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BIG JUNE IN MACAU: DETAILED REVIEW

The details show that June was even better than the headline. July should be more of the same.

 

 

June GGR grew 21.1% YoY to HK$27.45 billion (US$ 3.54 billion).  We estimate that including direct play, VIP hold was 3.03% versus a normalized 3.00%.  With normal VIP hold in both periods, GGR growth would have been 21.7% (similar to what was reported).  We expect the +20% growth to extend into July.  

 

Our favorite names are MPEL and MGM, both of whom had solid months.  MPEL gained share due in part to higher hold but Mass growth of 65% led the market.  MGM's June was outstanding.  Mass, VIP volume, and slot share were all above normal.  GGR grew 41%, the highest in almost 2 years.  Wynn was a laggard with only 4% GGR growth and share about 70bps below recent trend.  Here is the detail.

 

 

YOY TABLE OBSERVATIONS

 

Total table revenue grew 22% YoY.  Mass market growth continued its streak of around 30% growth rate, up 32% in June.  VIP volume and win rose 18%, the highest volume growth since January 2012.

 

LVS

Table win grew 33%, lead by 87% growth at SCC.  Mass revs remained strong at 55% while VIP RC grew 33%.  Including direct play, we estimate that LVS held at 2.8% in June compared to 3.1% last June, assuming direct play of 16% vs. 22% last year.  Four Seasons was the only property that held better than last June's.

  • Sands climbed 9%
    • Mass grew 30%
    • VIP revenue fell 5%
    • Sands held at 3.1% vs 3.4% in the same period last year.  We assume 11% direct play in June vs 9% in June 2012.
    • Junket RC grew 4%, ending a three month losing streak 
  • Venetian grew 28% 
    • Mass increased 35%
    • VIP revenue grew 21%
    • Junket VIP RC gained 40%, largest growth since May 2011
    • Assuming 27% direct play, hold was 3.3% compared to 3.8% in June 2012, assuming 28% direct play 
  • Four Seasons lost 2%
    • Mass revenue declined 33%
    • VIP revenue grew 7% but Junket VIP RC declined 5%. June hold (assuming 11% direct play) was 2.6% vs 2.2% in June 2012 when direct play was 16%.
  • Sands Cotai Central rocketed 87% higher
    • Mass jumped 186% to $96MM, a new monthly high 
    • VIP revenues grew 47% 
    • Junket RC volume of $4.4BN, up 87% YoY 
    • If we assume that direct play was 11%, hold would have been 2.5% 

MPEL

MPEL had a solid month, lobbing in the 2nd best table growth of 38%.  Mass continued to be white-hot at 65% (1st in the market) while VIP growth was 29%. We estimate that MPEL held at 3.22% vs 2.83% last June.  Estimated direct play was 10% in line with last year.

  • Altira table revenues grew 18%.  Mass rose 14% while VIP saw a 18% YoY increase.
    • VIP RC was flat
    • We estimate that hold was 3.4%, compared to 2.9% in the prior year
  • CoD table revenues grew 47% YoY
    • Mass increased 72%, continuing its impressive streak of strong YoY double-digit gains since the property opened
    • VIP win grew 46% and RC grew 25%
    • Assuming a 14% direct play level, hold was 3.1% in June compared to 2.8% last year (assuming 15% direct play)

WYNN

Wynn table revenues grew 6%

  • VIP revenues grew 9%, while VIP RC increased 6% 
  • Wynn held at 2.9% vs 2.9% last June
  • Mass revenues fell 3%, the 1st drop since June 2012

MGM

MGM had the strongest performance in June, growing 44% in table revenues. 

  • We estimate that hold was 3.1% adjusted for direct play of 7% vs hold of 3.4% last year assuming 9% direct play
  • VIP RC and Mass grew 64% and 37%, respectively

GALAXY

Galaxy was the laggard in June with tables revenues growth of 6%. VIP RC had the worst market performance, only 3% gain.  On the bright side, Mass growth was strong at 41%.  Hold was 3.3% in June 2013 vs. 3.6% last year.

  • StarWorld table revenues rose 6%
    • Mass soared 49%
    • VIP gained 1%.  
    • Junket RC rose 7%
    • Hold was 3.3% vs 3.5% last year
  • Galaxy Macau's table revenues grew 5%
    • Mass had another great month at 45% growth
    • VIP saw a 3rd consecutive decline at -5% but RC rose 2%
    • Hold was 3.3% vs 3.6% last June

SJM

Total table revenue grew 18%, with mass and VIP growth of 6% and 25%, respectively. RC volume also gained 16%.  SJM held at 2.9% vs 2.7% last year.

 

 

SEQUENTIAL MARKET SHARE - May to June (property specific details are for table share while company-wide statistics are calculated on total GGR, including slots):

 

LVS

Market share lost 50bps to 20.5%.  June’s share is below its 6-month average of 21.1% and better than its 2012 average share of 19.0%. 

  • Sands' share gained 70bps to 3.5%.  For comparison purposes, 2012 share was 3.9% and 6M trailing average share was 3.2%.
    • Mass share dropped 50bps to 5.4%
    • VIP rev share increased 120bps to 2.7%
    • RC share was 2.4%, +20bps MoM 
  • Venetian’s share fell 70bps to 7.8%.  2012 share was 7.9% and 6 month trailing share was 8.4%.
    • Mass share decreased 90bps to 13.5%
    • VIP share lost 60bps to 5.4%
    • Junket RC share was unchanged at 3.9%
  • FS gained lost 150bps to 2.2%.  This compares to 2012 share of 3.7% and 6M trailing average share of 3.2%.
    • VIP was lost 200bps to 2.7%
    • Mass share fell 50bps to 1.0%, matching an all-time low
    • Junket RC lost 110bps to 3.0%
  • Sands Cotai Central's table market share gained 90bps to 6.4%, which compares to the 6M trailing average share of 5.9%.
    • Mass share improved 120bps to 9.4%, a new high
    • VIP share climbed 0.8% to 5.2%
    • Junket RC share grew 50bps to 6.0%

MPEL

MPEL grew 60bps in share in June to 14.6%. Its 6 month trailing share is 14.1% and their 2012 share of 13.5%.  

