Sometimes it pays to be a contrarian investor. Kansas City Equity Partners and its star portfolio company, Inergy Partners LLC (NNM:NRGY), discovered that last year during a rocky period for both the private and public markets.
“We made the original investment in Inergy when the market was rewarding technology companies and ignoring [nearly everything else], so it was very out of favor,” said David Schulte, managing director at KCEP. “In fact, even my own partners and investment committee were skeptical about this investment. It was completely contrarian. Now it seems obvious.”
Inergy, the No. 7 player in the highly fragmented propane industry, last spring closed on nearly $115 million in financing. It received $15 million from a syndicate that included Kansas City Equity Partners, Kansas Venture Capital and Diamond State Ventures. It secured $96 million in bank loans.
The money was used in part to purchase Hoosier Propane, an Indiana propane distributor.
This initial funding was completed with a distinctive structure of private equity capital convertible into a security that would become junior to the common units upon a public offering. “It was an innovative structure, because the SEC and Ernst & Young could not find clear authority on the accounting treatment upon conversion,” said Schulte, adding that he and Inergy president John Sherman essentially bet that the public market would become available near term.
On July 26, 2001, Inergy LP went public with the smallest ever Master Limited Partnership structure in the propane industry at $35 million. AG Edwards led the offering. At the time, the roiling public market helped increase the value for MLPs due to the dividend-paying feature, and several had successfully completed their unit offerings around that time. Inergy priced at $22 a share. There was a 9% increase in aftermarket value the week after the IPO. Inergy increased production in the fourth quarter after going public, which Schulte said has never been done before by an MLP. Last year, the Wall Street Journal ranked Inergy as the ninth best market performer over a 12-month period on its “top performers scorecard.”
Its stock has generally been on the rise since the IPO, staying between $22 and $30, peaking at $33.26 a share earlier this month after announcing a supply agreement deal with Sunoco Inc. (NYSE:SUN).
In the agreement, Inergy will begin marketing 100% of Sunoco’s propane production at its refinery in Toledo, Ohio. Production at that refinery is approximately 4,000 barrels a day, or 62 million gallons per year.
Schulte called this agreement a coup, as it fosters immediate growth in its wholesale unit. It is the latest in a string of major deals for the company.
Inergy has acquired 13 companies since 1996 – two in 2001 – the most recent being Independent Propane Company (IPC), based in Irving, Texas. Inergy acquired IPC for approximately $91.5 million in December 2001, doubling the company’s size. (The other big acquisition of 2001 was Hoosier Propane, which at that time doubled the size of the company.)
Inergy’s revenue rose from about $94 million in fiscal year 2000 to roughly $223 million in 2001, an approximate 137% increase.
“There hasn’t been a consolidation story to emerge from here that’s had this much private equity invested from regional investment firms before in the last decade,” Schulte said. “From the private equity side of it, there was an excellent syndicate of investors that came together to make this possible.”
Schulte said it is Inergy’s credibility that keeps it winning the public market battle. And management is a large part of that credibility.
Sherman is a well-known veteran of the propane industry. He has worked in senior positions at NGC Corp. (now Dynegy); LPG Services Group (a company he founded); and Ferrellgas. While at Dynegy, the marketing group under Sherman’s authority was responsible for marketing more than one billion gallons of propane annually, about 10% of U.S. retail demand.
Sherman worked alongside Inergy’s core group of executives for several years, as well, including Bill Gautreaux, Carl Hughes and Mike Fox, with whom he worked with at Ferrellgas. Sherman and his team sold the company they founded, LPG, to Dynegy in 1996 for nearly $9 million and turned their attention to creating an opportunity in the highly fragmented propane industry (Inergy), where there are anywhere from 5,000 to 8,000 small players, alhough the top 10 have one third of the market.