Compression Leader
Hanover Company Becomes Driving
Forcing In Industry
By Jeff Share, Editor
Pipeline & Gas Journal
It’s been quite a ride for The Hanover Company. The Houston-based business was formed
through a combination of small compression firms in August 1990. In the decade since
outsourcing, consolidation and M&A activity became buzzwords in the energy business,
Hanover has been a model with an enviable record.
From humble beginnings, which included just 20,000 horsepower of units sitting idle on a
pipeline, Hanover has emerged as the market leader in full service natural gas compression
systems. In 1997, Hanover launched an initial public offering. The next year, revenues set
a record, jumping from $198.8 million to $282 million. With 1,200 employees, Hanover is
the world’s largest operator of rental compressor horsepower, having expanded from
781,000 hp at the end of 1997 to over 1.3 million hp, owning 3,400 units ranging from 26
hp to 8,000 hp.
In 1995, Enron became a 10 percent partner. That brought in capital which helped Hanover
become an international player with a project that eventually turned into ownership of a
contract compressor company in Venezuela.
Today—some 25 acquisitions later—Hanover ranks as the top contract or rental
fleet company in the world. It is also the largest provider of compressor fabrication in
the nation, due to increased demand and its acquisitions of Eureka Energy Systems and the
Packaged Power Systems Division of Waukesha-Pearce Industries. Hanover-Smith, its Oil
& Gas Production Equipment division, is the second-largest operation of its kind for
products such as separators, heaters and dehydrators.
Hanover’s vastly enlarged headquarters in rural northwest Houston serves as the hub
of its growing empire with spokes in Victoria and Midland, TX, Oklahoma City and Fort
Smith, AR. In addition to Houston, Hanover has plants in Kilgore and Corpus Christi, TX;
Farmington, NM; Red Deer, Canada; and Caracas, Venezuela. Hanover operates in Canada;
Colom-bia; Bolivia; Argentina; Venezuela; Peru; and Mexico with work in Brazil coming
shortly and a just-announced venture in West Africa. They have four domestic vice
presidents and one international VP, all responsible for making decisions in their
particular regions.
In an interview with P&GJ, Michael McGhan, president and CEO, and Chet Erwin, senior
vice president of sales & marketing, described a company that is essentially built on
three legs, the contract fleet being the core supported by two other entities: fabrication
of compression and production equipment. In recent years, they’ve also acquired some
gas treatment plants that may eventually add a fourth leg to their bottom line. Producers
comprise 65 percent of Hanover’s rental business vs. 35 percent for gatherers,
processors and pipelines. In compressor sales, gatherers and processors comprise 85
percent of the business vs. 15 percent for producers.
"Contract (rental) compression will always be the mother ship," McGhan insisted.
"It’s allowed the company’s revenues and profit margins to consistently go
up. In the past nine months, you’ve seen most oil service companies’ financial
performances plunge because they’re so tied to commodity pricing. That also somewhat
affects our core contract business, but if there’s demand for gas, they need
compression, of which we have a variable supply."
During the mid 1990s, the need for gas compression grew at an annual rate of about 10
percent, actually outpacing the growth in natural gas demand. The rental compression
business grew at a 14 percent rate as users saw that outsourcing would improve their
finances while meeting their changing compression needs. Hanover’s rental business
saw a 46 percent growth during this period until it now controls about 27 percent of the
contract business, earning $200 million annually, ranking No. 1 worldwide. The trend in
the rental fleet is toward larger units, they said. A decade ago, the average horsepower
was 130 hp; today it’s risen to 400 hp at Hanover. It is indicative of where the
market is going with central gathering vs. wellhead leading the way, McGhan said.
Hanover entered the compression fabrication sector in 1991, buying a company that was
earning about $5 million annually and packaging between 10,000-12,000 hp. Last year,
Hanover built between 200,000-220,000 hp, earning $110 million, and now ranks among the
leaders in units of 4,400 hp and below. Half of those packages are used to fund growth of
the core rental business while the remaining 100,000 hp is sold to third-party customers.