  • Altira’s share was unchanged at 3.8%, in-line with its 6 month trailing and 2012 shares
    • Mass share lost 20bps to 1.1%
    • VIP gained 20bps to 5.0%
    • VIP RC share fell 70bps to 4.5%
  • CoD’s share rose 40bps to 10.6%, above the property’s 2012 and 6M trailing share of 9.4% and 10.2%, respectively.
    • Mass market share slipped 10bps to 12.4%
    • VIP share gained 60bps to 9.8%
    • Junket share dropped 60bps to 8.7%

WYNN

Wynn was the largest share loser in June after rising the most in May.  GGR share was 10.2%, down 180bps MoM.  2012 average share was 11.9% and their 6M trailing average share has been 11.0%.

  • Mass share was fell 100bps to 6.3%
  • VIP share tumbled 210bps to 11.8%
  • Junket RC share dropped 50bps to 12.0%

MGM 

MGM’s market share dropped 30bps to 11.0%, but still above its 6M and 2012 average of 9.9% 

  • Mass share gained 20bps to 8.0%
  • VIP share dropped 70bps to 11.9%
  • Junket RC slipped 10bps to 11.7%

GALAXY

Galaxy's share gained 0.5% to 19.3%, above its 2012 average and 6-month average share of 19.0% and 18.3%, respectively

  • Galaxy Macau share improved 90bps to 10.9%
    • Mass share gained 20bps to 10.6%
    • VIP share improved 120bps to 11.1%
    • RC share gained 100bps to 10.7%
  • Starworld share lost 20bps to 7.6%
    • Mass share gained 20bps to 3.6%
    • VIP share dropped 30bps to 9.3%
    • RC share lost 50bps to 9.0%

SJM

SJM gained 160bps to 24.5% (which was an all-time low), but still below their 2012 average of 26.7% and their 6M trailing average of 25.6%

  • Mass market shares gained 180bps to 26.5%
  • VIP share gained 170bps to 24.5%
  • Junket RC share rose 190bps to 27.5%

 

Slot Revenue

 

Slot revenue grew 12% YoY to $139MM in June

  • LVS had the best YoY growth at 36% to $45MM
  • MPEL grew 25% to $28MM
  • MGM gained 13% to $25MM
  • GALAXY rose 6% to $14MM
  • SJM dropped 8% to $13MM
  • WYNN had the worst YoY slot performance, tumbling 27% to $14MM

BIG JUNE IN MACAU: DETAILED REVIEW - hh


Breitburn (BBEP) is LINN Energy Junior

Takeaway: If you think LINN Energy is a good short, you should be short BBEP...

We are adding short Breitburn Energy Partners (BBEP, $18.42/unit, $1.8B market cap) to our "Best Ideas" list.

 

Breitburn Energy Partners (BBEP) is LINN Energy junior.  Perhaps the CFO’s have been comparing notes, because BBEP plays many of the same accounting games that LINN does with the intention of giving undue benefit to non-GAAP financial measures - adjusted EBITDA and distributable cash flow (DCF).  We imagine that BBEP’s management team doesn't feel too good this morning reading about the SEC's informal investigation into LINN's use of non-GAAP financial measures and hedging strategy... We continue to be amazed by what we are finding in this upstream MLP sector.  Analysts and investors have been either asleep at the wheel or willfully blind, allowing these companies to get away with egregious accounting practices that inflate non-GAAP financial measures far beyond the economic reality of the underlying business and assets.  As is the case with LINN Energy, we believe that BBEP’s distribution is largely a mirage, funded with capital raises that are disguised with a variety of creative accounting schemes.  We believe fair value for BBEP is between $2 - $8 /unit, ~70% below the current unit price.

 

There’s a lot not to like.  Here are the key issues we've identified so far:

  • Non-GAAP financial measures far from economic reality (actual EBITDA, net income, free cash flow);
  • Derivatives accounting methodology (realized gain = cash settlement);
  • History of manipulating the hedge book (terminating contracts early);
  • Acquisition of in-the-money derivatives, the cost of which is not deducted from DCF;
  • Inappropriate adjustments to non-GAAP measures (unit-based compensation, acquired cash flow from acquisitions, non-cash interest expense);
  • History of changing or removing key disclosures in 10-K’s and 10-Q’s;
  • Poor maintenance capex and distributable cash flow disclosure in regulatory filings;
  • Poor reserve report disclosure in the 10-K's;
  • High cost producer;
  • Significantly understated maintenance capex;
  • Awful record of organic reserve replacement and drill bit capital efficiency (organic F&D cost +$40/boe in 2012);
  • Deep in-the-money natural gas swaps rolling off in 2013 (realized gains were ~66% of distributions paid in 2012, but that will shift to a realized loss by 2014);
  • Over-levered (BBEP is flirting with its total leverage covenant of 4.75x debt/TTM adjusted EBITDA);
  • Large equity raise (we estimate ~$300MM) needed in 3Q13 to avoid breaching total leverage covenant;
  • Poor corporate governance;
  • Significantly over-valued.   We believe that there’s ~70% downside to a fair value equity price of ~$5.00/unit.  BBEP was almost a 0 in 2009 – that could easily happen again.

Background


Breitburn Energy Partners LP (BBEP) is an upstream MLP with oil and natural gas production in multiple US onshore basins.  Provident Energy Trust (formerly PVE CN) spun out BBEP in a 2006 IPO.  “Breitburn GP” is the general partner, but it has no economic interest in the LP after BBEP acquired the entire GP interest from Provident and the founders (Randall Breitenbach and Halbert Washburn) in 2008.

 

Key assets for BBEP are the Antrim Shale in Michigan (35% of total proved reserves at YE12), legacy oil fields in Wyoming, heavy oil fields in California (Kern County), the Permian Basin, and oil fields in Florida. 

 

In June 2013, BBEP announced that it had acquired Whiting’s (WLL) EOR assets in Oklahoma for  ~$800MM (excluding acquired hedges and associated midstream assets).  Pro forma this transaction, production will be ~34,000 boe/d (63% liquids, 37% natural gas), and proved reserves will be 184 MMboe.

