Shorting the MLPs: BBEP and ROYT

Takeaway: Time to sell your upstream MLP? That time started long ago.

Hedgeye senior Energy sector analyst Kevin Kaiser expands his work in upstream MLPs, a group he considers ripe for shorting.  In Tuesday’s institutional call he laid out the short case for Breitburn Energy Partners (BBEP), an upstream MLP, and Pacific Coast Oil Trust (ROYT), an oil royalty trust.


You have probably heard the screeching around Kaiser’s work on LINN Energy, a battle that has been raging in the pages of Barron’s and on television, as well as across the Twittersphere. 


In June the SEC put pressure on LINN to be more transparent in their accounting and followed up last week with an SEC inquiry – an announcement that dropped the price of LINN’s publicly traded units and won Kaiser some instant converts in the investing world.


Shorting the MLPs: BBEP and ROYT - d77


Kaiser put out a full note on BBEP a week ago.  A few key takeaways were highlighted in Tuesday’s call:


The General Partner of BBEP no longer has any direct economic interest in the MLP after the LP acquired the GP stake in 2008.  Most GPs retain only a small ownership of around 2%, which counts as “skin in the game,” if only just.  Zero is about as skinless as you can get – while still drawing management fees.


Kaiser’s calculations clash with BBEP’s.  His evaluation of operating fields the MLP acquired just a month ago indicates BBEP paid $770 million for properties worth not more than $690 million.


This becomes more complicated, because BBEP funded the acquisition completely through bank borrowings.  In order to obtain the financing, BBEP had its banks amend the loan covenants, allowing the company to take on more indebtedness.  Kaiser estimates BBEP will have to do an equity raise before the end of the third quarter, or risk breaching their new debt ratio limits.  Kaiser believes this will result in around 12% dilution to current unit holders.


Another key number affecting Distributable Cash Flow (DCF – the money out of which you get paid as a unitholder) is “maintenance capex,” the amount of money an oil and gas producer has to pay each year just to maintain the same level of production.


BBEP never provides a full and clear accounting of their DCF.  They mention numbers and project distributions on their conference calls, but they don’t publish a breakdown of DCF.  This means you either have to take their word for it – which most investors apparently do – or do your own work.  Which Kaiser did.


BBEP also doesn’t publish a clear definition of what they consider maintenance capex, and Kaiser says their working definition appears to differ from conference call to conference call.  For this year, BBEP management estimates a requirement of $88 million maintenance capex.  Kaiser’s calculation is a whopping $228 million, based on its Depreciation, Depletion & Amortization rate (the standard method of accounting for exploration and development of new oil and gas reserves).


All in, Kaiser figures NAV for BBEP is around $7 per unit, or less than half today’s price in the marketplace.  The NAV is, at any given moment, the most realistic measure of the expectation of all future payouts the trust should be able to deliver – thus, while NAV may not be the price of an MLP, it is the best proxy for the actual value.  Enthusiastic write-ups from major Wall Street firms notwithstanding, Kaiser says no investor should ever pay above NAV for an MLP, a mistake investors routinely make, especially in the early years of the trust’s trading history when most of the in-ground assets remain and the trust’s finances are still pretty straightforward. 



Cutting to the chase, Kaiser calculates the NAV of ROYT at around $9 at current commodity prices, or about half its current market price.


ROYT is a royalty trust, a tax-advantaged entity that has ownership rights to in-ground oil and gas.  Like an MLP, a royalty trust benefits from the sales of those deposits, and like an MLP, it distributes the lion’s share of those cash flows to unit holders.  Like MLPs, many royalty trusts pay high dividends – the current yield on ROYT is over 10%.  Unlike MLPs, the trusts do not acquire additional operating properties to bolster future payments.  When the assets conveyed to the trust are depleted, the trust simply ceases to exist.  As with the MLPs that have recently come under Kaiser’s lens, royalty trusts may also take advantage of financial engineering to make sure they meet dividend payments,


Affiliates of BBEP brought ROYT public last year, taking advantage of a pricing anomaly in domestic oil that has since started fading from the markets – though apparently not from enthusiastic analyst valuations for ROYT.


