BREITBURN ENERGY PARTNERS LP BBEP W
December 30, 2009 - 1:03pm EST by
backinthetetons34
2009 2010
Price: 10.97 EPS nm nm
Shares Out. (in M): 53 P/E nm nm
Market Cap (in M): 579 P/FCF 3.1x nm
Net Debt (in M): 574 EBIT 0 0
TEV: 1,153 TEV/EBIT nm nm

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Description

Introduction

As described on the partnership's website (www.breitburn.com):

"BreitBurn Energy Partners L.P. is an independent oil and gas partnership focused on the acquisition, exploitation and development of oil and gas properties in the United States. Our objective is to manage our oil and gas producing properties for the purpose of generating cash flow and making distributions to our unitholders.

Our assets consist primarily of producing and non-producing crude oil and natural gas reserves located in the Antrim Shale in Michigan, the Los Angeles Basin in California, the Wind River and Big Horn Basins in central Wyoming, the Sunniland Trend in Florida, and the New Albany Shale in Indiana and Kentucky. Our assets are characterized by stable, long-lived production and reserve life indexes averaging greater than 16 years. Our fields generally have long production histories, with some fields producing for over 100 years. We have high net revenue interests in our properties."

The following table provides additional detail on the partnership assets:

 

Est. Proved

YTD 2009 Avg.

% Proved

Description

Reserves (Boe)*

Daily Prod. (Boepd)

Developed

Antrium Shale (MI)

80,900,000

10,400

92%

Los Angeles Basin (CA)

12,400,000

3,150

98%

Wind River and Big Horn Basins (WY)

6,200,000

2,170

90%

Sunniland Trend (FL)

2,000,000

1,430

100%

New Albany Shale (IN/KY)

900,000

580

100%

 

102,400,000

17,730

 

* As of December 31, 2008.  As noted in the presentation given at the "Wells Fargo Securities Pipeline and MLP Symposium" this month (December 2009), the 102.4 MMboe shown above, would equate to "140 MMboe per new SEC avg. price rules effect. for YE 2009 reserves". 

While production is approximately balanced currently - FY 2009 guidance was 46% oil and 54% natural gas - the partnership proved reserves were approximately 75% natural gas and 25% crude oil at December 31, 2008.

I would argue that BBEP has the characteristics of a quasi-utility and does not present the speculative underpinnings or cyclicality of an oil and gas exploration and production company.    

Such an argument rests on four basic principles:

  1. The extensive hedging portfolio presently in place works to stabilize cash flows from operating activities, thus dampening the effects of changes in commodity prices.  While net income has proven to be extremely volatile over the past two years, cash flows from operating activities have proven to be incredibly stable.  Such an outcome is remarkable considering the sheer volatility in commodity prices during 2008 and 2009.  The hedge portfolio was most recently outlined in the presentation given at the "Wells Fargo Securities Pipeline and MLP Symposium" in December 2009 as follows:

 

 

 

 

 

 

 

 

% of Est. Total

Year

 

Oil

Avg. Price ($/bbl)

 

Gas

Avg. Price ($/mmbtu)

 

Production Hedged

2010

 

89%

$80.89

 

85%

$8.26

 

87%

2011

 

77%

$77.51

 

75%

$7.92

 

76%

2012

 

63%

$88.35

 

69%

$8.05

 

66%

2013

 

50%

$76.82

 

48%

$6.92

 

49%

In addition to what is presented in the table above, BBEP has begun to add hedges on both oil and natural gas in 2014

  1. The oil and gas assets of the partnership are long-lived.  Given the 102.4 MMboe of estimated proved reserves (92% of which are proved developed), production at the high end of 2009 guidance of 6.5 MMboe, would not exhaust the resources of the partnership for approximately 15.75 years.
  2. When acquiring oil and gas properties, the partnership looks to acquire properties which are currently producing.  As such, the partnership is not dependent upon the successful discovery of resources.  Any future acquisitions would be based upon the expected cash flow to be derived from existing production.   
  3. Compared to the prevailing C-corporation structure of most publicly traded companies, and especially those companies dependent upon finite resources, the master limited partnership ("MLP") structure better aligns the interests of management with that of common unitholders (shareholders).  Given the flow-through nature of an MLP in regard to income and associated taxes, the market value of an MLP is overwhelmingly based upon the current distribution level.  Given this, the retention of earnings by management is not typically rewarded in equity markets and thus provides incentive for management to distribute earnings and/or free cash flow.  Companies engaged in the monetization of finite resources are dependent upon a return of capital.  Shareholders not being compensated for the depletion of the assets they own should be the extraordinary case rather than the common example.

Regardless of how one were to group Breitburn Energy Partners L.P., it would be difficult to dispute the claim that the partnership presents compelling value and an attractive investment opportunity.

Fundamental Data

I. Capitalization

The following table presents a summarized view of data related to the capitalization of BBEP (numbers are in millions, except per share data):

Company

Breitburn Energy Partners L.P.

Exchange: ticker

Nasdaq: BBEP

Current market price (Dec. 29, 2009)

10.97

Common units outstanding (Nov. 6, 2009)

52.78

Common units outstanding, diluted (Nov. 6, 2009)*

55.74

Resulting market capitalization, basic

578.99

Long-term debt (Oct. 31, 2009)

576.00

Cash (Sep. 30, 2009)

2.20

Resulting enterprise value

1,152.99

 

 

Tangible book value (Sep. 30, 2009)

1,266.60

Tangible book value per unit incl/ potential dilution

22.72

 

 

Debt-to-tangible equity, per balance sheet

45.48%

Debt-to-capital, per balance sheet

31.26%

* All outstanding potential dilutive securities, as of September 30, 2009, were antidilutive.  Given that the securities will become dilutive if the market price were to reflect underlying value, all have been included in "Common units outstanding, diluted" listed above.

As presented above, tangible book value totaled approximately $1,266.60 million at September 30, 2009.  This equates to a tangible book value per (diluted) share of $22.72.  Thus at the current market price of $10.97, units can be purchased at 48.28% of tangible book value.

Long-term debt stood at $736 million on December 31, 2008.  Through September 30, 2009, a total of $151 million in long-term debt had been repaid, leaving $585 million outstanding.  Per the third quarter conference call, during the month of October BBEP repaid an additional $9 million in long-term debt, leaving $576 million outstanding.  Management has continued to state their intention to continue to rapidly repay outstanding long-term debt.  Given the high and stable level of cash flow generated by the underlying business (discussed below), the current level of debt is more than manageable and additional debt reduction should not present difficulty.  Outstanding debt is projected to be $560 million at December 31, 2009.    

II. Earnings and Cash Flows

The following table provides detail as to the earnings and cash flow from operating activities produced by BBEP (numbers are in millions, except per share data):

Net Income FY ended Dec. 31, 2007

380.26

Net Income FY ended Dec. 31, 2008

(59.69)

Cash flow from operating activities FY ended Dec. 31, 2007

60.10

Cash flow from operating activities FY ended Dec. 31, 2008

226.70

 

 

Net Income nine months ended Sep. 30, 2008

129.09

Net Income nine months ended Sep. 30, 2009

(67.58)

Cash flows from operating activities nine months ended Sep. 30, 2008

190.96

Cash flows from operating activities nine months ended Sep. 30, 2009

183.97

As should be apparent from the above table, the results of an MLP are not reflected particularly well by Generally Accepted Accounting Principles given the non-cash charges related to unrealized/realized gains and losses on commodity-based derivatives.  It is therefore imperative to look beyond net income to the statements of cash flows to gauge the success or failure of such a business.  As presented in the table, net income earned by BBEP has been extremely volatile over the preceding three years, although cash flows from operating activities have been remarkably stable.   

BBEP purchased the overwhelming majority of the partnership assets during 2007 and results, therefore, do not reflect operation of those assets.  As such, 2007 is not considered to be representative of the results to be expected.  Given this, the cash flows from operating activities during the nine months ended September 30, 2009 and 2008, will be utilized to determine a baseline value.  While such a short period of available data is not desirable, given extremely long-lived assets and the relative certainty of future cash flows (via hedges extending materially into 2013), such data is viewed as a reliable indicator of future results.    

Cash flows from operating activities amount to $183.97 million and $190.96 million during the nine months ended September 30, 2009 and 2008, respectively.  If it is assumed that the nine months ended September 30, 2009 represent approximately 85% of the total cash flow from operating activities to be derived in 2009 (as it did in 2008), BBEP is on pace to produce Cash flows from operating activities of  $216.44 million during 2009.  Given the demonstrated stability, such estimation seems reasonable.  Note that in 2008 approximately 85% of all cash flows from operating activities were derived during the nine months ended September 30, 2008.  Given the extraordinary events which transpired from mid-September 2008 through December 31, 2008 (failure of Lehman Brothers, government intervention, etc.), such an estimate would appear conservative as it is difficult not to assume that cash flows were slightly depressed during the fourth quarter of 2008. 

