Proposed Investment in Warburg Pincus Energy

Memorandum to: State Investment Council
From: Christopher McDonough, Director
Subject: Proposed Investment in Warburg Pincus Energy, L.P.

The New Jersey Division of Investment (“Division”) is proposing an investment of $100 million in Warburg Pincus Energy, L.P (the “fund”). This memorandum is presented to the State Investment Council (the “Council”) pursuant to N.J.A.C. 17:16-69.9.

The Division is recommending this investment based on the following factors:

  • Attractive opportunity set: Favorable secular supply/demand trends in oil and gas are driven by increasing non-OECD consumption and limited production growth outside of North America. To keep up with the rising demand, the industry must target more complex reservoirs, resulting in increased capital costs to find and develop reserves and operate production. The sector’s capital intensity combined with forced divestures of assets from public companies leads to attractive opportunities for private capital.
  • Track record: Since 2000, Warburg Pincus (“Warburg” or “firm”) has invested $6.6 billion in 45 energy investments and generated an estimated Net Internal Rate of Return (“IRR”) and net multiple of 22.7% and 2.4x, respectively, as of December 31, 2013. For the realized energy investments only, the net IRR and net multiple are 25% and 3.0x, respectively. Compared to the public markets, the firm’s energy investments since 2000 have outperformed the S&P Energy index by over 700 bps. The energy investments also consistently ranked top quartile on a Net Total Value to Paid-In basis since 2000.
  • Investment style: Warburg emphasizes growth investing within the energy sector to build durable businesses of scale by backing operationally excellent management teams and providing them with the capital to grow their companies to the point where they become free cash flow positive. By building to the point of scale, it allows the fund to have multiple exit options ranging from a sale to a strategic partner or MLP to an IPO.

Furthermore, by providing lines of equity based on milestones, it allows the firm to cap investments in poor deals early and significantly back good performers. Analysis of their performance supports this concept, with a loss ratio of 8% since 2000 and capital invested skewed towards higher returning deals.

A report of the Investment Policy Committee (“IPC”) summarizing the details of the proposed investment is attached.

Division Staff and its consultant, Strategic Investment Solutions, undertook extensive due diligence on the proposed investment in accordance with the Division’s Alternative Investment Due Diligence Procedures.

As part of its due diligence process, staff determined that the fund has not engaged a third-party solicitor (a “placement agent”) in connection with New Jersey’s potential investment.

We will work with representatives of the Division of Law and outside counsel to review and negotiate specific terms of the legal documents to govern the investment. In addition, the proposed investment must comply with the Council’s regulation governing political contributions (N.J.A.C. 17:16-4).

Please note that the investment is authorized pursuant to Articles 69 and 71 of the Council’s regulations. The Warburg Pincus Energy, L.P. will be considered a commodity-related real asset investment, as defined under N.J.A.C. 17:16-71.1.

A formal written due diligence report for the proposed investment was sent to each member of the IPC and a meeting of the Committee was held on May 14, 2014. In addition to the formal written due diligence report, all other information obtained by the Division on the investment was made available to the IPC.

We look forward to discussing the proposed investment at the Council’s May 28, 2014 meeting.

Source: State of New Jersey State Investment Council