 

Reconciliation of BBEP's Non-GAAP Financials to Reality

 

According to BBEP, it generated $2.33/unit of DCF in 2012 for 1.38x coverage.  But our calculation of DCF suggests that BBEP only generated $0.08/unit of DCF in 2012 for 0.03x coverage.  We estimate that BBEP will generate only $0.46/unit of DCF in 2013 and $0.29/unit in 2014.  These figures are in-line with our forward EPU estimates, as they should be.

 

We discuss the adjustments we make to BBEP's non-GAAP measures in detail below, including the most significant adjustment, maintenance capex.  Here is the complete reconciliation:

 

Breitburn (BBEP) is LINN Energy Junior - bb1

 

Aggressive Derivatives Accounting and Games with the Hedge Book


We thought that LINN Energy was the only company that considered a “realized gain” equivalent to a “cash settlement.”  We thought wrong.  It appears to us that BBEP started doing the same thing in April 2012.  And changes in disclosure in the latest 10-Q suggests that management may now be trying to hide it, likely as a result of LINN Energy getting called out on this exact issue in a very public way (and we now know that the SEC is looking into LINN's hedging strategy).

 

In 2012, BBEP spent $30.0MM on premiums for commodity derivatives (puts, swaps, and swaptions).  There is no line item for “premiums paid” in the BBEP’s cash flow statement or reconciliations to adjusted EBITDA; we believe that the premiums paid are considered an unrealized loss.

 

So, BBEP pays $10 for a derivative, sells it for $11, and accounts for that transactions as:

  • $11 realized gain
  • $10 unrealized loss
  • $1 total gain
  • $11 adjusted EBITDA
  • $11 distributable cash flow

In our view, this is a ponzi mechanism.  Unrealized gains/losses are added back to adjusted EBITDA and DCF; including the premiums paid in unrealized losses is a clever way of excluding those cash costs from adjusted EBITDA and DCF.   It is just a way of flowing cash in one door and paying it back out of another as a distribution.  How can the SEC be okay with this?  How can you have an unrealized loss on a settled derivative? 

 

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The term “premiums” appears 7 times in the 3Q12 10-Q (filed 10/25/2012).  Here is an excerpt with our emphasis:

 

“Included in the above table are natural gas swaps and put options we entered into in June 2012, hedging a total of 18,628 BBtu from January 1, 2014 to December 31, 2016 at a weighted average Henry Hub price of $4.30 per MMBtu, for which we paid premiums of approximately $7.0 million, and crude oil option contracts we entered into in August 2012, hedging a total of 182,500 barrels from January 1, 2013 to December 31, 2013, at a weighted average NYMEX price of $90.00 per barrel, for which we paid premiums of approximately $1.3 million.


In July 2012, we exercised contracts and paid premiums of $2.5 million for swaption contracts entered into in April 2012 that provided options to hedge a total of 510,168 barrels of future crude oil production associated with the NiMin Energy Corp. ("NiMin") acquisition at then-current NYMEX WTI market prices, ranging from $104.80 per barrel in 2012 to $88.45 per barrel in 2017.  In July 2012, we also exercised contracts and paid premiums of $2.6 million for swaption contracts entered into in May 2012 that provided options to hedge a total of 634,485 barrels of future crude oil production associated with the Element Petroleum, LP ("Element") and CrownRock, L.P. ("CrownRock") acquisitions at then-current NYMEX WTI market prices, ranging from $98.35 per barrel in 2012 to $87.80 per barrel in 2017.”


The term “premiums” appears 8 times in the 2012 10-K (filed 2/28/2013).  Here is an excerpt with our emphasis:

 

“Operating activities. Our cash flow from operating activities in 2012 was $191.8 million compared to $128.5 million in 2011. The increase in cash flow from operating activities was primarily due to higher crude oil sales revenue and higher realized gains on commodity derivatives, partially offset by higher operating costs and higher interest expense. We paid $30.0 million in premiums on commodity derivative contracts in 2012 and paid $2.5 million to terminate an interest rate contract. See Note 5 to the consolidated financial statements in this report for more information regarding our derivatives.”


The term “premiums” appears 0 times in the 1Q13 10-Q (filed on 5/3/2013). 

 

Perhaps BBEP didn’t pay any premiums in 1Q13, or perhaps they did and didn’t disclose it?  Why doesn’t BBEP want to talk about premiums paid anymore?  Regardless, this accounting “trick” will result in $30MM of “fake DCF,” with most of it hitting between 2012 and 2016, by our estimates.  It’s not that material, but it probably would’ve gotten material had LINN Energy not been called out on it.  The SEC should make BBEP disclose the premiums paid for commodity derivatives that settle in every period for which it purchased them, including future periods.  The SEC has already forced LINN Energy to increase disclosure around this issue, we imagine that it will do the same to BBEP.

 

This is a desperate measure from BBEP.  In our view, it is a good indication that the current distribution is divorced from BBEP’s economic reality, and the situation is getting dire, forcing BBEP’s management to get more and more aggressive with its accounting standards.

 

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BBEP took it on the chin in the financial crisis.  The unit price fell more than 85% from the mid-$30’s in 2007 to $5 in late 2008.   In January 2009, it terminated 2011 and 2012 derivatives for a realized gain of $45.6MM, which it used “to pay down debt,” and entered into swaps at lower (market) prices.  BBEP terminated oil swaps that were struck up near $90/bbl and entered into new swaps at $63/bbl.  BBEP did the same thing again in June 2009, realized a gain of $25MM, and used the proceeds to pay down more debt.

 

In 2009, in addition to monetizing in-the-money swaps to pay off debt, BBEP adopted a poison pill, suspended making distributions, cut its capital budget by 75%, sold assets, and laid off employees. 

