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Funding dividends out of free cash flow ...  what a novel concept!

If any US E&P has an asset base potentially suitable for an upstream MLP, it would be Denbury Resources (DNR), the $7B enhanced oil recovery specialist.  For months DNR has contemplated new strategic initiatives, including forming an MLP.  But on Monday 11/11, DNR officially put the kibosh on that idea, and we couldn’t help but smile as CEO Phil Rykhoek gave the reasons why there is “no clear long-term benefit for Denbury shareholders” (Slide 16) in forming an MLP.

We have been, and remain, highly critical of and negative on upstream MLPs for many of the reasons that Rykhoek cited at the  DNR Analyst Day.  In our view, DNR’s decision to not go the upstream MLP route is a blow to the viability and sustainability of the structure and current E&P MLPs.  While the market is punishing DNR in the short-term for not “playing the game” (down 8.5% this week), we think that Rykhoek will eventually look smart for this decision.  And after listening to that Analyst Day call, we are interested in doing work on DNR … biased long side.

Below we list some quotes from DNR's CEO Phil Rykhoek on Upstream MLPs (our emphasis):

“If you look at the way the MLPs operate, most of them spend more than they make every year.  So how do they handle that?  Well, they continually raise equity, they continually buy things, and that is how they keep it going.

"But on a day-to-day operating philosophy, many of them, if you look at it, spend more than they make.  Now they argue what maintenance capital is versus growth capital, et cetera.  As I will show you on another slide, we would like to operate a bit differently and a bit more conservatively, and so we would expect to fund dividends out of operating cash flow.  So if you have $100, that $100 would be used for CapEx and dividends, and for the most part, we would be self-funded."

"We weren't sure how it would translate into the marketplace if we ran MLP kind of differently, so that is kind of what that comment means.  So long story short, we felt like it was better to not do an upstream MLP. And I think most of our shareholders would agree with that one, in fact, a very high percentage.”


“We expect to fund our dividends with cash flow. So hopefully we don't get into any debate or discussion on what is maintenance capital. We hope to make it very transparent.  Going back to the $100 example, you have $100, you might spend $80 on CapEx and $20 on dividends, but it would all generally be funded with cash flow.”

“If we have extra [cash flow], then we have the option of typical things that you can do at an E&P company. You can increase your CapEx; you can reduce your debt. But the other thing that we want to have in our portfolio is that we can repurchase shares.”


 The biggest positive I think for an MLP is that they usually trade at a higher multiple. Therefore, if you are using the currency to buy things, it's a good currency for acquisitions. If you trade at an 8 multiple versus a 6, if you're going to use equity to buy things, obviously we'd prefer that.  Of course, when you look at our situation, we very seldom use equity to buy things.”


“MLPs have IDRs; that is true. That is a potential value. And, of course, it raises capital. So to the extent you take it public, you raise money. Now there's a trade-off to that one, in the sense that if you look at everything as a whole, if you issue equity, you've also increased dilution. So it's not a free lunch, so to speak. And so we felt like we could manage it basically without having to raise capital.


“We basically felt like the negatives were stronger than the positives.”


“I think it was at the Citi conference where someone asked if we would consider an MLP, and it took a life of its own.  For those of you that I’ve talked to, which is most of you, we have worn this out, I think.  So hopefully we will do this about one more week, and then we won't talk about this again.”


“Question – Audience: Over the long-term, do have a long-term dividend yield target? You show the next couple of years, but as you looked out to the seven years, did you have a target there?

Answer – Phil Rykhoek, CEO: Well, I hope it goes down to about 1%, because I hope the stock price goes up. How's that?

Kevin Kaiser

Managing Director