Hanover Compressor Company

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Hanover Compressor Company

12001 N. Houston Rosslyn
Houston, Texas 77086
U.S.A.
Telephone: (281) 447-8787
Fax: (281) 447-0821
Web site: http://www.hanover-co.com

Public Company
Incorporated: 1990
Employees: 4,700
Sales: $1.0 billion (2002)
Stock Exchanges: New York
Ticker Symbol: HC
NAIC: 532412 Construction, Mining, and Forestry Machinery and Equipment Rental and Leasing

Hanover Compressor Company, based in Houston, Texas, provides natural gas compression services, operating the largest rental compression fleet in the industry, some 7,000 mobile units with a combined horsepower of 3.7 million. In addition, the company services the equipment, and also offers treatment services, compressor fabrication, production equipment fabrication, and measurement services. Although Hanover has a global reach, with operations on five continents, it operates primarily in the Western Hemisphere, but is stepping up its efforts to penetrate markets in Europe, Asia, and Australia.

Formation of Hanover Compressor Company: 1990

Compression is used to increase the pressure of natural gas in order to facilitate transit from the wellhead, through gathering pipelines and processing plants, to the main interstate pipelines. Natural gas reservoirs contain a sufficient level of pressure initially, but as the well is depleted it loses pressure until natural gas will no longer flow through the system on its own. As a result, compression equipment is used to more fully exploit the well. Two types of compressors are suitable for oilfield use: reciprocating and rotary. Both are cyclical in nature, taking in a certain quantity of gas, acting upon it, then discharging the compressed gas before repeating the process. A handful of companies dominated the market for compression from the 1960s through the 1980s. Hanover Compressor emerged as a major player during the 1990s, but compression was in many ways an afterthought to the company's parent corporation Hanover Energy, which was primarily involved in the pipeline business in west Texas, as well as interests in gas marketing and exploration. By 1990 the company owned 17 compressors. Michael J. McGhan and other veterans of the compression business approached Hanover about managing their fleet of compressors and expanding the operation. McGhan, a teacher by education, had previously served as a sales manager for Energy Industries, Inc. In October 1990 Hanover Compressor was incorporated in Delaware. Two months later the four-employee venture added three major compressor rental companies located in Texas and Louisiana, offering equity stakes to acquire them.

Hanover quickly attracted major investors, such as GKH Partners, which included brothers Jay and Tom Pritzker, better known for their ownership of the Hyatt hotel chain, and Dan Lufkin, cofounder of Donaldson Lufkin & Jenrette. In May 1991 GKH acquired a controlling interest in Hanover. Later, the company attracted further investments from Western Resources Inc. and a group of investors that included former Treasury Secretary William E. Simon. In a short period of time it also became apparent to Hanover Energy's management that its fledgling compressor endeavor held the most potential of any of its businesses. The company decided to focus on compressors, and sold off its other energy interests to fund expansion. McGhan, who had been the subsidiary's chief operating officer, now became Hanover's CEO in October 1991.

Hanover formalized its compressor business in 1992, creating a common logo for its regional companies while standardizing operations. It also adopted a hub-and-spoke structure with larger regional companies serving as hubs for the organization. Michael W. O'Connor was brought in as chairman of the board, bringing with him more than 20 years of experience in the industry, serving as president of Gas Compressors Inc. from 1965 through 1986. To accelerate growth Hanover adopted an acquisition leaseback program. As had been the case with its initial acquisitions, the company gave equity stakes to executives of acquired companies. McGhan explained Hanover's reasoning in a 1996 article in Oil & Gas Investor: "Bringing them in as partners was important because they are planners, thinkers and doers. They were ambassadors for us out in the field, building on decades-old relationships. We wanted to keep that local responsiveness." O'Connor added, "We left them running the businesses they had built with sweat equity—operations and customer relations were their concern. We brought the capital and marketing necessary to build the overall business."