Although management initially provided 2009 guidance of maintenance capital expenditures ("capex") of $60 million, as the year has progressed this amount has been reduced to $32 million in aggregate for 2009.  While such a difference seems extreme, BBEP has actually increased production slightly from the assumption which was underlying the $60 million figure.  The same level of $32 million currently represents management's baseline assumption for 2010.  Although this level of capex will be forced to increase if production is raised, such an increase would be accompanied by corresponding cash flow from operating activities. 

Assuming that cash flows from operating activities were maintained at the expected $216.44 million and $32 million was spent on capex, free cash flow (including changes in working capital) would amount to $184.44 million.  Such an amount of free cash flow, discounted at 15% (as a perpetuity) equates to $1,229.6 million, or approximately $22.06 per diluted common unit.  While the author has admitted that $32 million in capex is likely too low for future periods, it is the best estimate available; any other number would be purely subjective.  As opposed to interjecting subjectivity, a conservative discount rate has been utilized.   

While utilizing a perpetuity formula is not the conventional method used to perform equity analysis, given the stability of cash flows expected to be generated by BBEP and the conservative discount rate used, such a formula seems much less speculative than attempting to forecast free cash flow many years into the future.  Given that the future is something to be protected against rather than profited from, such a no-growth scenario seems most conservative.  If free cash flow were to unexpectedly decline, it is assumed that the use of a conservative discount rate and a cost basis below tangible book value would avoid loss.  

It should be noted that presently BBEP, given subdued production due to market prices, is producing free cash flow of approximately $11 million per month.  Such a level of free cash flow does not include any benefits provided through the monetization of hedges, and thus may be a more reliable indicator of the free cash flow generation which the partnership is capable of.  At such a level, BBEP would produce aggregate free cash flow of $132 million during a twelve month period.  Using the same discount rate of 15%, the total perpetuity value would equate to $880 million or $15.78 per diluted share.

III. "DDM - Distribution-Discount Model" / Peer comparison

Although much more subjective, seeing that the typical MLP investor is primarily interested in receipt of ongoing distributions, let me offer the following hypothetical valuation.  Assuming the $132 million in free cash flow in the more conservative situation presented above, approximately $2.50 would be available to distribute per common unit on an annual basis (which would of course represent 100% of FCF), again assuming no growth.  One of BBEP's peers with which I am familiar, EVEP, offers a 9.81% yield at the closing price on December 29, 2009.  EVEP trades at a slight premium (1.27x) to tangible book value.  While a single peer does not present an appropriate universe for comparison, EVEP is similar in that it is extremely well hedged, plus the yield seems consistent with the universe of healthy MLPs engaged in acquisition and production.  Much like BBEP, the unit price of EVEP took a significant hit in the latter part of 2008, touching a 52-week low of $11.76 in December 2008. Unlike BBEP, the distribution went uninterrupted and the unit price has since rebounded to $30.80 as of December 29, 2009.  While EVEP does not distribute 100% of free cash flow, assuming that BBEP did not invest in additional properties it is (hypothetically) conceivable that 100% could be distributed.

If a slightly higher yield were expected of BBEP, say 10%, the resulting price per common unit would be approximately $25. 

Note that the annual distribution was $2.08 when discontinued..  Reinstatement at such a level would represent 83.2% of (subdued) free cash flow.  At 10% the result is $20.80 per common unit.

To summarize the two estimated values presented above versus market price:

Current market price                                                                                                                            $10.97

 

Est. tangible book value                                                                                                                      $22.72

Est. perpetuity value of free cash flow using annualized 2008/2009 Q3 YTD FCF              $22.06

Est. perpetuity value of free cash flow assuming $11 million FCF per month                      $15.78

"Distribution-Discount Model"/Peer comparison @ $2.50/unit  and 10% r                         $25.00

"Distribution-Discount Model"/Peer comparison@ $2.08/unit and 10% r                           $20.80

It should be noted that the lowest value presented above, $15.78 per common unit, represents a 43.85% increase from the current market price.  It would appear that intrinsic value could be placed somewhere between $15.78 and $25.00.  The author believes it is presently around $22.50, although the future may invalidate this claim.   

History

The following information was presented by BBEP in the 10-K filed on March 2, 2009.  It is reproduced here to provide the potential investor with information on the formation of the current entity, as well as to provide a foundation upon which to judge the pending lawsuit filed by Quicksilver Resources Inc. ("KWK"): 

In 2006, we completed our initial public offering of 6,000,000 common units representing limited partner interests in us ("Common Units") and completed the sale of an additional 900,000 Common Units to cover over-allotments in the initial public offering at $18.50 per unit, or $17.205 per unit after payment of the underwriting discount. In connection with our initial public offering, BEC, our Predecessor, contributed to us certain fields in the Los Angeles Basin in California, including its interests in the Santa Fe Springs, Rosecrans and Brea Olinda Fields, and the Wind River and Big Horn Basins in central Wyoming.

On May 24, 2007, we sold 4,062,500 Common Units in a private placement at $32.00 per unit, resulting in proceeds of approximately $130 million.  The net proceeds of this private placement were used to acquire certain interests in oil leases and related assets from Calumet Florida L.L.C. and to reduce indebtedness under our credit facility. 

On May 25, 2007, we sold 2,967,744 Common Units in a private placement at $31.00 per unit, resulting in proceeds of approximately $92 million.  The net proceeds of this private placement were partially used to acquire a 99 percent limited partner interest in BEPI from TIFD and to terminate existing hedges related to future production from BEPI.

On November 1, 2007, we sold 16,666,667 Common Units in a third private placement at $27.00 per unit, resulting in proceeds of approximately $450 million.  The net proceeds from this private placement were used to fund a portion of the cash consideration for the acquisition of certain assets and equity interests in certain entities from Quicksilver (the "Quicksilver Acquisition"). Also on November 1, 2007, we issued 21,347,972 Common Units to Quicksilver as partial consideration for the Quicksilver Acquisition. [Note: Cash consideration paid to Quicksilver Resources, Inc. totaled $750 million]

On June 17, 2008, we purchased 14,404,962 Common Units from subsidiaries of Provident at $23.26 per unit, for a purchase price of approximately $335 million (the "Common Unit Purchase"). These units have been cancelled and are no longer outstanding.

On June 17, 2008, we also purchased Provident's 95.55 percent limited liability company interest in BreitBurn Management, which owned the General Partner, for a purchase price of approximately $10 million (the "BreitBurn Management Purchase").  See Note 4 to the consolidated financial statements in this report for the purchase price allocation for this transaction.  Also on June 17, 2008, we entered into a contribution agreement (the "Contribution Agreement") with the General Partner, BreitBurn Management and BreitBurn Corporation, which is wholly owned by the Co-Chief Executive Officers of the General Partner, Halbert S. Washburn and Randall H. Breitenbach, pursuant to which BreitBurn Corporation contributed its 4.45 percent limited liability company interest in BreitBurn Management to us in exchange for 19,955 Common Units, the economic value of which was equivalent to the value of their combined 4.45 percent interest in BreitBurn Management, and BreitBurn Management contributed its 100 percent limited liability company interest in the General Partner to us. On the same date, we entered into Amendment No. 1 to the First Amended and Restated Agreement of Limited Partnership of the Partnership, pursuant to which the economic portion of the General Partner's 0.66473 percent general partner interest in us was eliminated and our limited partners holding Common Units were given a right to nominate and vote in the election of directors to the Board of Directors of the General Partner.  As a result of these transactions (collectively, the "Purchase, Contribution and Partnership Transactions"), the General Partner and BreitBurn Management became our wholly owned subsidiaries.

On June 17, 2008, in connection with the Purchase, Contribution and Partnership Transactions, we and our wholly owned subsidiaries entered into the First Amendment to Amended and Restated Credit Agreement, Limited Waiver and Consent and First Amendment to Security Agreement ("Amendment No. 1 to the Credit Agreement"), with Wells Fargo Bank, National Association, as administrative agent. Amendment No. 1 to the Credit Agreement increased the borrowing base available under the Amended and Restated Credit Agreement dated November 1, 2007 from $750 million to $900 million.  We used borrowings under Amendment No. 1 to the Credit Agreement to finance the Common Unit Purchase and the BreitBurn Management Purchase.

On June 17, 2008, in connection with the Purchase, Contribution and Partnership Transactions, the Omnibus Agreement, dated October 10, 2006, among us, the General Partner, Provident, Pro GP and BEC was terminated in all respects.

On February 19, 2009, 134,377 Common Units were issued to employees under our 2006 Long-Term Incentive Plan, increasing our outstanding Common Units to 52,770,011.