 

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In 4Q2011, BBEP terminated WTI-linked oil swaps for a “termination cost” of $36.8MM and entered into new Brent-linked swaps, “in order to improve the effectiveness of [its] hedge portfolio.”  BBEP took a realized loss of $36.8MM on the termination; however, BBEP added that loss back to adjusted EBITDA

 

Recall that BBEP sold its 2011 and 2012 derivatives in 2009 to pay down debt, and re-hedged the oil volumes in the low $60’s.  Well BBEP didn’t really want to deal with those underwater hedges…

 

Oil prices were strong in late 2011 – the WTI 2012 swap was trading ~$100/bbl and the 2013 swap ~$95/bbl, with Brent at a $5 - $10/bbl premium.  As of 9/30/2011, BBEP was swapped out at WTI $77/bbl for 2012 and WTI $81/bbl for 2013.  Realized losses were coming…  So what does BBEP do?  It terminates some of the 2012, 2013, and 2014 underwater swaps and takes a realized loss of $36.8MM in 4Q12, adds it back to adjusted EBITDA, and resets its hedge book to strip prices (WTI and Brent).  BBEP added some new Brent swaps, which, in our view, was just to make it look like a strategic repositioning of the hedge book.  But, really, BBEP was staring at an underwater hedge book, and wanted out of it. 

 

It must be nice to include realized gains in non-GAAP measures like adjusted EBITDA and DCF, and if realized losses are imminent, just terminate the positions, add back the realized losses to adjusted EBITDA and DCF, and pretend like nothing really happened…  That add back was 16% of adjusted EBITDA and 36% of the distributions paid in 2011. 

 

Hedge book as of 9/30/2011:

Breitburn (BBEP) is LINN Energy Junior - bb2

 

Hedge book as of 12/31/2011:

Breitburn (BBEP) is LINN Energy Junior - bb3

 

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Along with BBEP’s recent acquisition of WLL’s Postle Field, it also bought in-the-money oil swaps from WLL.  What BBEP paid WLL for these swaps was not disclosed, but WLL disclosed that the hedges cost them $44.9MM.  We estimate that BBEP paid WLL ~$40MM for the swaps, which management confirmed on the deal conference call.  And despite the acquisition not scheduled to close until 7/31/2013, BBEP will realize the economics of the hedges starting on 4/1/2013. 

 

BBEP could have just hedged out these volumes on its own at current strip prices at little-to-no cash cost.  But buying these hedges from WLL it just another way for BBEP to “buy DCF.”    The cost of these derivatives is not included in realized gains/losses, adjusted EBITDA or DCF; it’s essentially paying cash for cash and paying it back out to unitholders as DCF.

 

The hedges acquired include 6,100 bbl/d from 4/1/13 through 12/31/13 at WTI $98.50; by our estimates, that’s good for ~$6.4MM of incremental DCF in 2013.  We estimate that at current strip prices, acquired realized gains will be $10MM in 2014, $17MM in 2015, and $4MM in 2016.  If one puts an 8% yield target on that 2014 number, that’s $125MM ($1.25/unit) of “value” for this “strategy.”

 

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BBEP is getting more and more aggressive with its hedge book and derivatives accounting because the writing is on the wall.  It entered into high priced natural gas swaps back in 2009 when the 2013 strip was above $6.00/MMBtu, but 2013 is the last year when it will really have that benefit of those high-priced gas swaps.  BBEP has 58.1 MMMBtu/d swapped at an average price of $5.87/MMBtu for 2013, but that falls off to 46.1 MMMBtu/d swapped at an average price of $5.08/MMBtu in 2014.      

 

In 2012, realized gains on derivatives were $87.6MM (66% of distributions paid); we estimate that realized gains will be only $23MM in 2013, and BBEP will take a realized loss of -$11MM in 2014 (we adjust realized gains/losses to properly account for premiums paid, which we flat line at $7.5MM per year from 2013 through 2016).  That’s a painful swing, and BBEP is trying to avoid it.

 

Inadequate Non-GAAP Disclosures

 

Analysts and investors primarily value BBEP using DCF/unit and a yield target.  However, BBEP does not publish a reconciliation of any measures to DCF in its 10-K's, 10-Q's, or press releases.  In fact, the terms "distributable cash flow," "DCF," and "maintenance capex" do not even show up in these filings.  Occasionally, management will announce these results on quarterly conference calls (in 2009 it did not).  Management defines DCF = adjusted EBITDA minus cash interest expense and estimated maintenance capex.  Management will also provide forward-looking guidance on these figures, but never publishes an actual reconciliation to DCF.   

 

Understated Maintenance Capex

 

BBEP is one of the more cryptic companies with respect to “maintenance capex.”  BBEP does not define it in 10-K’s or 10-Q’s and they don’t even publish the number in quarterly press releases.  Sometimes management will give the number on the quarterly conference call, but sometimes not.  This is very strange given its importance in calculating DCF. 

 

On the 5/3/2013 conference call, management said, “We define maintenance capital as that amount of annual investment required to keep production approximately flat year-over-year.”  They went on to say, “When we look at maintenance capital, we're looking out five years and we're looking at our reserve report and our capital plans for that five-year period and we feel comfortable with the 23% of EBITDA, 20% to 25% range.”

 

In the latest BBEP investor presentation, a footnote reads, “Maintenance capital is defined as the estimated amount of investment in capital projects and obligatory spending on existing facilities and operations needed to hold production approximately constant for the period.”

 

On the 3/9/2011 conference call, BBEP said that, “Our approach to estimating maintenance capital requirements is very rigorous and based on our reserve data, as well as our long range financial plans.”

 

As far as we can tell, BBEP does not have a consistent, explicit definition of maintenance capex.  We have no idea what goes into this calculation; and we would love to data behind see this “very rigorous” approach, because we just don’t buy it.  We think that this slide from BBEP’s 6/19/13 investor presentation shows  about how rigorous BBEP is in estimating maintenance capex:

 

Breitburn (BBEP) is LINN Energy Junior - bb4

 

23% of EBITDA!  Voila!

 

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BBEP’s drill bit performance is so bad that we are wondering what exactly it spends its money on.  It is one the worst record of organic reserve replacement that we have seen from an onshore E&P.  We presume that BBEP recognizes this, which is why they stopped disclosing the amount of organic reserve adds (extensions, discoveries, infill drilling, recompletions, etc) after 2009.  In its reserve report, BBEP’s line item is only “revisions,” which groups together extensions, discoveries, infill drilling, recompletions, technical revisions, price revisions, and timing revisions.  This makes it very difficult to assess BBEP’s performance with the drill bit, as price revisions account for the majority of the total revisions.

