• run with the bulls

    get your first month

    of hedgeye free


Retail Ideas: Where We Stand on WWW, FNP, RH and NKE

Takeaway: Here's our financial overview of where we stand on our Best Ideas. Next up is the 'what can go wrong' analysis. Then some new Bench Ideas.

Here's an update on our key longs in 2013, most notable WWW, FNP, RH, and NKE. While style factors in the market will ebb and flow as it relates to liking small-cap, high-beta names with high short-interest (i.e. everything except Nike), the crux of our long-term calls on the names revolve on earnings, and how much the market does or does not respect the upside (or downside) relative to consensus.


This is an overview of our key calls, and a financial representation of where we're different from consensus.  Next, keep an eye out for more detailed reviews in the 'what could go wrong' department, which we think is critical at this point (so we avoid the dreaded 'round-trip').  Finally, look out for some new names that are currently sitting our idea bench. Enjoy the 4th.


Brian McGough 



1) WWW:  The Street is grossly underestimating the revenue growth opportunity as the legacy WWW scales its recently-acquired brands over its global infrastructure. Under its former owner, Sperry, Keds, Saucony and Stride-Rite only generated 5% of its sales outside of the US, and most of that was in Mexico and Canada. Legacy WWW, on the other hand, is the most global footwear company in the world (yes, even moreso than NKE and AdiBok), with 65% of units sold outside the US through an elaborate network of seamlessly-integrated third-party distributors. Given that the infrastructure is already in place, the incremental sales should be brought on close to a 20% incremental margin, versus 8% margin today. Similarly, minimal capital is needed on the balance sheet to grow these brands, making the growth trajectory over the next 3-5 years very ROIC accretive. The stock might look expensive at 19x earnings and 12x cash flow, but the street’s numbers are low by an incremental 10% per year. We're at $5.65 to the Street's $4.25 four years out.  We’d buy aggressively on a pullback, but are not so sure that will happen. We think WWW is a double over 2-3 years. It’s rare to find names like this.


Retail Ideas: Where We Stand on WWW, FNP, RH and NKE - www


2) FNP: One of the best growth stories in retail. The brand has an $800mm footprint today, but we can build up to at least a $2bn-$3bn footprint over 5-years. What's unique about Kate Spade is that it has a considerable growth runway in its’ existing US handbag business, but also in a) new categories like ready-to-wear, fragrances, eyewear and other accessories, b) new concepts like Kate Space Saturday and Jack Spade, and c) new geographies like Japan and China (already proven), and d) new channel growth opportunities with Outlet growth and e-commerce development.  One thing we like in particular about FNP is that Kate is sitting at an operating margin near 10%. Note that Coach and Kors are closer to 30%. We won't argue that Kate is Coach or Kors -- as its sales per square foot are 40% below those concepts (for now). FNP has been investing in Kate's infrastructure which it will leverage as the top line continues to grow. In other words, we're not very concerned about margins slipping at Kate. Quite the opposite, actually, as we think that margins will approach 20% within 5-years. In the end, we’ve got Kate Spade EBITDA going from $127mm this year to over $440 by year-5 of our model. In the interim, FNP should jettison Lucky and Juicy -- and have $350mm in cash left over after completely mitigating its debt burden. That should leave the company with about $2.25 in EPS power in year 5 based on our math. Spot-checking that math even more simply, let's use a $3bn revenue footprint and a 15% operating margin (maybe the rev is aggressive, but the margin is conservative). we get $450mm in EBIT. After 38% tax rate (which is likely to come down as Int'l % goes up) and 119mm shares, we get $2.35 in EPS. This puts the $22.50 stock price in a different light. We liked it at $5, we liked it at $10, and while we will be vigilant about overstaying our welcome, we still like it at $22.50.


Retail Ideas: Where We Stand on WWW, FNP, RH and NKE - fnp


3) RH: At risk of sounding sensationalistic after talking about the upside in WWW and FNP, we'll say that RH has a growth algorithm that is unparalleled in retail.  Having historically been a retailer that is held hostage to ebbs and flows in the economy and the home furnishings business through its undersized retail stores as well as its catalogue business, the company is dramatically expanding into new categories in the Home Furnishings space in which its current market share is zero. This includes RH Kitchens, RH Tableware, RH Antiques, RH Fine Art, and RH Objects of Curiosity, to name a few.  We're seeing square footage growth bottom out today while the company puts up comps in the +40% range. Then over the next three years, we're going to see square footage growth accelerate to close to 20% by our math at the same time comps will very gradually slow -- but still remain healthy as the new 25k-40k square foot Design Galleries (with sales/square foot between $1,000-$1,500) take the place of the existing 10k square foot stores (ss/ft $600-$800) and make up a greater proportion of RH's overall store base. In other words, the revenue outlook is becoming more stable, not less. Another angle… with the ability to show only 20% of its product to the end consumer, it’s been logistically impossible to showcase all its product offering.  We like to say it's like having a dozen Ferrari's but only a two-car garage. With the recent preannouncements and earnings release, the consensus has come a bit closer to our estimates, but we're still 50% ahead of the Street  in 2015. We think that the longer-term earnings power of RH is better than $5 per share ($3+ bn in sales, and a 12% operating margin). Like WWW and FNP, we'd love it on a pullback. But for now we can't point to one.