On December 22, 2008, we entered into a Unit Purchase Rights Agreement, dated as of December 22, 2008 (the "Rights Agreement"), between us and American Stock Transfer & Trust Company LLC, as Rights Agent.  Under the Rights Agreement, each holder of Common Units at the close of business on December 31, 2008 automatically received a distribution of one unit purchase right (a "Right"), which entitles the registered holder to purchase from us one additional Common Unit at a price of $40.00 per Common Unit, subject to adjustment. We entered into the Rights Agreement to increase the likelihood that our unitholders receive fair and equal treatment in the event of a takeover proposal.

The issuance of the Rights was not taxable to the holders of the Common Units, had no dilutive effect, will not affect our reported earnings per Common Unit, and will not change the method of trading of the Common Units. The Rights will not trade separately from the Common Units unless the Rights become exercisable.  The Rights will become exercisable if a person or group acquires beneficial ownership of 20 percent or more of the outstanding Common Units or commences, or announces its intention to commence, a tender offer that could result in beneficial ownership of 20 percent or more of the outstanding Common Units. If the Rights become exercisable, each Right will entitle holders, other than the acquiring party, to purchase a number of Common Units having a market value of twice the then-current exercise price of the Right. Such provision will not apply to any person who, prior to the adoption of the Rights Agreement, beneficially owns 20 percent or more of the outstanding Common Units until such person acquires beneficial ownership of any additional Common Units.

The Rights Agreement has a term of three years and will expire on December 22, 2011, unless the term is extended, the Rights are earlier redeemed or we terminate the Rights Agreement.

As of December 31, 2008, the public unitholders, the institutional investors in our private placements and Quicksilver owned 98.69 percent of the outstanding Common Units. BEC owned 690,751 Common Units, representing a 1.31 percent limited partner interest. We own 100 percent of the General Partner, BreitBurn Management and BOLP.

Our Predecessor BEC, was a 96.02 percent owned indirect subsidiary of Provident until August 26, 2008, when members of our senior management, in their individual capacities, together with Metalmark Capital Partners ("Metalmark"), Greenhill Capital Partners ("Greenhill") and a third-party institutional investor, completed the acquisition of BEC, our Predecessor.  This transaction included the acquisition of a 96.02 percent indirect interest in BEC, previously owned by Provident, and the remaining indirect interests in BEC, previously owned by Randall H. Breitenbach, Halbert S. Washburn and other members of the our senior management.  BEC was a separate U.S. subsidiary of Provident and was our Predecessor.

In connection with the acquisition of Provident's ownership in BEC by members of senior management, Metalmark, Greenhill and a third party institutional investor, BreitBurn Management entered into a five-year Administrative Services Agreement to manage BEC's properties. In addition, we entered into an Omnibus Agreement with BEC detailing rights with respect to business opportunities and providing us with a right of first offer with respect to the sale of assets by BEC.

Cessation of common unit distributions

Management of BBEP chose to cease distributions to unitholders following the Q4 2008 distribution (which was made in the first quarter of 2009) instead of engaging in a dilutive unit offering far below tangible book value.  Given the precipitous decline in commodity prices from early summer 2008 through the end of 2008, the amount available for BBEP to borrow on the outstanding credit facility was impaired by a reduction in the borrowing base.  The BBEP borrowing base faces redetermination each year in April and October and the following covenants apply:

 

- BBEP is restricted from paying distributions unless the outstanding debt is less than 90 percent of the borrowing base and  they possess the ability to borrow at least 10 percent of the borrowing base while remaining in compliance with all terms and conditions of the credit facility, and

- The BBEP leverage ratio does not exceed 3.50 to 1.00 (which is total indebtedness to EBITDAX)

In April 2009 the redetermination lowered the borrowing base from $900 million to $750 million, thus placing the partnership in a position where more than 90 percent of the borrowing base was outstanding.  Management has stated that they attempted to pursue other financing arrangements at this time to avoid distributions from being discontinued, but that no suitable financing was available, nor was the general partner willing to issue equity at the prevailing low market prices.  Given the extent of dislocation in capital markets at the beginning of 2009, such a statement seems plausible and the author believes management made the appropriate decision for retaining value over the medium-to-long term. 

In April 2009 the borrowing base was reaffirmed at $732 million, having been lowered due to monetization of certain hedges in June and one non-core asset sale during July.  At September 30, 2009 the partnership presented total long-term debt of $585 million.  During the conference call which accompanied the third quarter 2009 earnings release, management stated that at October 31, 2009 total outstanding long-term debt was $576 million, which represents 78.69% of the borrowing base.  Per page 14 of the Form 10-Q filed in early November, the partnership is "in compliance with the credit facility's covenants" at September 30, 2009.  While distributions could be resumed currently, management has stated a desire to achieve a leverage ratio closer to 2.50 to 1.00, prior to doing so.  Given the current level of cash flow produced by BBEP, this equates to bringing total long-term debt down to just over $500 million.  Given that BBEP has reduced debt by approximately $160 million during 2009 through October 31, 2009, which includes the asset monetization mentioned above, and current level of free cash flow, such a ratio seems likely within the coming six month period.  It should be noted that the borrowing base was reaffirmed in October 2009.        

While the interruption in unitholder distributions was not the catalyst for the low unit price witnessed during the preceding 52-week period, the lack of the distribution has hindered BBEP's market price from advancing along with most commodities, asset classes and peers within the MLP space.  The reinstatement, as discussed below, is one of the primary catalysts to potentially propel the market price.            

Risk Factors

The most relevant risk factors to an investment in BBEP involve the following:

 

  1. Ongoing litigation

The following excerpt, from the Form 10-Q filed for the period ending September 30, 2009, is presented to provide a short summary of the lawsuit filed KWK:

"On October 31, 2008, Quicksilver, an owner of 40.44 percent of our Common Units, instituted a lawsuit in the District Court of Tarrant County, Texas naming us as a defendant along with BreitBurn GP, BOLP, BOGP, Randall H. Breitenbach, Halbert S. Washburn, Gregory J. Moroney, Charles S. Weiss, Randall J. Findlay, Thomas W. Buchanan, Grant D. Billing and Provident.  On August 3, 2009, Quicksilver filed the Third Amended Petition and asserted twelve different counts against the various defendants.  The primary claims are as follows:  Quicksilver alleges that BOLP breached the Contribution Agreement with Quicksilver, dated September 11, 2007, based on allegations that we made false and misleading statements relating to its relationship with Provident.  Quicksilver also alleges common law and statutory fraud claims against all of the defendants by contending that the defendants made false and misleading statements to induce Quicksilver to acquire Common Units in us.  Finally, Quicksilver alleges claims for breach of the Partnership's First Amended and Restated Agreement of Limited Partnership, dated as of October 10, 2006 ("Partnership Agreement"), and other common law claims relating to certain transactions and an amendment to the Partnership Agreement that occurred in June 2008.  Quicksilver seeks a permanent injunction, a declaratory judgment relating primarily to the interpretation of the Partnership Agreement and the voting rights in that agreement, indemnification, punitive or exemplary damages, avoidance of BreitBurn GP's assignment to us of all of its economic interest in us, attorneys' fees and costs, pre- and post-judgment interest, and monetary damages.  Pursuant to an agreement among the parties to the lawsuit, a hearing on Quicksilver's request for a permanent injunction and declaratory relief was scheduled for September 2009.    The hearing on the permanent injunction and declaratory relief has now been rescheduled, and all of Quicksilver's claims, including those previously set for hearing in September 2009, are set for trial in April 2010."

Although mentioned in the above paragraph, details regarding the Partnership Agreement are lacking.  The changes to the Partnership Agreement in June 2008 provided limited partners the right to nominate and vote in the election of the directors to the Board of Directors of the General Partner, while simultaneously stating that (from Form 8-K):

"(B) if  at any time any person or group beneficially owns 20% or more of the Outstanding Partnership Securities (as defined in the Partnership Agreement) of any class then outstanding, then all Partnership Securities (as defined in the Partnership Agreement) owned by such person or group in excess of 20% of the Outstanding Partnership Securities of the applicable class may not be voted, and in each case, the foregoing Common Units will not be counted when calculating the required votes for such matter and will not be deemed to be Outstanding (as defined in the Partnership Agreement) for purposes of determining a quorum for such meeting...Notwithstanding the foregoing sentence, the Board of Directors of the General Partner may, by action specifically referencing votes for the election of directors, determine that the limitation set forth in clause (B) above will not apply to a specific person or group ."

Of course the only entity to which the 20% or greater rule applied was/is KWK.  The voting restrictions were later characterized as a "safeguard" to avoid undue influence by any one person or group.             

In early December 2009 it was announced that Quicksilver Resources Inc. had dropped part of the lawsuit lawsuit.  Per the December 7, 2009 BBEP press release:

"In summary, all claims asserted against all current and former directors of Breitburn concerning Breitburn's purchase of Provident Energy Trust's interests and the ammendment of Breitburn's Partnership Agreement have been dismissed.