 

In 2012, total revisions were -27.1 MMboe “primarily related to a decrease in natural gas prices.”  BBEP also tells us that, “The decrease in 2012 was primarily the result of a 30.9 MMboe (185.6 Bcf) decrease in natural gas reserves driven primarily by a decrease in natural gas prices. Price related reserve revisions were partially offset by drilling, recompletions, workovers, addition of new drilling locations and revised estimates of existing reserves.”  This implies that organic reserve adds in 2012 were 3.8 MMboe.  In 2012, total costs incurred excluding proved acquisition costs were $253MM, implying an organic F&D cost of $66.54/boe.  If we back out unproved acquisition costs of $88MM from costs incurred, the organic F&D cost was $42.92.   

 

Total “revisions” over the past 3 years are -7.2 MMboe, and over the past 5 years are -23.8 MMboe, for an organic reserve replacement ratio of -33% and -67%, respectively.  Because of scant disclosure, we are not able to back out the price revisions and calculate an average organic F&D number over the periods.  But consider that over the past 5 years, BBEP has aggregate costs incurred (excluding proved acquisition costs) of $609MM and organic reserve replacement was negative (revisions of -23.8 MMboe vs. production of 35.4 MMboe).  Said another way, BBEP needed to find and develop another 59 MMboe of proved reserves with the drill bit over that period for organic reserve replacement to be 100%.  Assuming an F&D cost of $20/boe (generous for BBEP), that’s an incremental $1.2 billion of capital.      

 

We estimate that maintenance capex over the last 5 years was ~$262MM, or $7/boe produced.  It’s difficult to know for sure because it’s not actually a statistic that BBEP makes readily available on a consistent basis.  During 2009, maintenance capex was an uncomfortable topic, and management stopped giving the data on the conference calls.

 

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Strangely, BBEP’s historic PUD conversion cost has been quite good, especially relative to the capital efficiency of its total capital program.  The 3 and 5 year average PUD conversion costs were $11.07/boe and $10.53/boe, respectively.  Unfortunately for BBEP, the capital spent converting PUDs was only 9% of total costs incurred in 2012 (excluding proved acquisition costs), and BBEP only has 29.7 MMboe of PUD reserves as of YE12, 20% of total proved reserves.

 

BBEP’s 3 and 5 year all-in FD&A cost was $24.95/boe and $41.26/boe, respectively.  Still a poor result, especially for an E&P that produces a lot of natural gas (56% of total production in 2012).

 

Breitburn (BBEP) is LINN Energy Junior - bb5

 

As BBEP has grown via acquisition over the last three years, the capex budget has skyrocketed, though the maintenance capex budget has not kept pace.  We believe that BBEP is getting more and more aggressive with its maintenance capex budget; at this point, the maintenance capex rate of ~$8/boe produced is ridiculously low, and not supported at all by prior period drill bit performance. 

 

In 2010, maintenance capex was 67% of total capex; BBEP’s guidance suggests that it will only be ~30% in 2013.  Implied growth capex has grown at a 22% CAGR between 2008 and 2013, while maintenance capex grew only at a 10% CAGR.  The decline in capital efficiency is notable, particularly for implied growth capex.  In 2013, total capex per boe produced will be ~$27/boe (up from $16/boe in 2012).  BBEP’s growth capex per boe produced will be ~$19/boe (up from $8/boe in 2012), while maintenance capex will be $8/boe (flat from 2012).  BBEP's maintenance capex is more than twice as efficient as its growth capex, which is convenient for a company that deducts only maintenance capex from DCF.    

 

Breitburn (BBEP) is LINN Energy Junior - bb6

 

How understated is maintenance capex?  Well in 2012 BBEP incurred $152MM of “development costs” and added 3.8 MMboe of proved reserves, for a per boe rate of $40.21 (this is generous to not include any of the capital BBEP spent on land and asset retirement obligations).  Production was 7.0 MMboe in 2012, so to keep the reserve base flat in 2013 BBEP would need to add 7.0MMboe of reserves with the drill bit.  $40.21/boe x 7.0 MMboe = $281MM.  Compare that to BBEP’s 2013 maintenance capex guidance of $88MM.   This suggests that maintenance capex for 2013 is understated by $193MM, which is equal to 100% of the forecasted distribution.

 

Even if we given BBEP some benefit of doubt and assume an organic F&D cost of $25/boe – which is not even in the ball park of BBEP’s actual results – that would imply $176MM of maintenance capex, double BBEP’s guide. 

 

Aggressive Adjustments to Non-GAAP Financial Measures


BBEP backdates the effective date of an acquisition, and adds “net operating cash flow from acquisitions, effective date through closing date” to adjusted EBITDA.  The purchase price is adjusted higher for the amount of “net operating cash flow” acquired between the effective date and the closing date, so this runs through the “property acquisitions” line in the cash flow statement.  Again – this is paying cash for cash, and calling it distributable cash flow.  Further – as far as we can tell – BBEP does not assign any “maintenance capex” to the acquired operating cash flows.  This adjustment was $2.9MM in 2011 (3% of distributions paid) and $19.9MM in 2012 (15% of distributions paid).

 

BBEP’s recent Postle Field acquisition has an expected closing date of 7/31/13 and an effective date of 4/1/13, so BBEP is acquiring 4 months of “net operating cash flow” from WLL.  We estimate that the Postle Field generates ~$10MM of EBITDA per month at current prices; acquired “net operating cash flow” from this deal alone could be ~$40MM...However – it appears that management has recently “got religion” (from the 6/24/13 deal conference call):

 

<Q - Analyst>: “Okay. Thanks. And just last question from me, just as a point of clarification, will you be realizing an add-back in the second quarter for the cash flow from this acquisition between the effective date and closing date?”


<A –BBEP CFO James G. Jackson>: “Praneeth, it's Jim. We won't be doing that.”


Why not?  BBEP used to make this adjustment, now they think it's a bad idea?

 

------

 

BBEP adds back unit-based compensation to adjusted EBITDA.  Imagine how profitable BBEP would be if it paid all of its employees and contractors in equity!  EBITDA does not = non-cash.  Unit-based compensation is an economic expense, and it is aggressive, in our view, to add it back to adjusted EBITDA and DCF.  In 2012, the adjustment was $22.2MM, or 8% of adjusted EBITDA and 17% of distributions paid.

