LGCY and BAS

Local company. Got friends that work there. Stock has fallen below a dollar since the oil slump.

Any thoughts? Is this a classic case of overreaction? Or is it < $1 for a good reason?


BAS actually isn’t in town anymore. They moved. But I worked in internal audit there, and now I’m curious if it’s a bargain at < $2. Might be time to load up while this is selling at a fire sale price.

Great questions, Greenman.

Paging bromion… I hope he weighs in on this one!

LGCY is a clown show.

^Wow. That’s really helpful.

Anybody else want to be similarly helpful?

(i) LGCY. An E&P company should never be organized as a MLP. E&P business is very capital intensive. Producing wells get nice free cash flow, but the natural decline of the wells require new wells to be drilled and that requires a lot of capital (leaving little cash flow to distribute). I don’t know LGCY but almost all of these E&P MLP’s have to borrow, sell assets or rely heavily on hedges (that eventually roll off) to pay their dividends. They end up being very leveraged with too much debt (interest eats up a lot of cash flow). E&P MLP is an oxymoron.

(ii) BAS. They have senior unsecured notes that trade at 20 cents on the dollar. Given that, why is the equity worth anything beyond option value? They have to restructure their balance sheet. I’d much rather buy the debt than own the equity. That debt will probably convert to equity-like security at some point (if they dont liquidate), heavily diluting existing equity. The oilfield services space is full of way too many players in the US. It’s a total disaster and is where the worst pain is in the oil downturn. Definitely would not want to own the equity of this company. The debt may be a different story.

I wouldn’t buy either. The debt investors are probably going to take large losses, implying little left for equity. Both are companies you can trade for big moves but ultimately they will have to restructure their balance sheets.

Thanks. But I’m curious–why do you say E&P companies should never be organized as MLP’s? It seems that it makes no difference to the operations (or value) of the business, but a lot of difference to the owners and their tax return.

Because they have to change their distributions of free cash flow to qualify as an MLP.

It requires a ton of capital to drill and complete new oil and gas wells in North America. Because wells that have already been drilled and completed experience natural declines in production, E&P’s have to drill and complete new wells to offset the natural decline. The capital expenditures that are required to maintain production eat up a lot of cash flow.

If you look at the cash flow statements of the largest, best E&P’s in the USA you’ll see basically none of them generate free cash flow (Operating Cash Flow - Capex). It’s b/c capex is very high in the E&P business.

E&P is just not a free cash flow producing business model b/c maintenance capex (to keep production flat) is so high. Pipelines are much better suited for MLP’s. You spend $1B on a pipeline and it’ll produce cash flow for years with only minimal maintenance capex. The pipeline’s production does not decline over time like an oil well.

If you look at the E&P MLP’s like LINE, BBEP, MEMP, in most years they pay out more in dividends than Operating Cash Flow - Capex. They funded those cash flow deficits with mostly debt or asset sales. That’s just not sustainable long term. 2015 looks better but it’s b/c a lot of their production was hedged at higher prices and those hedges are now rolling off.

TLDR Version: MLP’s are designed to produce dividends and the E&P business model is too capital intensive to produce free cash flow to support the dividends

LGCY - up 61% today

Just FYI - when I posted this, LGCY was 0.67 and BAS was 1.89 (last time I checked). Remind me to come back and look at this from time to time, so I can embarass myself.

Tommy has great insight in this thread, he is dead on.

Tommy hit it pretty well. Some other upstream MLPs not mentioned exist seemingly just to make their affiliated E&P look better, kind of like off balance sheet financing. Look at SN (E&P) and SPP (it’s affiliate MLP). Last year in a deal worth close to $100M, SPP paid SN close to $100k per flowing barrel for existing wells that are declining, and they only got the producing wells. No interest in the land or any future wells. I mean we were seeing transactions near that multiple back when oil was $100/bbl for growth assets! The fact that they paid that for declining wells borders full on breach of fiduciary duty to shareholders, IMO. Of course, the president of SN is also on the board of SPP, and the CEO of SN is also Board Chairman of SPP. No conflict of interests there…

PXD had spun some of its assets into an upstream MLP for a while that IIRC focused mostly on vertical wells, which decline less harshly than horizontal wells, but they would up undoing that and bought the MLP back using their own at the time overvalued stock.

The only E&P company that comes to mind that might be suited to being an MLP is DNR, because the maintenance capex is a lot lower in the CO2 flood business and I think they own sources of CO2 .

LGCY - 1.97

BAS - 1.78

as of 6/22

I’d still rather own the debt in both cases than the equity. LGCY’s equity has been good (congrats to you, Greenman), outpacing the return on the debt over this time period, but BAS equity has reduced while its sr. unsecured notes have doubled.

Even with the rally in oil, both LGCY and BAS have unsustainable balance sheets. Owning the equity behind a massive amount of debt is asking for trouble. Neither company can service their debt, so you’re going to see a substantial dilution to equity if/when debt converts. I think the equity of both companies is only option value; let’s say a call option on WTI with a strike of $75/bbl that expires in 12-24 months. The debt investors will ride the upside in the business more than the equity guys when all is said and done. Just my opinion.

I think LGCY would be as much an option on nat gas as WTI. They do have one of the lower cost structures, but agree the better way to play it is with the debt (the PFDs are an option, but paying taxes on the suspended dividends make that tough). Debt has run a long way though.

BAS unsecured debt proposed to fully convert to newly created equity in a pre-packaged Chapter 11. Dilution.