Hanover enjoyed steady growth over the next three years. Sales improved from $33 million in 1992 to more than $56 million in 1994, while net income increased from $988,000 to $4.4 million during the same period. The company entered a new phase of growth in 1995 when it began an extended acquisition spree. In January Hanover acquired compressor rental assets from CBC Compression for $2.7 million in cash. A month later it completed two deals. First, it added 106 units with an aggregate of 14,190 horsepower from Gale Force Compression Services, Inc. for approximately $11.5 million in cash and stock. Hanover then bought the production equipment fabrication assets of Smith Industries, Inc. for $2.7 million in cash. The purpose of the latter deal was to take advantage of Smith's long-term relationships with customers in order to drum up further business when these companies were in the market for compression equipment.

Looking to Foreign Markets: Mid-1990s

Also during 1995 Hanover began to look overseas, a result of an increasing number of customers doing business internationally. Several of the acquisitions Hanover made in the second half of 1995 were predicated on the acquisition of overseas assets. One such deal was the $6.5 million cash and stock purchase of Proyetco Gas Natural, C.A., a Caracas, Venezuela, company. Late in 1995 Hanover also acquired a subsidiary of Western Resources, Astra Resources Compression, a $61.4 million deal, of which $55 million came in the form of stock. Astra brought with it major assets in Argentina, 145 compressors with nearly 104,000 horsepower, greatly bolstering Hanover's share of the Latin American market as well as adding a U.S. operation. Another important decision made in 1995 was to commit resources to the Gulf of Mexico, a region that most competing firms were exiting because it was considered both hazardous and dangerous. When that region enjoyed a boom over the next two years, Hanover was well positioned to reap the rewards. In addition, because wells in the Gulf were being depleted at an accelerated rate, the area would have an increasing need for compression services.

To fund its growth, Hanover was able in December 1995 to increase its line of revolving credit from $35 million to $90 million, backed by a group of bankers led by Chemical Bank. The company was also able to raise $21.6 million in a private placement of stock sold to some of its principal investors. Also in December 1995 an even more significant source of funding, as well as an alliance was found, in Enron Corporation. At the time, at least, Enron appeared to be the ideal partner. Several years would elapse before Enron imploded, mired in fiscal scandal, and Hanover would find itself tarnished by its relationship to one of the most notorious corporate miscreants in American history. The first connection with Enron was forged in late December when Enron Capital & Trade Resources, the largest trader of natural gas in North America, bought $20 million in Hanover common stock and another $10 million in preferred. Moreover, it created a $100 million credit facility to fund Hanover's further expansion. The Enron alliance, according to Hanover officials, was expected to greatly help Hanover in its efforts to expand in both domestic and foreign markets. As Enron expanded globally, it would need compression services, and Hanover hoped to fill that need. Because of its 1995 acquisitions, Hanover, in terms of horsepower, possessed the second largest fleet in the rental compression industry, trailing only Tidewater, which the previous year had gained the top spot after picking up Halliburton's rental compression fleet. The rapid rise of Hanover was also reflected on the balance sheet. In 1995 revenues approached $96 million, coupled with a net profit of $5.6 million. A year later Hanover posted more than $136 million in revenues and a $10.4 million profit. In 1996 the company completed further acquisitions. On February 1, Hanover acquired compressor assets from New Prospect Drilling Company and Oxley Petroleum, paying $4.5 million in cash and another $225,000 in stock. Then in May 1996 Hanover paid nearly $2 million in cash for compressor units of Cactus Compression.

Going Public: 1997

Hanover went public in July 1997 and its stock began trading on the New York Stock Exchange. The company completed two further acquisitions during the course of the year. In September it paid nearly $6.3 million in cash for Wagner Equipment, Inc. and Gas Tech Compression Services, Inc. Two months later, Hanover paid $5.6 million for a 35 percent interest in Collicutt Mechanical Services, Ltd. Also in 1997 Hanover formed a joint venture with Enron in Venezuela to build and operate a gas compression project. For the year, Hanover recorded total revenues of nearly $198.8 million and net income of more than $18 million. Exceptional growth for the company continued in 1998, as sales approached $282 million and net income topped $30.3 million. A major strategic acquisition of the year was the purchase of the Packaged Power Systems Division of Waukesha-Pearce Industries Inc., a deal which included equipment and a lease/purchase agreement on a fabrication plant. Also in 1998, Hanover acquired Arkoma Compression Services, Inc. for $17.2 million in cash, and paid another $25.3 million to buy Eureka Energy Systems, Inc. In a lesser deal, Hanover bought a 10 percent interest in Cosacol for $2 million.