ROYT’s home fields in California produce a grade of crude oil that generally trades anywhere from $5 to $12 a barrel below the NYMEX WTI benchmark.  Starting in mid-2011, the price lines crossed, and California crude traded at a premium through the end of last year.  Prices have since started declining, and look to revert to their historical relationship some time next year – which is coincidentally also when ROYT’s hedge on its oil and gas properties will roll off.  This combination could produce a double-whammy for ROYT unitholders. 


Kaiser says no one should pay a penny above a concretely demonstrable NAV for ROYT.  In particular, a conservative NAV calculation must be based on a realistic projection of oil prices, which Kaiser says ROYT’s current price is definitely not.  With the units trading at about a 100% premium to what Kaiser calls a reasonable NAV, that spells S-E-L-L.


Conclusion: Up the Stream Without a Paddle?

Kaiser believes the whole high-yield oil and gas sector is vulnerable, in particular the eleven publicly-traded upstream MLPs, whose distributions come from cash flows from oil and gas producing operations.


Kaiser sees the group as largely characterized by aggressive or irregular accounting and heavy dependence on non-GAAP measures in order to arrive at the reported free cash flow numbers they need to justify their distributions.  Opaque accounting and reporting practices are often promoted in an atmosphere of poor corporate governance, with little effort made to mask interlocking ownerships and nested interests. 


So far, both the IRS and the SEC have permitted the loose and idiosyncratic accounting and reporting that characterizes these entities.  Many of these companies have gone through the initial production stages of their properties and now face low organic growth prospects.  Since they must keep making payments in order to satisfy unitholders, there is clear incentive to raise cash By Any Means Necessary.  This can result in MLPs routinely paying out distributions well in excess of actual cash flows generated by their business.


Kaiser notes that the royalty trusts as a group are down about 40% from last year.  This has the perverse effect of making them look more attractive, because the distributions work out in many cases to near-double digit yields, based on price.  The great majority of unitholders are individual investors who buy only on basis of quoted yield.  Kaiser says this is the absolute worst way to value these vehicles.


For one thing, the payments are largely not derived from actual oil or gas production – indeed, in some cases they may not be based at all on actual production, but on a combination of accounting offsets, and the distribution of proceeds from capital raises.


The recent SEC inquiry into LINN’s accounting practices may be the tip of a fast-melting iceberg.  We believe market transparency is a good thing – though we also recognize that forcing it at this time will hurt large numbers of individual investors, a consideration that may temper the SEC’s zeal to force more disclosure too soon.


These companies’ market prices are generally well protected because there’s a powerful narrative around them, coupled with the knee-jerk reaction of Short Sellers = Very Bad Guys.  It is significant to note that major brokerage firms came out with upbeat BUY recommendations on LINN immediately after the stock dropped on news of the SEC inquiry.  We read a couple of reports from household name firms, looking in vain for a set of calculations that might call Kaiser’s thesis into question.  In fact, these reports simply said “this is still a great stock to buy” and contained no factual analysis – the most informative numbers were the page numbers.


If the SEC is looking at possible manipulation of the markets, maybe they should start by asking why major brokerage firms, whose retail brokers have sold these MLP to so many of their customers over the years, should be touting these stocks without even addressing arguments about their viability. 

There have been some cheap shots at Hedgeye over Kaiser’s work, and at Kaiser personally.  There has been lots of indignation expressed – by managements of these companies, by shareholders, and by the brokerage community.  But so far no one has produced a scrap of analytical work tackling Kaiser’s analysis head on.


Time to sell your upstream MLP?  That time started long ago.  The clock’s ticking.


Takeaway: Structural economic adjustment is a painful process.

Recent trends across China’s monthly economic indicators, including today’s June credit data, suggests a flat-to-slightly-down 2Q GDP print Sunday night. Consensus is at 7.5%, which has trended down from an estimate of 8.2% at the start of the 2nd quarter.


MARKET EYES CHINA GDP PRINT - Expectations Management


Another sharp immediate-term relief rally from oversold lows could occur Monday if the numbers are doctored up to come in ahead of bombed-out consensus expectations.


Looking out further, however, Finance Minster Lou Jiwei’s commentary yesterday afternoon all but confirms our TREND and TAIL duration expectations for the Chinese economy. The fact that the sell-side and Western financial media outlets are overly focused on the 2013 GDP growth target (is it 7% or 7.5%?) reminds us that consensus doesn’t understand the secular nature of China’s downshifting economy.


Like Lou Jiwei, we also want to emphasize that structural economic adjustment is a painful process.

