Our primary issue with BreitBurn Energy Partners (BBEP) is understated maintenance CapEx - and the Postle acquisition increases our concern. With increased scrutiny now around LINN Energy's (LINE, LNCO) maintenance CapEx policy, as evidenced by the stark changes in disclosure in its latest S-4/A, investors should strongly consider whether or not BBEP's maintenance CapEx level is appropriate, or light. We believe that it is very light. While this SEC review did not address BBEP's maintenance CapEx, it would not surprise us if one in the future does.
Postle Field Economics - Where's the Maintenance CapEx?
Comments from BBEP’s management team, as well as its forward guidance, suggests to us that is materially understating the amount of CapEx that it is needed to keep production flat (maintenance CapEx) on the Postle Field assets that it acquired in June 2013 and closed on in July 2013. After adjusting for appropriate maintenance CapEx, we do not believe that the acquisition is accretive to BBEP's DCF/unit.
From BBEP's 8/6/2013 2Q13 Earnings Conference Call (our emphasis):
Analyst: Thanks. Mark, question just circling back on maintenance capital, can you talk about whether or not the addition of the Postle asset will have much of an impact on the overall corporate decline curve and the intensity of trying to – of what you need to spend for maintenance capital?
COO Mark Pease: Jeff, we've looked at that and it is shallow decline, which is a good thing for us. Overall, it doesn't have much impact. I mean, it's pretty consistent with the maintenance capital that we see across the portfolio. So, while we have some areas that, as you look at them individually, they're higher than others. From a whole portfolio standpoint, Postle is right in there with the rest of our assets.
Analyst: Can you share what the cash flow just from that asset might be versus the capital that would be needed to keep it flat?
COO Mark L. Pease: Jim, I don't know what we've disclosed on that, on that the deal.
CFO James Jackson: Hey Jeff, it's Jim. We just haven't – we've not given that level of detail on Postle to date.
BBEP filed pro forma financial data for Postle in its 8/30/2013 8-K, so now we have that level of detail. Below are the key stats:
Production in April 2013 was 7,400 boe/d, down 9% from 2012 average. Total CapEx in 1H13 was $44MM, or ~$87MM annualized. This implies that this level of spend is insufficient to stem the production decline on this asset. This is consistent with the production and spending trends at Postle over the last three years. Production in April 2013 was down 20% from the 2010 average.
After the acquisition, BBEP guided 2H13 maintenance CapEx to $55MM (see the 6/24/13 investor presentation), with Postle expected to close on August 1st (5 full month contribution in 2013). 2Q13 maintenance CapEx was $19.5MM without Postle, as stated by management on the 2Q13 conference call, so this acquisition resulted in an ~$8MM/quarter increase in Maintenance CapEx. BBEP's guidance suggests that maintenance CapEx on Postle will be ~$32MM/year; this is difficult to reconcile with the facts that annualized CapEx at Postle since 2011 was ~$84MM, and production was in decline. Maintenance CapEx is supposed to be the capital required to keep production flat...
Total CapEx on Postle was 54% of EBITDA in 1H13, and production is in decline. BBEP’s maintenance CapEx in 2Q13 was only 23% of EBITDA. Yet, management states that the Postle Field maintenance CapEx, “From a whole portfolio standpoint, Postle is right in there with the rest of our assets.” In our view, the data does not support this assertion.
And while management stated on the deal call that the acquisition was “right around, maybe even a little less than 6X expected forward EBITDA,” the stand-alone Postle assets (excluding derivative assets/liabilities) were acquired for 11x 1H13 annualized free cash flow, and the asset is in decline. EBITDA can be a misleading measure for a CO2 flood due to capitalized CO2.
The total Postle purchase price (ex. derivative assets and liabilities) was ~$815MM, 0.83x the YE12 standardized measure of $985MM.
If BBEP finances this acquisition with 50% equity and 50% debt, we do not believe that it will be accretive to DCF/unit. The asset requires significantly more capital to keep production flat than BBEP is letting on, as the actual data from 2010 - 1H13 shows.
BBEP Makes Public Correspondences with the SEC
BBEP made its 2013 correspondences with the SEC public late last week. The SEC first sent a letter to CFO James Jackson on March 27, 2013 with comments related to BBEP’s 2012 10-K. BBEP and the SEC traded a series of letters and phone conversations between May 2013 and August 2013. On August 28, 2013, the SEC completed its review.