Quicksilver continues to make claims in its lawsuit against Breitburn Energy Partners, L.P. and two subsidiareis, as well as against Provident Energy Trust."  

Having reviewed a great deal of information related to the lawsuit, it would appear that the following two items are the primary points of contention for KWK:

 

  1. The alteration of the partnership agreement which resulted in Quicksilver Resources Inc., as an owner of greater than 20% of common units, being unable to vote their units for the election of directors to the General Partner Board of Directors.
  2. The transaction with Provident, which resulted in additional leverage and ultimately (because of greater than 90% of the borrowing base being outstanding) cessation of Common Unit distributions.

In regard to the first item, while the changes disallowing a 20% or greater owner are somewhat strange and it appears likely that the ammendement to the Partnership Agreement was completed to prevent Quicksilver Resources Inc. from being able to control the board of the General Partner ("GP"), a number of things should be remembered:

 

  • - On November 1, 2007, which is when the KWK asset acquistioin was completed and shares were distributed to KWK, KWK did not have the ability to vote for members of the GP Board of Directors. BBEP (the limited partnership) at that time did not own the GP. In other words, they agreed to the inability to elect the GP Board of Directors.
  • - An election of GP directors has not occurred to date as the annual meeting has been rescheduled a number of times and is now to take place once the KWK lawsuit has been ruled upon. Even if a 20% or greater owner had the ability to vote for GP directors they would not have had the opportunity.
  • - Finally, it must be rembered that KWK still has the ability to vote their common units in relation to the limited partnership. As such, KWK could vote all of their common units to effectively remove the GP.

As stated in Form 8-K filed December 1, 2009:

"The Court also held that the directors of the General Partner did not make the requisite determination required by the Partnership Agreement in approving the Amendment that the Amendment would not adversely affect the Limited Partners (including any particular class of Partnership Interest) in any material respect.  If the court enters a final order holding that the Amendment was not properly approved by the directors of the General Partner, then the entire Amendment would be invlaid and the Limited Partners would have no right to vote in the election of directos."   

Considering this, it should be noted that KWK is intent on allowing the amendment to remain, but having the amendment ammended.  Regardless of the outcome on this item, it is doubtful that the other limited partners will be materially affected, as it is diffuclt to prove KWK has been harmed and they do own 40.44% of BBEP, i.e. any material deterioration in the value of BBEP affects them the most.  

**BBEP announced on December 30, 2009 that they have revised the Partnership Agreement.  "The Revised Ammendment does not give the limited partners the right to vote for directors [of the GP]."  It will be interesting to see the KWK repsonse, as they are no longer "singled out".  

Regarding the second item, the Provident trasnactions, it appears that the disagreement relates ultimately to the cessation of partnership distributions.  The Provident transaction forced BBEP to take on additional leverage, which was not an issue until the borrowing base was redetermined.  The trasnactions relating to Provident appears defesible and cessation of the distribution, although painful in the short term, was the best long-term decision available.  BBEP paid approximately market price for the 14,404,962 shares owned by Provident ($23.26 per unit) and cancelled the units upon acquisition.  Given that this portion of the suit concerns all unit holders, it is difficult to see an outcome that materially affects the aggregate value of BBEP.  It should be noted that a number of factors make the common units in this transaction likely more valuable to BBEP than to other market participants.  Namely, there existed a possibility that the sale of the Provident units, when aggregated with other market transactions, could have constituted a (technical) change in control, which would have accelerated certain benefits to employees, been an event of default under the partnership credit facility and caused a "technical tax termination of the Partnership".

In summary, the author views the lawsuit as a potential catalyst once resolved, rather than a threat.  While the claims are serious in nature, probability seems low that any outcome would damage materially the underlying value of the BBEP limited partnership, as Quicksilver Resources Inc. (KWK) owns such a large percentage of BBEP.  Any outcome which impaired the value of BBEP would theoretically damage their economic interest in BBEP.  It would appear with the dropping of certain claims by KWK, as well as the December 30, 2009 announcement by BBEP, that a resolution is desired by all parties. 

It should be noted that insurance is paying for the BBEP portion of litigation. 

 

  1. Prolonged period of weakness in natural gas prices

The prices of oil and natural gas are volatile and difficult (if not impossible) to predict in the short- to medium-term, as even if accurate supply/demand data were attainable, speculative forces still work to distort the fundamental prices which would result.  Having admitted this, the author feels as though a significant period of weakness lies ahead for natural gas, as there is simply far too much natural gas in (domestic) storage, production remains far too high, and the economic backdrop is not likely to provide the demand to offset these factors.  Although such an outcome is troubling for an entity dependent upon the spot price of natural gas, such a scenario is far less worrisome for BBEP given significant hedges extending into 2013 (now into 2014).  A prolonged period of weak natural gas prices would be expected to remove many unhedged and overly leveraged competitors, thus rebalancing supply with demand, prior to price weakness affecting BBEP.  Such a scenario should provide enormous opportunity for an entity such as BBEP, as many productive wells would be "for sale" with attractive fundamentals.

Conclusion

To conclude, there exists a significant margin of safety in the common units of Breitburn Energy Partners L.P.  Given a price-to-tangible book value of approximately 48.28% presently, as well as estimated free cash flow yield (using the subdued $132 million FCF) in excess of 22.79% (11.45% when enterprise value is utilized as the denominator), the probability of loss appears exceedingly low.  Given such a low valuation coupled with the potential catalysts mentioned above, the likelihood of realizing capital gains appears good.  The great thing about this particular opportunity is that the reinstatement of the distribution should assist in realizing the significant undervaluation currently present (capital gain), while also providing an excellent yield on an ongoing basis (current income).  If the price were to rise to the most conservative value calculated of $15.78, capital appreciation of 43.85% would be achieved.  Further, if the distribution were to approach the level paid in February 2009, the annualized per unit distribution would equate to $2.08, or approximately 18.96% at a purchase price of $10.97. 

While the dividend may not be initially reinstated at the previous level of $2.08, given the free cash flow generation of BBEP, as well as cash flow stability, there is no reason to believe it would not approach that level within a short period of time.  The capital markets do not reward a flow-through entity for earnings and cash flow retention.

Catalyst

Primary catalyst:

Reinstatement of distributions

Secondary catalyst:

Resolution of ongoing litigation

Disclosure: The author owns BBEP common unit, as well as EVEP common units.

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    Description

    Introduction

    As described on the partnership's website (www.breitburn.com):

    "BreitBurn Energy Partners L.P. is an independent oil and gas partnership focused on the acquisition, exploitation and development of oil and gas properties in the United States. Our objective is to manage our oil and gas producing properties for the purpose of generating cash flow and making distributions to our unitholders.

    Our assets consist primarily of producing and non-producing crude oil and natural gas reserves located in the Antrim Shale in Michigan, the Los Angeles Basin in California, the Wind River and Big Horn Basins in central Wyoming, the Sunniland Trend in Florida, and the New Albany Shale in Indiana and Kentucky. Our assets are characterized by stable, long-lived production and reserve life indexes averaging greater than 16 years. Our fields generally have long production histories, with some fields producing for over 100 years. We have high net revenue interests in our properties."

    The following table provides additional detail on the partnership assets:

     

    Est. Proved

    YTD 2009 Avg.

    % Proved

    Description

    Reserves (Boe)*

    Daily Prod. (Boepd)

    Developed

    Antrium Shale (MI)

    80,900,000

    10,400

    92%

    Los Angeles Basin (CA)

    12,400,000

    3,150

    98%

    Wind River and Big Horn Basins (WY)

    6,200,000

    2,170

    90%

    Sunniland Trend (FL)

    2,000,000

    1,430

    100%

    New Albany Shale (IN/KY)

    900,000

    580

    100%

     

    102,400,000

    17,730

     

    * As of December 31, 2008.  As noted in the presentation given at the "Wells Fargo Securities Pipeline and MLP Symposium" this month (December 2009), the 102.4 MMboe shown above, would equate to "140 MMboe per new SEC avg. price rules effect. for YE 2009 reserves". 

    While production is approximately balanced currently - FY 2009 guidance was 46% oil and 54% natural gas - the partnership proved reserves were approximately 75% natural gas and 25% crude oil at December 31, 2008.

    I would argue that BBEP has the characteristics of a quasi-utility and does not present the speculative underpinnings or cyclicality of an oil and gas exploration and production company.    