Retail Ideas: Where We Stand on WWW, FNP, RH and NKE - rh


4) NKE: Not the huge upside that we see in any other names above. But our estimates are 10-15% ahead of consensus for the next 3-years.  The chief concern most people tend to share with Nike is that the US business, which has been fueling Nike's bottom line, mathematically needs to continue to slow on the margin.   But keep in mind that we have proof that Europe -- both Central and Western -- has stabilized in this business, and we’re anniversarying a slowdown last year in China, and Emerging Markets.  In fact, the company already reported high single digit futures growth, which is in part due to better product pricing (nice tailwind). By the time we begin to lose visibility in the business, the event calendar heats up with World Cup in Brazil.  In the interim, inventories are growing at a lesser rate than both sales and futures, which adds to the bullish gross margin setup.  In all reality, Nike probably set a low bar with its earnings guidance. Our $3.17 for the year is about $0.15 above the Street. The only thing that could stop Nike at this point is Nike. With its current management transition of no fewer than half a dozen senior roles, there will definitely be uncertainty in the organization. But aside from the now infamous Bill Perez CEO year (2005/06) we've never seen a Nike management transition that did not work. It's one area where the company is flawless.


Retail Ideas: Where We Stand on WWW, FNP, RH and NKE - nke

LINE: The Battle Wages On

Takeaway: LINN Energy (LINE) remains overvalued. Our fair value estimates are more than 40% lower than the current stock price.

(Editor's note: The following excerpt comes from today's Hedgeye Morning Newsletter. If you would like more information on how you can sign up to receive these newsletters, please click here.)


“If someone picks on your brother and you don’t stand up for him, don’t bother coming home.”

-Larry Bird, quoting his father (paraphrased)


From a stock research perspective, the last couple of months at Hedgeye have been interesting.  Specifically, our Senior Energy Analyst Kevin Kaiser has been knees deep in a classic battleground stock: LINN Energy.  Kaiser has done an immense amount of independent work on the stock and concluded that the Company is overvalued.  In fact, our fair value estimates are more than 40% lower than the current stock price.


LINE: The Battle Wages On - linn


This research has raised the ire of the Company’s management who has publicly refuted our thesis, has led to numerous ad hominem attacks from the likes of Jim “The Entertainer” Cramer, and also led to a letter to the editor of Barron’s from a large hedge funds that has accused the short sellers of LINN to be “unprincipled”.  (Ironic from a hedge fund that routinely shorts securities.)


Now, admittedly, when we think we are on to something we tend to go all in.  In this instance, that included presenting on the idea a couple of times, participating in the Barron’s article, and publicly defending our research and our analyst.  To Larry Bird’s quote above, if you are not going to defend your ideas and your teammates, don’t bother coming back to Hedgeye headquarters.


Late last night, we were rewarded for our hard work as LINN Energy 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.”


Now to be fair, this is America, and certainly the Company is innocent until “proven guilty” by the SEC, but nonetheless this was part of our point in warning investors that some of LINN’s practices were likely to attract the scrutiny of the SEC.


As always, though, Mr. Market will ultimately let us know if we are correct in our research on this name.  After all, in the short run the stock market is a voting machine and in the long run it’s a weighing machine.


Back to the global macro grind . . .



This note was originally published July 02, 2013 at 06:20 in Restaurants

With the exception of Burger King, the Street is expecting a continued recovery in same-store sales trends for the biggest QSR chains in 2H13.  The following is a look at what each chain will be promoting for the balance of 2013 in order to drive incremental customers.



WEN - Wendy’s

  • Pretzel Bacon Cheeseburger – the national rollout of the summer LTO will begin by July 4th weekend in the U.S. and Canada and could potentially become a permanent menu item
  • Berry Almond Chicken Salad – returned at the end of May for its yearly appearance
  • Strawberry Tea and Strawberry Lemonade
  • Waffle Cone Frosty

HEDGEYE – Expectations are high for the Pretzel Bacon Cheeseburger.  The product is different enough to potentially generate significant trial.  The retail price for the burger is expected to be $4.69, which is an expensive burger, particularly when most consumers are looking for items with better value.  Given the extremely difficult comparisons in 2Q13 and 3Q13, management is relying upon the new burger to drive traffic and check.  Street expectations are for a 1.0% increase in 2Q13 same-store sales.  We believe that the turnaround at Wendy’s is going to take time.