 

BBEP deducts “cash interest expense” from adjusted EBITDA to arrive at DCF, not total interest expense and other financing fees.  In 2012, the difference was $7.3MM, or 6% of distributions paid.

 

BBEP does not deduct cash taxes from adjusted EBITDA to arrive at DCF, despite BBEP being subject to some federal and states taxes.  BBEP has paid cash income taxes between $0.2MM and $0.5MM in each of the last three years.

 

In total, we estimate that these adjustments boosted DCF in 2012 by $50MM, or 38% of distributions paid.   

 

Dangerously Over-Levered; Large Equity Raise is Imminent


BBEP has levered up in a big way pro forma this $890MM Postle Field acquisition that it has funded entirely with debt (up until now anyway).  We believe that BBEP will breach its amended total leverage covenant of 4.75x debt/TTM adjusted EBITDA (using BBEP’s aggressive definition of adjusted EBITDA) if it does not raise ~$300MM of equity before the end of 3Q13.  This could be highly dilutive; if BBEP manages to sell $300MM of equity at $17.00/unit, that would be 17.6MM new shares and ~18% dilution.

 

Even if BBEP manages to sell $300MM equity in 3Q13, we estimate that net debt will be back to ~$1.8B by YE14 (assuming no distribution cut and $300MM of capital spending in 2014), and total debt/TTM adjusted EBITDA will be back at 3.9x (again, using BBEP’s definition), pushing up against the leverage covenant of 4.0x.  So another capital raise will likely be necessary in 2014.

 

Poor Corporate Governance and Little Alignment with BBEP Unitholders


We recap the following situation involving BBEP's board and executive officers because we think it is indicative of BBEP's corporate governance standards and commitment to the LP unitholders:

 

In September 2007, BBEP acquired natural gas and oil assets from Quicksilver Resources (KWK) for $1.5B, with $750MM paid in cash and $750MM in BBEP common units.  KWK received 21.3MM common units at an average unit price of $35/unit; KWK became BBEP’s largest unitholder with a 32% stake, and was locked up on those shares until November 1, 2008.

 

Provident Energy Trust (PVE CN) held 14.4MM BBEP common units (22% of total) and a 95.55% interest in the GP stake (equivalent to 0.4MM BBEP common units) in February 2008 when it announced that it was seeking an exit from this investment.

 

On 6/17/08, BBEP announced that it would acquire Provident’s entire stake in the common units and its GP interest, as well as the founders’  interest in the GP (4.45%), for $345MM cash, or ~$23.25/BBEP unit.  This was a 5% premium to the unit price as of the 6/16/08 close.  BBEP funded the deal with a draw on the credit facility.

 

In late 2008, BBEP’s unit price collapsed to $5/unit in a solvency/liquidity crisis.  In 2009, BBEP suspended the distribution, cut capex 75%, monetized in-the-money swap contracts, and sold off assets.  It was not a good situation. 

 

KWK took a bath on its BBEP shares, as the equity that it was locked up on fell from ~$750MM in value in September 2007 to ~$100MM in value in December 2008.  Provident Energy Trust and BBEP’s founders made out nicely with their exit at $23/unit.  But BBEP unitholders got killed as this transaction, in part, nearly put BBEP into bankruptcy.


As you can imagine, in October 2008, KWK filed a fairly scathing lawsuit against Breitburn Energy Partners LP, Provident Energy, and individuals on the board of BBEP, including the founders Randall Breitenbach and Halbert Washburn.

 

In December 2009, KWK settled with BBEP and a third party for $18.0MM cash, along with conditions for KWK to put two directors on the board of the GP, and BBEP to resume paying the quarterly distribution.  Over the course of 2010 and 2011, KWK sold all of its BBEP common units for estimated proceeds of ~$275MM (~$13/unit).

 

------

 

All directors and executive officers own only 2.5% of the common units outstanding, with founders Randall Breitenbach and Halbert Washburn each holding 1.0%.  No other insider beneficially owns a material stake.  Annual bonuses are discretionary, and it appears from the proxy that BBEP’s executive officers get paid primarily for buying assets and raising capital.  BBEP does not make its performance goals public, so there is no way of knowing what they exactly are and whether or not BBEP is achieving them.

     

Valuation

 

1.  We believe that fair value for BBEP equity is a mid-single digit number, call is between $2 - 8/unit.

 

2.  We estimate that BBEP will earn $0.37/unit in 2014; with the current annual distribution run rate at $1.90/unit, alarm bells should be ringing.  BBEP is currently trading at +50x 2014E earnings vs. the S&P E&P Index at 12x.  A market multiple implies a fair price of ~$4.00/unit, ~80% downside from the current price.

 

3.  We estimate that BBEP will generate $430MM of open EBITDA in 2014.  BBEP is currently trading at 8.4x 2014E EBITDA vs. the S&P E&P Index at 4.2x.  A market multiple implies a fair price of $2.50/unit.  A premium multiple of 5.0x 2014E EBITDA implies a fair price of ~$5.50/unit, ~70% downside from the current price.

 

4.  For our net asset value calculation, we relied primarily upon the SEC standardized measure as of YE12.  We assume that BBEP paid fair value for WLL's Postle Field - after all, it was on the market for a long time in a highly competitve asset acquisition market; we value the acquired oil assets at $800MM and give BBEP credit for the acquired hedges and midstream assets in other PP&E and the net derivative asset.  We then assume 15 years of G&A - in line with the reserve life - at the 2014 rate, and discount it back at 10%.  Our NAV is $7.70/unit, ~60% downside from the current price.

 

Breitburn (BBEP) is LINN Energy Junior - bb7

 

Summary

 

If you think short LINN Energy is a good idea, you should be short BBEP.  The similarities between the two companies with respect to derivatives accounting, aggressive adjustments to non-GAAP measures, and understated maintenance capex are uncanny.  BBEP's leverage situation is more desperate, with an large equity raise needed this quarter.  Fair value = $5.00/unit.  The distribution is little more than a figment of management's imagination and their ability to raise enough capital to fund it.