    Such an argument rests on four basic principles:

    1. The extensive hedging portfolio presently in place works to stabilize cash flows from operating activities, thus dampening the effects of changes in commodity prices.  While net income has proven to be extremely volatile over the past two years, cash flows from operating activities have proven to be incredibly stable.  Such an outcome is remarkable considering the sheer volatility in commodity prices during 2008 and 2009.  The hedge portfolio was most recently outlined in the presentation given at the "Wells Fargo Securities Pipeline and MLP Symposium" in December 2009 as follows:

     

     

     

     

     

     

     

     

    % of Est. Total

    Year

     

    Oil

    Avg. Price ($/bbl)

     

    Gas

    Avg. Price ($/mmbtu)

     

    Production Hedged

    2010

     

    89%

    $80.89

     

    85%

    $8.26

     

    87%

    2011

     

    77%

    $77.51

     

    75%

    $7.92

     

    76%

    2012

     

    63%

    $88.35

     

    69%

    $8.05

     

    66%

    2013

     

    50%

    $76.82

     

    48%

    $6.92

     

    49%

    In addition to what is presented in the table above, BBEP has begun to add hedges on both oil and natural gas in 2014

    1. The oil and gas assets of the partnership are long-lived.  Given the 102.4 MMboe of estimated proved reserves (92% of which are proved developed), production at the high end of 2009 guidance of 6.5 MMboe, would not exhaust the resources of the partnership for approximately 15.75 years.
    2. When acquiring oil and gas properties, the partnership looks to acquire properties which are currently producing.  As such, the partnership is not dependent upon the successful discovery of resources.  Any future acquisitions would be based upon the expected cash flow to be derived from existing production.   
    3. Compared to the prevailing C-corporation structure of most publicly traded companies, and especially those companies dependent upon finite resources, the master limited partnership ("MLP") structure better aligns the interests of management with that of common unitholders (shareholders).  Given the flow-through nature of an MLP in regard to income and associated taxes, the market value of an MLP is overwhelmingly based upon the current distribution level.  Given this, the retention of earnings by management is not typically rewarded in equity markets and thus provides incentive for management to distribute earnings and/or free cash flow.  Companies engaged in the monetization of finite resources are dependent upon a return of capital.  Shareholders not being compensated for the depletion of the assets they own should be the extraordinary case rather than the common example.

    Regardless of how one were to group Breitburn Energy Partners L.P., it would be difficult to dispute the claim that the partnership presents compelling value and an attractive investment opportunity.

    Fundamental Data

    I. Capitalization

    The following table presents a summarized view of data related to the capitalization of BBEP (numbers are in millions, except per share data):

    Company

    Breitburn Energy Partners L.P.

    Exchange: ticker

    Nasdaq: BBEP

    Current market price (Dec. 29, 2009)

    10.97

    Common units outstanding (Nov. 6, 2009)

    52.78

    Common units outstanding, diluted (Nov. 6, 2009)*

    55.74

    Resulting market capitalization, basic

    578.99

    Long-term debt (Oct. 31, 2009)

    576.00

    Cash (Sep. 30, 2009)

    2.20

    Resulting enterprise value

    1,152.99

     

     

    Tangible book value (Sep. 30, 2009)

    1,266.60

    Tangible book value per unit incl/ potential dilution

    22.72

     

     

    Debt-to-tangible equity, per balance sheet

    45.48%

    Debt-to-capital, per balance sheet

    31.26%

    * All outstanding potential dilutive securities, as of September 30, 2009, were antidilutive.  Given that the securities will become dilutive if the market price were to reflect underlying value, all have been included in "Common units outstanding, diluted" listed above.

    As presented above, tangible book value totaled approximately $1,266.60 million at September 30, 2009.  This equates to a tangible book value per (diluted) share of $22.72.  Thus at the current market price of $10.97, units can be purchased at 48.28% of tangible book value.

    Long-term debt stood at $736 million on December 31, 2008.  Through September 30, 2009, a total of $151 million in long-term debt had been repaid, leaving $585 million outstanding.  Per the third quarter conference call, during the month of October BBEP repaid an additional $9 million in long-term debt, leaving $576 million outstanding.  Management has continued to state their intention to continue to rapidly repay outstanding long-term debt.  Given the high and stable level of cash flow generated by the underlying business (discussed below), the current level of debt is more than manageable and additional debt reduction should not present difficulty.  Outstanding debt is projected to be $560 million at December 31, 2009.    

    II. Earnings and Cash Flows

    The following table provides detail as to the earnings and cash flow from operating activities produced by BBEP (numbers are in millions, except per share data):

    Net Income FY ended Dec. 31, 2007

    380.26

    Net Income FY ended Dec. 31, 2008

    (59.69)

    Cash flow from operating activities FY ended Dec. 31, 2007

    60.10

    Cash flow from operating activities FY ended Dec. 31, 2008

    226.70

     

     

    Net Income nine months ended Sep. 30, 2008

    129.09

    Net Income nine months ended Sep. 30, 2009

    (67.58)

    Cash flows from operating activities nine months ended Sep. 30, 2008

    190.96

    Cash flows from operating activities nine months ended Sep. 30, 2009

    183.97

    As should be apparent from the above table, the results of an MLP are not reflected particularly well by Generally Accepted Accounting Principles given the non-cash charges related to unrealized/realized gains and losses on commodity-based derivatives.  It is therefore imperative to look beyond net income to the statements of cash flows to gauge the success or failure of such a business.  As presented in the table, net income earned by BBEP has been extremely volatile over the preceding three years, although cash flows from operating activities have been remarkably stable.   

    BBEP purchased the overwhelming majority of the partnership assets during 2007 and results, therefore, do not reflect operation of those assets.  As such, 2007 is not considered to be representative of the results to be expected.  Given this, the cash flows from operating activities during the nine months ended September 30, 2009 and 2008, will be utilized to determine a baseline value.  While such a short period of available data is not desirable, given extremely long-lived assets and the relative certainty of future cash flows (via hedges extending materially into 2013), such data is viewed as a reliable indicator of future results.    

    Cash flows from operating activities amount to $183.97 million and $190.96 million during the nine months ended September 30, 2009 and 2008, respectively.  If it is assumed that the nine months ended September 30, 2009 represent approximately 85% of the total cash flow from operating activities to be derived in 2009 (as it did in 2008), BBEP is on pace to produce Cash flows from operating activities of  $216.44 million during 2009.  Given the demonstrated stability, such estimation seems reasonable.  Note that in 2008 approximately 85% of all cash flows from operating activities were derived during the nine months ended September 30, 2008.  Given the extraordinary events which transpired from mid-September 2008 through December 31, 2008 (failure of Lehman Brothers, government intervention, etc.), such an estimate would appear conservative as it is difficult not to assume that cash flows were slightly depressed during the fourth quarter of 2008. 

    Although management initially provided 2009 guidance of maintenance capital expenditures ("capex") of $60 million, as the year has progressed this amount has been reduced to $32 million in aggregate for 2009.  While such a difference seems extreme, BBEP has actually increased production slightly from the assumption which was underlying the $60 million figure.  The same level of $32 million currently represents management's baseline assumption for 2010.  Although this level of capex will be forced to increase if production is raised, such an increase would be accompanied by corresponding cash flow from operating activities. 

    Assuming that cash flows from operating activities were maintained at the expected $216.44 million and $32 million was spent on capex, free cash flow (including changes in working capital) would amount to $184.44 million.  Such an amount of free cash flow, discounted at 15% (as a perpetuity) equates to $1,229.6 million, or approximately $22.06 per diluted common unit.  While the author has admitted that $32 million in capex is likely too low for future periods, it is the best estimate available; any other number would be purely subjective.  As opposed to interjecting subjectivity, a conservative discount rate has been utilized.   

    While utilizing a perpetuity formula is not the conventional method used to perform equity analysis, given the stability of cash flows expected to be generated by BBEP and the conservative discount rate used, such a formula seems much less speculative than attempting to forecast free cash flow many years into the future.  Given that the future is something to be protected against rather than profited from, such a no-growth scenario seems most conservative.  If free cash flow were to unexpectedly decline, it is assumed that the use of a conservative discount rate and a cost basis below tangible book value would avoid loss.  

    It should be noted that presently BBEP, given subdued production due to market prices, is producing free cash flow of approximately $11 million per month.  Such a level of free cash flow does not include any benefits provided through the monetization of hedges, and thus may be a more reliable indicator of the free cash flow generation which the partnership is capable of.  At such a level, BBEP would produce aggregate free cash flow of $132 million during a twelve month period.  Using the same discount rate of 15%, the total perpetuity value would equate to $880 million or $15.78 per diluted share.

