Melrose Resources: Easily digested

Oil and gas independents have steadily extended their reach from the now vanilla prospects in the North Sea. While asset sales and licence trading will keep bankers busy in this region, the more ambitious operators are now looking much further away in growing their business. Banks, in turn, have had to explore new horizons in political risk.

Melrose Resources illustrates the new lengths to which banks must go to support a client during its expansion phase. It is one of the largest loans for an international portfolio of independent assets to be underwritten by a single institution – in this case Bank of Scotland. The $300 million loan syndicated successfully, and Melrose followed it with a well-received equity offering.

The financing supports the acquisition by Melrose of Merlon Petroleum, for which Melrose agreed to pay $265 million on 13 April 2006. Merlon had substantial interests in the Nile Delta in Egypt and in the Permian Basin in the US. Indeed, Merlon was a partner with Melrose in the Al Mansoura field in Egypt.

The acquisition immediately altered the geographic profile of Melrose, which had until then primarily operated in Bulgaria and Egypt. It also drastically altered the financial profile of Melrose, which previously had primarily funded itself using equity and short-term bank lending.

Melrose immediately appointed Bank of Scotland to arrange the necessary debt financing, and Bank of Scotland, having done limited business with the operator in the past, was able to conduct the necessary due diligence at high speed. The far-flung nature of the assets, which are much less accessible to an Edinburgh-based banker than North Sea fields, made this a challenge.

The enlarged Melrose, however, benefits from a diverse base of assets, spread across three jurisdictions, although Egyptian reserves predominate. It had 131.4 billion cubic feet equivalent (bcfe) in proved oil and gas reserves, and 125 bcfe probable in Egypt at the time it announced the acquisition. Bulgaria, on the other hand, accounted for 47.6 bcfe proved and 7.6 bcfe probable, and the US accounted for 97.5 bcfe proved and 135.7 probable.

The resultant debt package is structured in three tranches, secured upon each of the sets of assets, and overall pricing on the facility will be linked to the blend of assets in the portfolio at any given time, and their reserves. Bank of Scotland is retaining a $10 million mezzanine tranche for its own account.

While BoS moved fast to underwrite the facility, it took a little more time to syndicate the debt. The acquisition closed on 30 June, and Melrose subsequently reported slightly lower operating profit for the first six months of 2006, compared to the same period in 2005, blaming in part the financing costs associated with the acquisition.

Still, on 7 November, Melrose placed 22.7 million new shares, raising $134.5 million in net proceeds. The Adair Trusts, which control the company, and are linked to chief executive Robert Adair, bought into the issue to maintain a 52% stake. The market capitalization of Melrose had reached £385 million ($753 million at today's rates) with the issue.

Moreover, drilling results from Egypt pointed to the potential for Melrose to increase its reserves. All of these factors encouraged BoS to launch syndication in November, and the process justified the bank's aggressive underwriting commitment.

The bank group participating in the debt consisted of the International Finance Corporation, BNP Paribas, Calyon, HVB, Fortis, KBC, Société Générale, Natixis, Bank of Ireland and DZ Bank. The banks will have been heartened by the margins on offer on the deal, which, while below 400bp, still translated into an effective interest rate of roughly 9%.

The deal attracts comparisons will Tullow, another operator with a mixture of OECD and non-OECD assets, which has been active in overseas acquisitions. Indeed, one of the few more prominent financings for independents in 2006 was the bank debt backing Tullow's acquisition of Australia's Hardman.

Current valuations of oil and gas assets mean that speedy and dedicated bank backing is essential if independents are to compete properly for the best oil and gas prospects overseas. The fact that these are located outside of the North Sea makes the necessary due diligence skills, and the presence of substantial in-house engineering expertise, a prerequisite for banks to compete. Cross-border reserve-based lending will come to dominate the Edinburgh banks' business.

Melrose Resources Plc
Status: Closed April 2006, syndicated December
Size: $753 million
Location: Bulgaria, Egypt and US
Description: Financing for the acquisition of Merlon Petroleum
Sponsor: Melrose Resources
Debt: $300 million
Underwriter: Bank of Scotland
Legal counsel to the lenders: Dundas Wilson
Legal counsel to the sponsor: Todds Murray