 

Kevin Kaiser

Senior Analyst

(o)

 


LINN Energy & The SEC News

Takeaway: Reaction to the SEC’s Informal Investigation of LINN Energy.

This note was originally published July 02, 2013 at 09:15 in Energy

In a press release put out after market hours last night (7/1/13), LINN Energy (LINE, LNCO) disclosed that the SEC has commenced a private, non-public inquiry regarding LINN and LinnCo.  We quote the body of the press release in its entirety, with our emphasis:

 

LINN Energy & The SEC News - SEC Bldg

 

“LINN Energy, LLC (Nasdaq:LINE) ("LINN") and LinnCo, LLC (Nasdaq:LNCO) ("LinnCo") announced that they have been notified by the staff of the Securities and Exchange Commission ("SEC") that its Fort Worth Regional Office has commenced a private, non-public inquiry regarding LINN and LinnCo. The SEC has requested the preservation of documents and communications that are potentially relevant to, among other things, LinnCo's proposed merger with Berry Petroleum Company, and LINN and LinnCo's use of non-GAAP financial measures and hedging strategy. The SEC has stated that the fact of the inquiry should not be construed as an indication that the SEC or its staff has a negative view of any entity, individual or security. LINN and LinnCo are cooperating fully with the SEC in this matter.

 

Although the impact of the inquiry on the timing of LinnCo's proposed merger with Berry Petroleum Company is difficult to predict, LinnCo and LINN remain committed to the completion of the transaction.”

 

This is a good start and the SEC appears to be looking in the right places – non-GAAP financials, commodity derivatives, and terms of the LINN/BRY merger.  Our negative view on LINN Energy was largely predicated on all three of these issues.  We speculate that possible outcomes of this investigation are that the SEC ultimately requires LINN to:

  • Restate prior period non-GAAP financials, including adjusted EBITDA and distributable cash flow (DCF);
  • Restate prior period “realized gains/losses” and “unrealized gains/losses” on commodity derivatives;
  • Redefine “realized gains/losses” and “unrealized gains/losses” such that realized gain = settlement minus cost basis;
  • Disclose the premiums paid for commodity derivatives that settle in all future periods;
  • Increase disclosure on how, exactly, LINN defines and calculates estimated maintenance capex;
  • Provide a reconciliation of prior period estimated maintenance capex to actual maintenance capex;
  • Make maintenance capex a more transparent and less subjective measure, such as an F&D cost or DD&A rate;
  • Include maintenance capital needed to maintain other PP&E (plants, pipes, etc.) in maintenance capex;
  • Increase disclosure on the tax consequences of the LINN/BRY merger on LINE, LNCO, and BRY, specifically with respect to the election of the “remedial method”;
  • Revise forward-looking guidance for maintenance capex, adjusted EBITDA, and DCF.

We believe that the SEC inquiry puts the proposed LINN/BRY merger at serious risk.  Note that the press release does not say that “LinnCo, LINN, AND BERRY remain committed to the completion of the transaction.”  The press release was also not jointly issued by LINN and BRY, as was the 5/31/13 joint press release title, "LINN Energy, LinnCo and Berry Petroleum Company Provide Update on Merger."

 

For anyone bullish long-term on stand-alone BRY, we believe that this is good news.  It’s likely that LINN/BRY will not close the merger while the investigation is ongoing, and Berry will be free to terminate the merger without paying the $83.7MM ($1.50/share) termination fee if the merger does not close by the “End Date,” October 31, 2013.  It’s impossible to predict how long the SEC’s investigation will take, but they can be on the order of several months to quarters.  This site provides a simple overview of the SEC's investigation process.  Further, our interpretation of the proxy is that the SEC's investigation of LINN qualifies as an "LINN Party Material Adverse Effect," which allows Berry to terminate the merger at any time without penalty.

 

For LINE/LNCO, this is devastating.  The SEC shining a light on LINN’s non-GAAP measures will likely show investors how far they are from economic reality (net income per unit, for instance).  And with the BRY merger now in serious doubt, the “LINN will buy every C-Corp E&P out there” bull case doesn’t seem like such a great idea.  We will also see more consecutive quarters of organic results from LINN, which we expect will show flat-to-declining production, rendering LINN’s estimated maintenance capex number more and more difficult to defend.  We also believe that there’s a good chance that the distribution will ultimately be cut as the SEC’s actions could materially reduce “DCF/unit” going forward.  That’s going to make it difficult to value LINN with a yield target.  And there will be a wave of negative feedback.  JP Morgan and Raymond James downgraded LINE/LNCO to neutral this morning; we expect other analysts to follow suit, or just suspend coverage.  Recall that LINN is largely retail-owned, and for years, LINN thrived partly thanks to the constantly bullish recommendations from these analysts.

 

We maintain that fair value for LINE (LNCO) is around ~8.00/unit (share).

 

As far as broader implications of this investigation go – we imagine that there are quite a few MLP executives that are feeling a little uneasy about the SEC looking into LINN’s non-GAAP measures, which likely includes maintenance capex and DCF.  Our research suggests that understated maintenance capex (and overstated DCF) is endemic in the MLP sector – particularly among the upstream MLPs.  If the SEC requires LINN to enhance disclosure on maintenance capex and/or make the calculation of maintenance capex a less subjective exercise, it would be negative for the entire sector.  We would highlight Breitburn Energy Partners LP (BBEP), EV Energy Partners LP (EVEP), and QR Energy LP (QRE) as companies that may significantly understate maintenance capex, and as a result, overstate DCF.

 

Kevin Kaiser

Senior Analyst    

kkaiser@hedgeye.com


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Reactions to the SEC’s Informal Investigation of LINN Energy

In a press release put out after market hours last night (7/1/13), LINN Energy (LINE, LNCO) disclosed that the SEC has commenced a private, non-public inquiry regarding LINN and LinnCo.  We quote the body of the press release in its entirety, with our emphasis:

 

“LINN Energy, LLC (Nasdaq:LINE) ("LINN") and LinnCo, LLC (Nasdaq:LNCO) ("LinnCo") announced that they have been notified by the staff of the Securities and Exchange Commission ("SEC") that its Fort Worth Regional Office has commenced a private, non-public inquiry regarding LINN and LinnCo. The SEC has requested the preservation of documents and communications that are potentially relevant to, among other things, LinnCo's proposed merger with Berry Petroleum Company, and LINN and LinnCo's use of non-GAAP financial measures and hedging strategy. The SEC has stated that the fact of the inquiry should not be construed as an indication that the SEC or its staff has a negative view of any entity, individual or security. LINN and LinnCo are cooperating fully with the SEC in this matter.