    III. "DDM - Distribution-Discount Model" / Peer comparison

    Although much more subjective, seeing that the typical MLP investor is primarily interested in receipt of ongoing distributions, let me offer the following hypothetical valuation.  Assuming the $132 million in free cash flow in the more conservative situation presented above, approximately $2.50 would be available to distribute per common unit on an annual basis (which would of course represent 100% of FCF), again assuming no growth.  One of BBEP's peers with which I am familiar, EVEP, offers a 9.81% yield at the closing price on December 29, 2009.  EVEP trades at a slight premium (1.27x) to tangible book value.  While a single peer does not present an appropriate universe for comparison, EVEP is similar in that it is extremely well hedged, plus the yield seems consistent with the universe of healthy MLPs engaged in acquisition and production.  Much like BBEP, the unit price of EVEP took a significant hit in the latter part of 2008, touching a 52-week low of $11.76 in December 2008. Unlike BBEP, the distribution went uninterrupted and the unit price has since rebounded to $30.80 as of December 29, 2009.  While EVEP does not distribute 100% of free cash flow, assuming that BBEP did not invest in additional properties it is (hypothetically) conceivable that 100% could be distributed.

    If a slightly higher yield were expected of BBEP, say 10%, the resulting price per common unit would be approximately $25. 

    Note that the annual distribution was $2.08 when discontinued..  Reinstatement at such a level would represent 83.2% of (subdued) free cash flow.  At 10% the result is $20.80 per common unit.

    To summarize the two estimated values presented above versus market price:

    Current market price                                                                                                                            $10.97

     

    Est. tangible book value                                                                                                                      $22.72

    Est. perpetuity value of free cash flow using annualized 2008/2009 Q3 YTD FCF              $22.06

    Est. perpetuity value of free cash flow assuming $11 million FCF per month                      $15.78

    "Distribution-Discount Model"/Peer comparison @ $2.50/unit  and 10% r                         $25.00

    "Distribution-Discount Model"/Peer comparison@ $2.08/unit and 10% r                           $20.80

    It should be noted that the lowest value presented above, $15.78 per common unit, represents a 43.85% increase from the current market price.  It would appear that intrinsic value could be placed somewhere between $15.78 and $25.00.  The author believes it is presently around $22.50, although the future may invalidate this claim.   

    History

    The following information was presented by BBEP in the 10-K filed on March 2, 2009.  It is reproduced here to provide the potential investor with information on the formation of the current entity, as well as to provide a foundation upon which to judge the pending lawsuit filed by Quicksilver Resources Inc. ("KWK"): 

    In 2006, we completed our initial public offering of 6,000,000 common units representing limited partner interests in us ("Common Units") and completed the sale of an additional 900,000 Common Units to cover over-allotments in the initial public offering at $18.50 per unit, or $17.205 per unit after payment of the underwriting discount. In connection with our initial public offering, BEC, our Predecessor, contributed to us certain fields in the Los Angeles Basin in California, including its interests in the Santa Fe Springs, Rosecrans and Brea Olinda Fields, and the Wind River and Big Horn Basins in central Wyoming.

    On May 24, 2007, we sold 4,062,500 Common Units in a private placement at $32.00 per unit, resulting in proceeds of approximately $130 million.  The net proceeds of this private placement were used to acquire certain interests in oil leases and related assets from Calumet Florida L.L.C. and to reduce indebtedness under our credit facility. 

    On May 25, 2007, we sold 2,967,744 Common Units in a private placement at $31.00 per unit, resulting in proceeds of approximately $92 million.  The net proceeds of this private placement were partially used to acquire a 99 percent limited partner interest in BEPI from TIFD and to terminate existing hedges related to future production from BEPI.

    On November 1, 2007, we sold 16,666,667 Common Units in a third private placement at $27.00 per unit, resulting in proceeds of approximately $450 million.  The net proceeds from this private placement were used to fund a portion of the cash consideration for the acquisition of certain assets and equity interests in certain entities from Quicksilver (the "Quicksilver Acquisition"). Also on November 1, 2007, we issued 21,347,972 Common Units to Quicksilver as partial consideration for the Quicksilver Acquisition. [Note: Cash consideration paid to Quicksilver Resources, Inc. totaled $750 million]

    On June 17, 2008, we purchased 14,404,962 Common Units from subsidiaries of Provident at $23.26 per unit, for a purchase price of approximately $335 million (the "Common Unit Purchase"). These units have been cancelled and are no longer outstanding.

    On June 17, 2008, we also purchased Provident's 95.55 percent limited liability company interest in BreitBurn Management, which owned the General Partner, for a purchase price of approximately $10 million (the "BreitBurn Management Purchase").  See Note 4 to the consolidated financial statements in this report for the purchase price allocation for this transaction.  Also on June 17, 2008, we entered into a contribution agreement (the "Contribution Agreement") with the General Partner, BreitBurn Management and BreitBurn Corporation, which is wholly owned by the Co-Chief Executive Officers of the General Partner, Halbert S. Washburn and Randall H. Breitenbach, pursuant to which BreitBurn Corporation contributed its 4.45 percent limited liability company interest in BreitBurn Management to us in exchange for 19,955 Common Units, the economic value of which was equivalent to the value of their combined 4.45 percent interest in BreitBurn Management, and BreitBurn Management contributed its 100 percent limited liability company interest in the General Partner to us. On the same date, we entered into Amendment No. 1 to the First Amended and Restated Agreement of Limited Partnership of the Partnership, pursuant to which the economic portion of the General Partner's 0.66473 percent general partner interest in us was eliminated and our limited partners holding Common Units were given a right to nominate and vote in the election of directors to the Board of Directors of the General Partner.  As a result of these transactions (collectively, the "Purchase, Contribution and Partnership Transactions"), the General Partner and BreitBurn Management became our wholly owned subsidiaries.

    On June 17, 2008, in connection with the Purchase, Contribution and Partnership Transactions, we and our wholly owned subsidiaries entered into the First Amendment to Amended and Restated Credit Agreement, Limited Waiver and Consent and First Amendment to Security Agreement ("Amendment No. 1 to the Credit Agreement"), with Wells Fargo Bank, National Association, as administrative agent. Amendment No. 1 to the Credit Agreement increased the borrowing base available under the Amended and Restated Credit Agreement dated November 1, 2007 from $750 million to $900 million.  We used borrowings under Amendment No. 1 to the Credit Agreement to finance the Common Unit Purchase and the BreitBurn Management Purchase.

    On June 17, 2008, in connection with the Purchase, Contribution and Partnership Transactions, the Omnibus Agreement, dated October 10, 2006, among us, the General Partner, Provident, Pro GP and BEC was terminated in all respects.

    On February 19, 2009, 134,377 Common Units were issued to employees under our 2006 Long-Term Incentive Plan, increasing our outstanding Common Units to 52,770,011.

    On December 22, 2008, we entered into a Unit Purchase Rights Agreement, dated as of December 22, 2008 (the "Rights Agreement"), between us and American Stock Transfer & Trust Company LLC, as Rights Agent.  Under the Rights Agreement, each holder of Common Units at the close of business on December 31, 2008 automatically received a distribution of one unit purchase right (a "Right"), which entitles the registered holder to purchase from us one additional Common Unit at a price of $40.00 per Common Unit, subject to adjustment. We entered into the Rights Agreement to increase the likelihood that our unitholders receive fair and equal treatment in the event of a takeover proposal.

    The issuance of the Rights was not taxable to the holders of the Common Units, had no dilutive effect, will not affect our reported earnings per Common Unit, and will not change the method of trading of the Common Units. The Rights will not trade separately from the Common Units unless the Rights become exercisable.  The Rights will become exercisable if a person or group acquires beneficial ownership of 20 percent or more of the outstanding Common Units or commences, or announces its intention to commence, a tender offer that could result in beneficial ownership of 20 percent or more of the outstanding Common Units. If the Rights become exercisable, each Right will entitle holders, other than the acquiring party, to purchase a number of Common Units having a market value of twice the then-current exercise price of the Right. Such provision will not apply to any person who, prior to the adoption of the Rights Agreement, beneficially owns 20 percent or more of the outstanding Common Units until such person acquires beneficial ownership of any additional Common Units.

    The Rights Agreement has a term of three years and will expire on December 22, 2011, unless the term is extended, the Rights are earlier redeemed or we terminate the Rights Agreement.

    As of December 31, 2008, the public unitholders, the institutional investors in our private placements and Quicksilver owned 98.69 percent of the outstanding Common Units. BEC owned 690,751 Common Units, representing a 1.31 percent limited partner interest. We own 100 percent of the General Partner, BreitBurn Management and BOLP.

    Our Predecessor BEC, was a 96.02 percent owned indirect subsidiary of Provident until August 26, 2008, when members of our senior management, in their individual capacities, together with Metalmark Capital Partners ("Metalmark"), Greenhill Capital Partners ("Greenhill") and a third-party institutional investor, completed the acquisition of BEC, our Predecessor.  This transaction included the acquisition of a 96.02 percent indirect interest in BEC, previously owned by Provident, and the remaining indirect interests in BEC, previously owned by Randall H. Breitenbach, Halbert S. Washburn and other members of the our senior management.  BEC was a separate U.S. subsidiary of Provident and was our Predecessor.