Hanover, which has had to increase its manufacturing space ten-fold to handle the
fabrication, averages about 1,550 hp per package compared to 1,000 hp for its nearest
competitor, Erwin said. "We identified the large horsepower—the pipeline and
gathering marketplace—as our niche for compression sales."
There was some concern on Wall Street when Hanover moved into gas treatment, with analysts
questioning whether they were competing with some of their own customers by offering a
bundled service. The answer is no, McGhan said.
"A field service company is basically out there trying to find ways to gather more
gas to feed to their mother ship - the major pipelines. We don’t take ownership of
the gas or the pipe. Customers ready to sell gas have asked us to install either part or
all of the treatment facility and operate it for them. When the project’s over, we
just go on to the next job," McGhan said.
With treatment and compression and power generators—Hanover now owns 50 electric
power generators driven by natural gas engines—added to the mix, Hanover became a
turnkey operator. Rather than continue buying power generators, Hanover decided to build
its own, and recently bought a plant in Houston to fabricate power generation units for
internal jobs. Now, they’re also selling power generators to third parties.
McGhan identified four key drivers as stimulating the company’s growth: increasing
domestic market share; developing global markets; acquisition and leaseback of customer
compressor fleets; and selected corporate acquisitions.
"First is the normal domestic market share because there are new projects going on
from the wellhead through gathering systems, some pipeline, storage and plant compression.
That’s the day-in, day-out business. Second is international—South America and
our move into Canada in 1997. We really turned that into an outsourcing market in 1998-99.
There’s business in Africa, the Middle East and Southeast Asia. We’re slowly
moving that way."
International Market
Bolivia is a good example of how the company operates. When the just-completed
Bolivia-to-Brazil pipeline began construction two years ago, Hanover did not feel that it
had the right products to offer the consortium.
"They’ve got the big pipeline gas stations installed, but they still need the
gas source that’s coming out of Bolivia so we went back there and today it’s
become one of our higher growth areas. We’re putting field-gathering compression in
with treating facilities to supply the gas to that pipeline," McGhan said. All told,
Hanover is involved in nine jobs in Bolivia and Argentina that will ultimately be worth
about $100 million.
Nigeria has a new law that will outlaw the flaring of natural gas. Its biggest producer,
Shell, is making plans to install compression for re-injection. Hanover just signed a
joint venture, Hanover Global Nigeria Ltd., to construct and provide Global Energy with
over 20,000 hp of compression facilities and a 150 MMcf/d cryogenic gas plant, in an
investment of approximately $45 million. The project, which includes several barges and is
to be in operation by mid-2000, requires construction of 30 miles of pipeline and
processing facilities that will market 12,000 barrels of NGL daily.
Acquisition Leasebacks
"The third area of growth is the acquisition leaseback program where we go to
producers, large gatherers and pipeline companies that own their own assets and offer to
run their compression operations for them. We’ll offer them good dollars for their
equipment, sign them to long-term contracts, not just on that equipment but on all their
compression needs because no one can tell what you’ll need several years down the
road," McGhan said.
Being able to guarantee run time is important, but these deals also free up badly needed
cash for their customers to apply to their core businesses. Those capital markets dried up
in late 1998 and Hanover was quick to respond. This has been especially true in Canada
where producers, who at first bucked the outsourcing trend by preferring to own and
operate their own compression, are under increasing pressure to find new gas for the
pipelines being built, but have lacked bank financing. Today, Hanover has aligned itself
with three of the top 10 independents in Canada with acquisition leaseback programs and
more opportunities are en route, Erwin said. Hanover is also planning to expand its
Canadian manufacturing facility to 100,000 square feet, enabling it to build 100,000 hp
next year.