What were the SEC’s major concerns?
- Explanation of the “net operating cash flows from effective date through the closing date of an acquisition” adjustment in adjusted EBITDA.
- Explanation of why there was not a larger impairment charge in 2012 given -31% natural gas reserve revision.
- Explanation of commodity derivatives accounting – realized gains (losses), unrealized gains (losses), and premiums paid.
- Questionable application of the 5-year PUD rule.
- No pro forma financials for the 2012 Permian acquisitions.
What were the outcomes?
- 2012 10-K was revised, removing “Net operating cash flow from acquisitions, effective date through closing date.”
- No further impairment required, as BBEP successfully argued that the assets passed the impairment test – whether or not the undiscounted proved and risk-adjusted probable and possible reserve cash flows were in excess of the assets’ carrying values (net book value).
- Revised, increased, and improved disclosure around derivatives accounting and premiums paid. BBEP amended its 2012 10-K and 1Q13 10-Q “to revise its disclosures from a separate presentation of realized and unrealized derivative gains or losses to a combined presentation for derivative gains or losses. In addition, the Partnership will add back total derivative gains or losses and also provide separate disclosure of derivative contract settlement amounts in its Consolidated Statement of Cash Flows as well as in its Adjusted EBITDA table. The Partnership will also disclose the amount of premiums for derivative contracts paid in earlier periods that apply to contracts settled during the period(s) shown in a footnote disclosure to its Adjusted EBITDA table” (8/14/13 Correspondence, pg. 4).
- BBEP will prospectively apply a strict definition of the 5-year rule. At YE12, BBEP had 3.3 MMboe of PUD reserves (2% of total) that were scheduled to be developed outside of five years from their initial disclosure. These reserves had a standardized measure of $23.6MM (1% of total) at YE12.
- No pro forma financials necessary, as BBEP successfully argued that the acquisitions were not material.
- We believe that BBEP’s use of non-GAAP measures is aggressive. The SEC addressed two of our issues with adjusted EBITDA in its review – the adjustment for net operating CF between the closing and effective dates of acquisitions, and BBEP’s exclusion of commodity derivative premiums paid. This should prevent BBEP from making these aggressive adjustments going forward – in 2012 they increased DCF by ~11%.
- In our view, BBEP’s biggest issue and source of over-valuation is understated maintenance CapEx, which we detailed in our 8/7/13 note, BBEP 2Q Review: Understated Maintenance CapEx = Majority of DCF. By our calculations, BBEP’s organic production in the 12 months from 2Q12 – 2Q13 was down 0.3% YoY, while total organic CapEx exceeded maintenance CapEx by $130MM. If BBEP increased maintenance CapEx by that amount, we estimate that DCF would get cut by ~80%. The SEC did not at all address maintenance CapEx in this review, presumably because there is no mention of it or DCF in BBEP’s SEC filings. We cannot understand why BBEP’s maintenance CapEx and DCF is not disclosed, explained, and reconciled (both maintenance CapEx and DCF) to the nearest GAAP figures in its SEC filings – or even in its earnings press releases – despite the obvious importance of these non-GAAP figures to investors. Maintenance CapEx is addressed in the FAQ section of BBEP’s website, though, in our view, the definition just begs additional questions.
- BBEP disclosed that the net book value of its Antrim Shale field was $891MM at YE12, which was 33% of total net PP&E. At YE12, BBEP’s Antrim Shale reserves were ~242 Bcfe and 2012 production was ~48 MMcfe/d. In our view, the fair value of this asset today is likely only ~$300MM, nearly $600MM below YE12 net book value. Transaction multiples for comparable dry gas properties today are ~$1 - $2/proved Bcfe. The last major Antrim Shale deal was LINN Energy’s March 2010 acquisition of HighMount Exploration’s properties for $330MM. Those properties had 266 Bcfe of proved reserves, putting the deal multiple at $1.24/Bcfe. More recently, in August 2013, Atlas Resource Partners (ARP) acquired 466 Bcf of natural gas 1P reserves in New Mexico and Alabama for $733MM, putting that transaction multiple at $1.57/Bcfe.