Q3 2013 Macro Themes Conference Call

Q3 2013 Macro Themes Conference Call - 3Q13themesdialb


Hedgeye's Macro Team, led by CEO Keith McCullough and DOR Daryl Jones, is hosting its highly anticipated Quarterly Macro Themes conference call with a presentation and a live Q&A session for participants. The presentation highlights the THREE MOST IMPORTANT MACRO TRENDS that our team has identified for the quarter, analyzing potential impacts across multiple scenarios and identifying investment opportunities. The Q3 2013 Macro Themes Call will be held Monday, July 15th at 11:00am EDT.              




  1. #RatesRising: The 30Y bull cycle in bonds is over.  We'll discuss the cross-asset class implications of the reversal and how to be positioned for the ongoing deflation of Bernanke's last (and largest) bubble.  
  2. #DebtDeflation:With total outstanding debt equal to three times equity, we give caution to the impact of debt deflating and offer investment vehicles to play this theme.
  3. #AsianContagion: China sneezes and the rest of Asia catches the flu. #RisingRates and #StrongDollar continue to perpetuate #EmergingOutflows across the developing Asia region while a likely resurgence of positive sentiment surrounding the Abenomics agenda and continued yen weakness should help Japanese equities continue to outperform the region.  



  • Toll Free Number:
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  • Conference Code: 317583#
  • Materials: CLICK HERE (Slides will download one hour prior to the start of the call)



Please email if you have any questions. 



the macro show

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Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

Morning Reads on Our Radar Screen

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

Keith McCullough – CEO

30yrs old, giving up $77M > NJ Devils star Kovalchuk announces retirement (via ESPN)

China Can Endure Growth Slowdown to 6.5%, Finance Chief Says (via Bloomberg)

Treasury Secretary says China to hand audit work to SEC (via Reuters)

Egypt prepares for rival Ramadan protests (via BBC)


Morning Reads on Our Radar Screen - asia


Daryl Jones – Macro

China GDP To Hit 6.7% (via Zero Hedge)

ETF Simplicity Betrayed by Volatility in Market Selloff (via Bloomberg)


Tom Tobin – Healthcare

Affordable Care Act insurance unaffordable for college students (via

The Affordable Care Act: The key to opening up ‘job lock’ (via The Bay State Banner)


Josh Steiner & Jonathan Casteleyn – Financials

JPMorgan Profit Rises 31% on Trading, Beats Estimates (via Bloomberg)


Matt Hedrick – Macro

European Parliament demands spending increase (via The Telegraph


Todd Jordan – Gaming

Cash declaration idea ‘not targeting’ gaming: Tam (via Macau Business Daily)


Has the Fed lost its monetary mojo? Hedgeye Risk Management CEO Keith McCullough weighs in on myriad market signals and whether the Bernanke Fed's Monetary Viagra has finally lost its potency. 


Failure of Fed Viagra?

Client Talking Points


Is that all Bernanke’s got? The US Dollar Index holds immediate-term TRADE support of $82.52; Gold fails at my $1312 TRADE line in kind. The Fed Chief's Dollar Devaluation attempts are being met with less and less stamina. I can’t imagine why? The Fed’s Balance Sheet is only at $3.504 TRILLION right now (I guess the +11.4 BILLION it's up week-over-week just doesn’t cut it) Rate of change impotence.


Over in Asia, Chinese stocks, the KOSPI, etc didn’t care much for Bernanke’s monetary escapades. Shanghai and Hong Kong closed down -1.6% and -0.8%, respectively; that's despite the all-time highs in the SP500 and Russell. Don’t forget that every single major Asian Equity market remains bearish on our intermediate-term TREND duration (other than Japan). #GrowthSlowing


The weakest link stops going up first. With the exception of the FTSE and DAX right now (both are only up +1% above their TREND lines), all of Europe is bearish TREND as well. Italy is down small this morning, but notably down post the USA Viagra thing. And it's still down -1.5% year-to-date for the MIB index is the point. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


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


TREASURIES: 2.53% 10yr - Bernanke, is that all you got? you need to snap 2.4% to get me to stop shorting bonds



"If the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse."

-- Seth Klarman, Baupost


The Fed's balance sheet is now 25% of US GDP and the Fed is currently in possession of 30% of all 10-Year equivalents. (Zero Hedge)

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.