    In connection with the acquisition of Provident's ownership in BEC by members of senior management, Metalmark, Greenhill and a third party institutional investor, BreitBurn Management entered into a five-year Administrative Services Agreement to manage BEC's properties. In addition, we entered into an Omnibus Agreement with BEC detailing rights with respect to business opportunities and providing us with a right of first offer with respect to the sale of assets by BEC.

    Cessation of common unit distributions

    Management of BBEP chose to cease distributions to unitholders following the Q4 2008 distribution (which was made in the first quarter of 2009) instead of engaging in a dilutive unit offering far below tangible book value.  Given the precipitous decline in commodity prices from early summer 2008 through the end of 2008, the amount available for BBEP to borrow on the outstanding credit facility was impaired by a reduction in the borrowing base.  The BBEP borrowing base faces redetermination each year in April and October and the following covenants apply:

     

    - BBEP is restricted from paying distributions unless the outstanding debt is less than 90 percent of the borrowing base and  they possess the ability to borrow at least 10 percent of the borrowing base while remaining in compliance with all terms and conditions of the credit facility, and

    - The BBEP leverage ratio does not exceed 3.50 to 1.00 (which is total indebtedness to EBITDAX)

    In April 2009 the redetermination lowered the borrowing base from $900 million to $750 million, thus placing the partnership in a position where more than 90 percent of the borrowing base was outstanding.  Management has stated that they attempted to pursue other financing arrangements at this time to avoid distributions from being discontinued, but that no suitable financing was available, nor was the general partner willing to issue equity at the prevailing low market prices.  Given the extent of dislocation in capital markets at the beginning of 2009, such a statement seems plausible and the author believes management made the appropriate decision for retaining value over the medium-to-long term. 

    In April 2009 the borrowing base was reaffirmed at $732 million, having been lowered due to monetization of certain hedges in June and one non-core asset sale during July.  At September 30, 2009 the partnership presented total long-term debt of $585 million.  During the conference call which accompanied the third quarter 2009 earnings release, management stated that at October 31, 2009 total outstanding long-term debt was $576 million, which represents 78.69% of the borrowing base.  Per page 14 of the Form 10-Q filed in early November, the partnership is "in compliance with the credit facility's covenants" at September 30, 2009.  While distributions could be resumed currently, management has stated a desire to achieve a leverage ratio closer to 2.50 to 1.00, prior to doing so.  Given the current level of cash flow produced by BBEP, this equates to bringing total long-term debt down to just over $500 million.  Given that BBEP has reduced debt by approximately $160 million during 2009 through October 31, 2009, which includes the asset monetization mentioned above, and current level of free cash flow, such a ratio seems likely within the coming six month period.  It should be noted that the borrowing base was reaffirmed in October 2009.        

    While the interruption in unitholder distributions was not the catalyst for the low unit price witnessed during the preceding 52-week period, the lack of the distribution has hindered BBEP's market price from advancing along with most commodities, asset classes and peers within the MLP space.  The reinstatement, as discussed below, is one of the primary catalysts to potentially propel the market price.            

    Risk Factors

    The most relevant risk factors to an investment in BBEP involve the following:

     

    1. Ongoing litigation

    The following excerpt, from the Form 10-Q filed for the period ending September 30, 2009, is presented to provide a short summary of the lawsuit filed KWK:

    "On October 31, 2008, Quicksilver, an owner of 40.44 percent of our Common Units, instituted a lawsuit in the District Court of Tarrant County, Texas naming us as a defendant along with BreitBurn GP, BOLP, BOGP, Randall H. Breitenbach, Halbert S. Washburn, Gregory J. Moroney, Charles S. Weiss, Randall J. Findlay, Thomas W. Buchanan, Grant D. Billing and Provident.  On August 3, 2009, Quicksilver filed the Third Amended Petition and asserted twelve different counts against the various defendants.  The primary claims are as follows:  Quicksilver alleges that BOLP breached the Contribution Agreement with Quicksilver, dated September 11, 2007, based on allegations that we made false and misleading statements relating to its relationship with Provident.  Quicksilver also alleges common law and statutory fraud claims against all of the defendants by contending that the defendants made false and misleading statements to induce Quicksilver to acquire Common Units in us.  Finally, Quicksilver alleges claims for breach of the Partnership's First Amended and Restated Agreement of Limited Partnership, dated as of October 10, 2006 ("Partnership Agreement"), and other common law claims relating to certain transactions and an amendment to the Partnership Agreement that occurred in June 2008.  Quicksilver seeks a permanent injunction, a declaratory judgment relating primarily to the interpretation of the Partnership Agreement and the voting rights in that agreement, indemnification, punitive or exemplary damages, avoidance of BreitBurn GP's assignment to us of all of its economic interest in us, attorneys' fees and costs, pre- and post-judgment interest, and monetary damages.  Pursuant to an agreement among the parties to the lawsuit, a hearing on Quicksilver's request for a permanent injunction and declaratory relief was scheduled for September 2009.    The hearing on the permanent injunction and declaratory relief has now been rescheduled, and all of Quicksilver's claims, including those previously set for hearing in September 2009, are set for trial in April 2010."

    Although mentioned in the above paragraph, details regarding the Partnership Agreement are lacking.  The changes to the Partnership Agreement in June 2008 provided limited partners the right to nominate and vote in the election of the directors to the Board of Directors of the General Partner, while simultaneously stating that (from Form 8-K):

    "(B) if  at any time any person or group beneficially owns 20% or more of the Outstanding Partnership Securities (as defined in the Partnership Agreement) of any class then outstanding, then all Partnership Securities (as defined in the Partnership Agreement) owned by such person or group in excess of 20% of the Outstanding Partnership Securities of the applicable class may not be voted, and in each case, the foregoing Common Units will not be counted when calculating the required votes for such matter and will not be deemed to be Outstanding (as defined in the Partnership Agreement) for purposes of determining a quorum for such meeting...Notwithstanding the foregoing sentence, the Board of Directors of the General Partner may, by action specifically referencing votes for the election of directors, determine that the limitation set forth in clause (B) above will not apply to a specific person or group ."

    Of course the only entity to which the 20% or greater rule applied was/is KWK.  The voting restrictions were later characterized as a "safeguard" to avoid undue influence by any one person or group.             

    In early December 2009 it was announced that Quicksilver Resources Inc. had dropped part of the lawsuit lawsuit.  Per the December 7, 2009 BBEP press release:

    "In summary, all claims asserted against all current and former directors of Breitburn concerning Breitburn's purchase of Provident Energy Trust's interests and the ammendment of Breitburn's Partnership Agreement have been dismissed.

    Quicksilver continues to make claims in its lawsuit against Breitburn Energy Partners, L.P. and two subsidiareis, as well as against Provident Energy Trust."  

    Having reviewed a great deal of information related to the lawsuit, it would appear that the following two items are the primary points of contention for KWK:

     

    1. The alteration of the partnership agreement which resulted in Quicksilver Resources Inc., as an owner of greater than 20% of common units, being unable to vote their units for the election of directors to the General Partner Board of Directors.
    2. The transaction with Provident, which resulted in additional leverage and ultimately (because of greater than 90% of the borrowing base being outstanding) cessation of Common Unit distributions.

    In regard to the first item, while the changes disallowing a 20% or greater owner are somewhat strange and it appears likely that the ammendement to the Partnership Agreement was completed to prevent Quicksilver Resources Inc. from being able to control the board of the General Partner ("GP"), a number of things should be remembered:

     

    As stated in Form 8-K filed December 1, 2009:

    "The Court also held that the directors of the General Partner did not make the requisite determination required by the Partnership Agreement in approving the Amendment that the Amendment would not adversely affect the Limited Partners (including any particular class of Partnership Interest) in any material respect.  If the court enters a final order holding that the Amendment was not properly approved by the directors of the General Partner, then the entire Amendment would be invlaid and the Limited Partners would have no right to vote in the election of directos."   

    Considering this, it should be noted that KWK is intent on allowing the amendment to remain, but having the amendment ammended.  Regardless of the outcome on this item, it is doubtful that the other limited partners will be materially affected, as it is diffuclt to prove KWK has been harmed and they do own 40.44% of BBEP, i.e. any material deterioration in the value of BBEP affects them the most.  

    **BBEP announced on December 30, 2009 that they have revised the Partnership Agreement.  "The Revised Ammendment does not give the limited partners the right to vote for directors [of the GP]."  It will be interesting to see the KWK repsonse, as they are no longer "singled out".  

    Regarding the second item, the Provident trasnactions, it appears that the disagreement relates ultimately to the cessation of partnership distributions.  The Provident transaction forced BBEP to take on additional leverage, which was not an issue until the borrowing base was redetermined.  The trasnactions relating to Provident appears defesible and cessation of the distribution, although painful in the short term, was the best long-term decision available.  BBEP paid approximately market price for the 14,404,962 shares owned by Provident ($23.26 per unit) and cancelled the units upon acquisition.  Given that this portion of the suit concerns all unit holders, it is difficult to see an outcome that materially affects the aggregate value of BBEP.  It should be noted that a number of factors make the common units in this transaction likely more valuable to BBEP than to other market participants.  Namely, there existed a possibility that the sale of the Provident units, when aggregated with other market transactions, could have constituted a (technical) change in control, which would have accelerated certain benefits to employees, been an event of default under the partnership credit facility and caused a "technical tax termination of the Partnership".