 

Although the impact of the inquiry on the timing of LinnCo's proposed merger with Berry Petroleum Company is difficult to predict, LinnCo and LINN remain committed to the completion of the transaction.”

 

This is a good start and the SEC appears to be looking in the right places – non-GAAP financials, commodity derivatives, and terms of the LINN/BRY merger.  Our negative view on LINN Energy was largely predicated on all three of these issues.  We speculate that possible outcomes of this investigation are that the SEC ultimately requires LINN to:

  • Restate prior period non-GAAP financials, including adjusted EBITDA and distributable cash flow (DCF);
  • Restate prior period “realized gains/losses” and “unrealized gains/losses” on commodity derivatives;
  • Redefine “realized gains/losses” and “unrealized gains/losses” such that realized gain = settlement minus cost basis;
  • Disclose the premiums paid for commodity derivatives that settle in all future periods;
  • Increase disclosure on how, exactly, LINN defines and calculates estimated maintenance capex;
  • Provide a reconciliation of prior period estimated maintenance capex to actual maintenance capex;
  • Make maintenance capex a more transparent and less subjective measure, such as an F&D cost or DD&A rate;
  • Include maintenance capital needed to maintain other PP&E (plants, pipes, etc.) in maintenance capex;
  • Increase disclosure on the tax consequences of the LINN/BRY merger on LINE, LNCO, and BRY, specifically with respect to the election of the “remedial method”;
  • Revise forward-looking guidance for maintenance capex, adjusted EBITDA, and DCF.

We believe that the SEC inquiry puts the proposed LINN/BRY merger at serious risk.  Note that the press release does not say that “LinnCo, LINN, AND BERRY remain committed to the completion of the transaction.”  The press release was also not jointly issued by LINN and BRY, as was the 5/31/13 joint press release title, "LINN Energy, LinnCo and Berry Petroleum Company Provide Update on Merger."

 

For anyone bullish long-term on stand-alone BRY, we believe that this is good news.  It’s likely that LINN/BRY will not close the merger while the investigation is ongoing, and Berry will be free to terminate the merger without paying the $83.7MM ($1.50/share) termination fee if the merger does not close by the “End Date,” October 31, 2013.  It’s impossible to predict how long the SEC’s investigation will take, but they can be on the order of several months to quarters.  This site provides a simple overview of the SEC's investigation process.  Further, our interpretation of the proxy is that the SEC's investigation of LINN qualifies as an "LINN Party Material Adverse Effect," which allows Berry to terminate the merger at any time without penalty.

 

For LINE/LNCO, this is devastating.  The SEC shining a light on LINN’s non-GAAP measures will likely show investors how far they are from economic reality (net income per unit, for instance).  And with the BRY merger now in serious doubt, the “LINN will buy every C-Corp E&P out there” bull case doesn’t seem like such a great idea.  We will also see more consecutive quarters of organic results from LINN, which we expect will show flat-to-declining production, rendering LINN’s estimated maintenance capex number more and more difficult to defend.  We also believe that there’s a good chance that the distribution will ultimately be cut as the SEC’s actions could materially reduce “DCF/unit” going forward.  That’s going to make it difficult to value LINN with a yield target.  And there will be a wave of negative feedback.  JP Morgan and Raymond James downgraded LINE/LNCO to neutral this morning; we expect other analysts to follow suit, or just suspend coverage.  Recall that LINN is largely retail-owned, and for years, LINN thrived partly thanks to the constantly bullish recommendations from these analysts.

 

We maintain that fair value for LINE (LNCO) is around ~8.00/unit (share).

 

As far as broader implications of this investigation go – we imagine that there are quite a few MLP executives that are feeling a little uneasy about the SEC looking into LINN’s non-GAAP measures, which likely includes maintenance capex and DCF.  Our research suggests that understated maintenance capex (and overstated DCF) is endemic in the MLP sector – particularly among the upstream MLPs.  If the SEC requires LINN to enhance disclosure on maintenance capex and/or make the calculation of maintenance capex a less subjective exercise, it would be negative for the entire sector.  We would highlight Breitburn Energy Partners LP (BBEP), EV Energy Partners LP (EVEP), and QR Energy LP (QRE) as companies that may significantly understate maintenance capex, and as a result, overstate DCF.

 

Kevin Kaiser

Senior Analyst    

(o)


It's All About the Benjamins

Client Talking Points

YEN

We've said it before, and we'll say it again: Get the US Dollar right and you will get a lot of other things "Big Macro" right. Yen (vs USD) is down for a 4th day in a row and the Weimar Nikkei has ripped a +6.8% 4-day move on that. It is now back above our 13,389 TREND line of support. The Dollar matters, folks.

GOLD

We have no short position currently in Gold. But we are looking at this $1268-1332 range (immediate-term TRADE resistance) to start re-populating our entire metals/mining book on the short side. Gold is a lot like AAPL was. Wall Street Consensus is still trying to call bottoms, instead of pressing one of the better Macro short calls there is. There is no support to $1174.

GREECE

Just in case you didn’t know how this whole debt/debauchery thing ends, now you know. Greek stocks were front-running the re-entry of the "Troikan Eurocrats" this week. Greece is down an astounding -26.4% since May 17. That there is what we call crashing. With most Asian and European Equity tapes bearish TREND right now, people are running out of places to put their money. Yes, that is a bullish catalyst for US Equity flows.

Asset Allocation

CASH 55% US EQUITIES 15%
INTL EQUITIES 6% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 24%

Top Long Ideas

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WWW

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MPEL

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Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

Three for the Road

QUOTE OF THE DAY

It is better to be hated for what you are than to be loved for something you are not.

- Andre Gide 

STAT OF THE DAY

Danske Bank A/S, the most-accurate gold forecaster tracked by Bloomberg over the past two years, predicts $1,000 in three months.



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