Given that this recent run has been driven largely by multiple expansion rather than earnings revisions, we expect the stock to “take a breather” at this point.  Due to a lack of catalysts, it will be difficult for the stock to continue on its current trajectory.  We believe the next two quarters are likely to see choppy top line performance from WEN.



YUM - Taco Bell

  • Will continue to build on the Doritos Locos Tacos and Cantina Bell platforms
  • Cool Ranch Doritos Locos Tacos – expected to be a strong performer in 2Q13
  • Will release a third flavor of Doritos Locos Tacos “soon”
  • New Cantina Double Steak Quesadilla

HEDGEYE – Taco Bell is up against a 13% comparison from last year.  The trends in 1Q13 suggest that Taco Bell will be see same-store sales down by 1% in 2Q13 compared to Street expectations of a 1.3% increase.  While this might be slightly disappointing, it is insignificant relative to the poor trends the company is seeing in China.  YUM has underperformed the S&P 500 by 820bps year-to-date and it is our view that the company’s performance in 2Q13 will do little to change the Street’s perception. 



MCD - McDonald’s

  • New variations of the Quarter Pounder will replace Angus Burgers
  • New Egg White Delight option on breakfast sandwiches
  • McCafe Blueberry Pomegranate Smoothie
  • McCafe Dulce de Leche Shake
  • Premium McWraps

HEDGEYE – Despite all that MCD has going on, we don’t believe the company’s performance is going to match the lofty expectations embedded in the numbers for 2H13.  While expectations are reasonable for McDonald’s USA to post 1.6% same-store sales in 2Q13, we suspect that 3% same-store sales estimates for 2H13 are too aggressive.  We remain bearish on MCD.



BKW - Burger King

  • Soft Serve Cones – $0.50 item will be available through August 4th
  • New Summer BBQ-themed menu
  • New Rib Sandwich (reminiscent of the MCD McRib)
  • Return of the Memphis BBQ Pulled Pork Sandwich
  • Carolina BBQ Whopper
  • Carolina BBQ Chicken Sandwich
  • Return of Sweet Potato Fries
  • Buffalo Chicken Strips
  • Frozen Lemonade and Frozen Strawberry Lemonade

HEDGEYE – We do not see anything in Burger King’s new product pipeline that suggests the company will separate itself from others in a very competitive QSR landscape.  BKW is comparing against 4.4% same-store sales growth and we believe the Street estimate of a 1.4% same-store sales decline in 2Q13 is too conservative.  It is very possible that 2Q13 same-store sales could be down nearly 2%.  We continue to believe the fundamental issues in the business model and the cash flow pressure on franchisees will prove to be two major headwinds sometime in the future; in the meantime, however, positive restaurant industry and macro data continue to support the stock.



TRENDS: FAST FOOD'S BIG 4  - big 4 sss2



Howard Penney

Managing Director



Rory Green

Senior Analyst



Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

Morning Reads on Our Radar Screen

Takeaway: A quick look at stories on Hedgeye's radar screen.

Kevin Kaiser – Energy

LINN Energy and LinnCo Voluntarily Disclose Informal SEC Inquiry (via LINN Energy)


Morning Reads on Our Radar Screen - radar


Keith McCullough – CEO

Manhattan Apartment Sales Increase Despite Reduced Inventory (#HousingsHammer via New York Times)

“Canadian National Canthem” (via YouTube)

Suicide bomber kills 22 in Iraqi Shi'ite mosque (via Reuters)


Daryl Jones – Macro

Oil Myths: The Hedgeye Rebuttal to Dan Dicker (Note: In light of Dicker’s support of Linn Energy. We thought we’d take a stroll down Memory Lane here … via The Reformed Broker)


Howard Penney – Restaurants

How a Pasta Chain Called Noodles & Co. Punked Wall Street (via Daily Beast)

Cracker Barrel Restaurant's Products Barred From Supermarkets (via Huffington Post)


Matt Hedrick – Macro

Italy Pushes $1,280 Silk Sweaters as Recession Cure (via Bloomberg)


Josh Steiner – Financials

Citi to pay Fannie $968 million in toxic mortgage deal (via New York Post)

BofA said to send appraisal reviews to India (via Charlotte Observer)


Jonathan Casteleyn – Financials

U.S. Banks Must Meet Basel Mark as Small Firms Get Easier Terms (via Bloomberg)


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.





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.



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 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 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 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 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


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):



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 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 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’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'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 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


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.


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? 




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.




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. 




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




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.”




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!




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.




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.




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




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



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.48%
  • SHORT SIGNALS 78.35%