The acquisition leaseback program began in 1991-92 with small deals averaging about
$150,000 and was instrumental in the fledgling company’s growth. As Hanover’s
balance sheet and reputation for flexibility and creativity grew, those deals moved into
the $750,000 range and now average $2-5 million, McGhan said. It was a relatively new
concept, but being a privately held company, Hanover was only answerable to itself. By the
time they turned to Wall Street in 1997, acquisition leasebacks were a proven success,
providing 15 percent of the company’s horsepower assets and $45 million worth of
business during the first six months of 1999. This also enables Hanover to boost its
market share by replacing competitors who may be renting machines elsewhere for these
customers.
Hanover has done three deals with Houston Pipeline Co., Enron’s intrastate affiliate,
in which it literally bought everything within the fence: compressors and compressor
stations in a 10-year operating agreement that also meant taking on those effected
employees. That was Hanover’s first intrastate deal. Now McGhan’s team is
discussing deals in the $5-$50 million range. They’re even cooking up one with a
major producer that could approach $150 million.
"Those kinds of deals are out there, but take longer because you’re dealing with
a lot more levels of bureaucracy and Hanover’s claim to fame is making acquisition
deals quickly, then going on to the next project," Erwin said. "We’ve been
so busy growing internationally and domestically through acquisitions of small regional
companies that we just haven’t had time to focus on more intrastate business."
After its first pipeline deal, Hanover found itself in the turbine business. Once it moved
internationally in 1995, many of those $50-$100 million jobs called for turbines. In 1997,
its acquisition leaseback with Houston Pipe Line netted three Solar turbines. Hanover now
owns a dozen turbines and has talked to major manufacturers about forming a distribution
relationship. Barring that, it may start its own turbine company from scratch, since it
already has some former employees of those manufacturers on the payroll.
"In the year 2000, you’re going to see turbines being a big part of our future
along with production equipment, fabrication compression, treating and power generation.
We’d rather own and operate it. There are a lot of opportunities out there, but
it’s trying to make a decision on who it is that will really meet our market area and
has the chemistry that can deal with Hanover," McGhan said.
Offshore
The Hanover execs alluded to a fourth factor driving the industry: the much-talked about
push toward a 30 Tcf natural gas market. More compression will be required at the
wellhead, gathering stations, processing and treating plants, storage centers and on the
pipelines. That can only mean a golden future for the compression sector, whether it means
bringing in gas from Canada or the deepwater Gulf of Mexico, where Hanover already
controls about 60 percent of the market share with some 250,000 hp of contract
compression. The investment harkens back to 1995, McGhan recalled.
"That was a pretty pivotal year for our company. Most of our competitors decided the
Gulf of Mexico was hazardous and expensive and that you couldn’t make any money. We
took a contrary position and aggressively went after the Gulf. By 1996-98 when it boomed,
we had positioned ourselves with service people to accommodate the offshore market. We now
have our own fleet of boats and mechanics who work seven days on and seven days off,"
he said. The company’s success led to the construction of a new facility south of
Lafayette, LA.
Experts have warned that fields in the Gulf are being depleted at a much faster rate than
was anticipated. This presents another ideal opportunity for the compression industry,
Erwin said.
"We’ve seen compression needs change in the Gulf from a standard 1-2 stage
application where suction pressure at the compressor is still pretty efficient at 200
pounds or so. Now we’re seeing a real demand for three-stage compression which will
take the pressure below 100 psig. It just continues to create demand for horsepower,"
he said.
Market Growth
There are approximately 15 million hp worth of skid-mounted compressor packages in the
U.S. under 4,500 hp - that does not include pipelines. Add the 45 million hp in the
pipeline market and it means that about 60 million hp is needed to move 21.5 Tcf (current
gas consumption in the U.S.) A 30 Tcf market will boost the need for compression to about
90 million hp. Compression horsepower is growing approximately 9 percent annually - at
least three times faster than natural gas demand growth.
"Even if gas demand stayed flat, your horsepower continues to increase because your
reservoir pressures are going down and the need for more compression goes up 6-8 percent a
year. On the delivery side, your pipeline pressures are going up across the country, and
your capacity is going up," McGhan said. Where they now typically see 800-1,000 psi
pressure on the pipeline side, those figures have inched up to 1,200 psi without a
problem, he said. Now, a number of pipelines, including Alliance, are going to 1,450
psi,
which requires additional compression. Canadian officials have even talked of bringing
lines in from western Canada at 1,800 psi or even higher.