Company Perspectives:

From the wellhead through the pipeline … Hanover people perform.

From 1999 to 2001, Hanover continued its impressive pattern of growth, completing a number of significant acquisitions that led to annual revenues topping the $1 billion mark and net income surpassing $72 million. The most important transactions occurred in 2001. The first was the $100 million stock transaction, plus the assumption of some $63 million in debt, that added OCE Compression Corporation. An even larger deal was completed in September 2001 when Hanover acquired the natural gas compression businesses of New York energy services giant Schlumberger Ltd. for $761 million. Of that amount, $270 million was cash, $150 million in the form of a long-term subordinated note, and the balance in stock. As a result, Schlumberger gained a 10 percent stake in Hanover. Not only did the acquisition strengthen Hanover's business in the United States and Latin America, it helped the company to gain a presence in the Middle East, Africa, and Asia. The Schlumberger deal, however, would also mark a high point for the company, at least temporarily, as Hanover experienced a number of difficult months following the Enron debacle that unfolded in the final months of 2001.

At first, the price of Hanover's stock dropped merely because of the company's association with Enron, but in February 2002 the company was hit with a securities class-action lawsuit that alleged violations of accounting rules in order to inflate the price of Hanover stock. Matters soon worsened for management when it had to admit that it would be restating profits over the previous two years, reducing the number by $8.9 million. Moreover, the Securities and Exchange Commission (SEC) began to look into a joint venture with Global Energy involving a gasprocessing joint venture in Nigeria. It was soon revealed that even though Hanover knew that Global had hit a snag with Royal Dutch/Shell about recovering natural gas from the project and that Hanover would not see any revenues until 2003, the company booked revenue based on the percentage of construction work completed. According to management, this was "accepted accounting practice." In a matter of days, O'Connor resigned as chair, offering no reason, but remained as a director. He was replaced by Victor Grijalva, a retired vice-chairman of Schlumberger.

Hanover's accounting problems only worsened as 2002 continued. The company would end up restating results three times, so that it had to admit that every annual report had issued since going public was flawed. In the meantime, McGhan resigned along with COO Charles D. Erwin. Grijalva assumed the additional duties of CEO until another former Schlumberger executive, Chad Deaton, was named as a permanent replacement. Deaton took immediate steps to shore up Hanover's reputation, calling on 38 senior managers to sign disclosure statements that revealed some further transactions, completed in 1999, that might be deemed questionable. The amounts involved were negligible, but were pursued as part of an effort to reassure shareholders that the company had finally gotten to the bottom of its accounting irregularities. Nevertheless, in November 2002 the SEC launched a formal investigation of Hanover. At the same time, during the last quarter of 2002, the company restructured its senior management team and conducted a review of Hanover's business and decided to sell off non-oilfield power generation facilities and some used equipment business lines in order to focus on expanding the company's core compression operations. Late in 2002, Hanover announced it was laying off some 500 people around the world in keeping with its realignment.

As part of an effort to resolve its problems with the SEC, Hanover in 2003 agreed to what many considered was a ground-breaking settlement to a shareholder class-action lawsuit. Not only did management agree to pay approximately $65 million to wronged shareholders, it granted power to shareholders to appoint two independent directors. Moreover, Hanover became the first company to agree to rotate its outside audit firm every five years as part of the settlement. Calling the agreement a milestone for Hanover, CEO Deaton also maintained that it demonstrated a commitment to putting these issues to rest and returning the company's focus to growing its compression business.

Key Dates:

1990:: Company is founded.
1996:: Enron Corporation invests in Hanover.
1997:: Company goes public.
2001:: Schlumberger's natural gas compression business is acquired for $761 million.
2002:: Shakeup in upper management occurs following accounting scandal.
2003:: Landmark settlement ends shareholder suit.