyout of TXU Corp., now called Energy Future Holdings.

KKR’s investment, which is structured as debt convertible into a substantial minority stake, comes out of its KKR 2006 Fund. KKR had committed about $12 billion of the $17.6 billion vehicle as of March 31, according to an update the firm provided to investors.

The modest size of the deal is atypical for KKR—which is known for its ability to close 11-figure deals without pause—but the firm is no stranger to minority investments. It owns 18 percent of Laureate Education Inc., a Baltimore-based for-profit post-secondary chain of universities in which it invested in 2007; and the firm in 2000 made a trust preferred investment in DPL Inc., a Dayton, Ohio-based power company, that was convertible into a stake of approximately 20 percent.

Smidt said the firm is not interested in eventually gaining control of the company. Rather, KKR sees this is as a long-term investment with a hold time of several years that eventually could be exited by way of a public offering.