McGhan and Erwin expect to boost compression assets from 1.3 million hp to as high as 5
million hp in the next three to five years. Compression companies themselves own about 4
million hp. Of the 15 million hp out in the market, 11 million hp conceivably might be for
sale. That doesn’t include the 45 million hp owned by the pipeline—another
viable market to pursue—they said. In recent years, the compression business has
consolidated dramatically to where there are about nine significant players, and Hanover
intends to continue to lead that trend, they said. In terms of a 60 million hp market,
increasing their share to 5 million is not that significant, they said.
"What we probably have going against us is that Hanover is a relatively young
company," McGhan acknowledged. "We don’t talk to a lot of the big
engineering firms. They may not know about us. We’re pretty selective with whom we do
business with. As we continue to grow our rental fleet from 3-5 million hp, can we go from
200,000 hp to 400,000 hp in new package sales every year? We’ve increased our floor
capacity by over 500,000 square feet over the last two years, bringing the total shop and
resources to over 1 million square feet."
New Venture
The recent downturn did slow Hanover’s growth plans, but it also made clients pay
closer attention to the acquisition leaseback business and the capital-induced outsourcing
that resulted in their benefit. But what happens when the capital markets return?
"Most of the players will have smartened up and realize they should put their capital
to good use in their core business where their returns are higher and not spend it on
things like compressor assets and treating facilities that will probably represent
single-digit returns in the form of savings," Erwin said.
Continuing to study ways of profiting through outsourcing, Hanover is in the process of
forming a measurement services company. McGhan said the company will be
"baseloaded" with Houston Pipe Line and operate in South and East Texas. The
measurement subsidiary will also focus on the prolific Hugoton Basin in the Midwest that
several of Hanover’s employees are already familiar with. He said they are talking to
other pipelines about joining the measurement company by selling off their assets in favor
of Hanover’s control.
The fragmentation of the measurement business even dwarfs that in the compression sector,
McGhan said. But what lies behind their strategy is that many companies prefer a neutral
party to be responsible for measuring gas, which prevents most pipeline companies from
setting up their own measurement businesses. Outsourcing measurement allows operating
companies, which have already seen margins squeezed drastically in recent years, to reduce
their operating expenses, Erwin said.
Hanover recently completed a project for Enron near Houston, installing 40,000 hp of
electric compression in four units. New federal regulations impacting emissions will
increase cost the compression operations for gas engines and create a market for electric
compression, McGhan said. There’s another factor looming, too.
"With deregulation, having electric compression suddenly makes sense where years ago
it was not an option because of the price of electricity. This market will continue to
grow, especially with the pipelines on larger projects in the non-attainment areas because
it doesn’t really leave them a lot of choice.
"Second," McGhan continued, "it will create opportunities for companies
that actually own emissions credits to sell those on the open market and go to electric
compression. It’s an interesting game being played out."
The Street
McGhan, a teacher by trade who helped found the company and has served as CEO since 1991,
agreed that building a large company so rapidly has created its share of challenges,
including the integration of many different corporate cultures into a hybrid with its own
uniqueness. This year, Hanover hopes to produce $400 million in sales, added to the $200
million from its rental business. What have the gurus on Wall Street been saying?
"They seem to be happy with us," McGhan said. Stock has moved back into the
$35-$37 range after dropping to $20 during the downturn last year.
"They’re watching a company that’s been on a 40-50 percent growth curve.
Though nobody’s promising 40-50 percent, but we think 25-30 percent is sustainable.
We have to manage our balance sheet carefully, but we’ve got a nice war chest with
capital in it to continue our normal course. Wall Street is expecting us to step out and
do a nice-sized acquisition in the next six to 12 months and we think there’ll be one
available by that time." P&GJ
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