    In summary, the author views the lawsuit as a potential catalyst once resolved, rather than a threat.  While the claims are serious in nature, probability seems low that any outcome would damage materially the underlying value of the BBEP limited partnership, as Quicksilver Resources Inc. (KWK) owns such a large percentage of BBEP.  Any outcome which impaired the value of BBEP would theoretically damage their economic interest in BBEP.  It would appear with the dropping of certain claims by KWK, as well as the December 30, 2009 announcement by BBEP, that a resolution is desired by all parties. 

    It should be noted that insurance is paying for the BBEP portion of litigation. 

     

    1. Prolonged period of weakness in natural gas prices

    The prices of oil and natural gas are volatile and difficult (if not impossible) to predict in the short- to medium-term, as even if accurate supply/demand data were attainable, speculative forces still work to distort the fundamental prices which would result.  Having admitted this, the author feels as though a significant period of weakness lies ahead for natural gas, as there is simply far too much natural gas in (domestic) storage, production remains far too high, and the economic backdrop is not likely to provide the demand to offset these factors.  Although such an outcome is troubling for an entity dependent upon the spot price of natural gas, such a scenario is far less worrisome for BBEP given significant hedges extending into 2013 (now into 2014).  A prolonged period of weak natural gas prices would be expected to remove many unhedged and overly leveraged competitors, thus rebalancing supply with demand, prior to price weakness affecting BBEP.  Such a scenario should provide enormous opportunity for an entity such as BBEP, as many productive wells would be "for sale" with attractive fundamentals.

    Conclusion

    To conclude, there exists a significant margin of safety in the common units of Breitburn Energy Partners L.P.  Given a price-to-tangible book value of approximately 48.28% presently, as well as estimated free cash flow yield (using the subdued $132 million FCF) in excess of 22.79% (11.45% when enterprise value is utilized as the denominator), the probability of loss appears exceedingly low.  Given such a low valuation coupled with the potential catalysts mentioned above, the likelihood of realizing capital gains appears good.  The great thing about this particular opportunity is that the reinstatement of the distribution should assist in realizing the significant undervaluation currently present (capital gain), while also providing an excellent yield on an ongoing basis (current income).  If the price were to rise to the most conservative value calculated of $15.78, capital appreciation of 43.85% would be achieved.  Further, if the distribution were to approach the level paid in February 2009, the annualized per unit distribution would equate to $2.08, or approximately 18.96% at a purchase price of $10.97. 

    While the dividend may not be initially reinstated at the previous level of $2.08, given the free cash flow generation of BBEP, as well as cash flow stability, there is no reason to believe it would not approach that level within a short period of time.  The capital markets do not reward a flow-through entity for earnings and cash flow retention.

    Catalyst

    Primary catalyst:

    Reinstatement of distributions

    Secondary catalyst:

    Resolution of ongoing litigation

    Disclosure: The author owns BBEP common unit, as well as EVEP common units.

    Messages


    SubjectValuation Method and Analysis of Litigation
    Entry12/30/2009 05:38 PM
    Membermjw248

    Given that BBEP's reserves are finite, I don't think its appropriate to use a perpetuity approach to valuing the company. I recognize that you use a high discount rate to compensate for that issue, but I think that just leaves you with a number that is not very meaningful.

    The value of BBEP's reserves on its balance sheet basically represent PV10 based on strip prices as of December 31, 2008. Strip prices for natural gas are down since then, while strip prices for oil are up. Based on the fact that the vast majority of BBEP's reserves are natural gas, I expect BBEP to write-down the value of its reserves by a fair amount in Q4.

    I think the most recent borrowing base redetermination provides some indication of the value of BBEP's reserves. BBEP's borrowing base was reaffirmed at $732 MM. A 60% advance rate (based on Tristone Capital's 3Q09 Energy Lender Price Survey) against the lender's estimate of the value of BBEP's proved properties and mid-stream assets implies an intrinsic value per unit of about $17 (reflecting adjustments for unproved properties, cash, derivatives, ARO, etc.).

    I'm not a lawyer, but I think your analysis of the Quicksilver litigation misses the mark. Quicksilver is claiming that BreitBurn fraudulently misrepresented its relationship with Provident. Here is my analysis of that claim:

     

    Quicksilver's claims of fraudulent misrepresentation lack supporting evidence.  Our instinct is that Quicksilver is on a fishing expedition for an unspecified "smoking gun" in a conspiracy that most likely does not exist.  In Quicksilver's Original Petition, Quicksilver cites broad, generic statements made by BreitBurn and Provident in press releases and SEC filings about the importance of their mutual relationship.  BreitBurn contends that all of the statements were true at the time they were made, a claim that seems reasonable based on the nature of the statements.  Importantly, Quicksilver provides no evidence of any representation made by BreitBurn or Provident about Provident's future intent regarding its investment in - and relationship with - BreitBurn.  BreitBurn highlights this fact in its Original Answer, and cites several examples from the Partnership's SEC filings where BreitBurn explicitly indicated that its relationship with Provident was subject to change.  There is simply not one hard fact in Quicksilver's Original Petition that supports its claim of fraudulent misrepresentation.  Quicksilver's accusation of fraud rests solely upon the following shaky logic:

    BreitBurn and Provident stated they had an important relationship with each other in press releases and SEC filings

    +             Provident announced a review of its stake in BreitBurn several months after the Quicksilver Transaction

    +             No evidence                                                                                                                                                     

    =             Scheme to defraud Quicksilver

    Unless Quicksilver discovers evidence that BreitBurn and Provident knew with certainty prior to the Quicksilver Transaction that Provident's relationship with BreitBurn would change, it seems unlikely that Quicksilver will be able to successfully argue its fraudulent misrepresentation allegations.  The probability that such a "smoking gun" exists appears remote.  Provident initiated its strategic review of its investment in BreitBurn roughly three months after the Quicksilver Transaction.  Upon announcing the review, Provident clearly and explicitly indicated that "there [was] no certainty that this process [would] result in any changes to Provident's ownership stake in its U.S. holdings."  Any "smoking gun" would need to directly contradict that statement, and would correspondingly require the existence of an elaborate, highly improbable conspiracy to disguise Provident's intentions with respect to its stake in BreitBurn.  There is very low probability that such a conspiracy exists, an even lower probability that a "smoking gun" exists, and as a result, an even lower probability that Quicksilver will be successful in arguing its allegations of fraudulent misrepresentation.

    Even if Quicksilver were to successfully argue its claims of fraud, monetary damages should be moderate in the expected scenario and would not by themselves change our investment decision in the worst case scenario.  Quicksilver is seeking both compensatory and exemplary damages.

    Quicksilver's Original Petition sheds some light on how Quicksilver may be thinking about the amount of compensatory damages.  In paragraph 37 of the petition, Quicksilver cites the 20% decline ($5.01 per share) in the price of the Common Units over the 10 day period following Provident's announcement of its strategic review.  If the courts were to accept that as the measure of the damages inflicted on Quicksilver, compensatory damages would be about $105 MM ($5 x ~21 MM shares). As one might imagine though, the time period over which Quicksilver chose to measure the impact of Provident's strategic review was the most favorable from Quicksilver's perspective.  On the day of Provident's announcement, the price of the Common Units declined only 4.3% ($1.09).  The price of the Common Units ended February 2008 down only 11.3% ($2.80) from the price prior to Provident's announcement.  BreitBurn could make a compelling argument that the stock market's indication of the damages to Quicksilver from BreitBurn not having a continuing relationship with Provident points to an amount significantly lower than $100 MM.  We would also expect BreitBurn to argue that many significant factors other than the market's expectation for the value lost from the possible termination of Provident's relationship with BreitBurn influenced the stock price movements after Provident's announcement, not the least of which would be the technical overhang in the Common Units created by the announcement.

    (Figures in thousands, except per unit figures)

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Decline from Feb 4

     

    Comp. Damages

     

     

     

     

    Closing Price

     

    $

     

    %

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    BreitBurn Common Units:

     

     

     

     

     

     

     

     

     

     

    Units owned by Quicksilver

    21,348

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Pre-Provident Announcement

    02/04/08

    $24.83

     

    -

     

    -

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Days Post-Announcement:

     

     

     

     

     

     

     

     

     

     

    1 days

    02/05/08

    $23.74

     

    ($1.09)

     

    -4.4%

     

    $23,269

     

     

    10 days

    02/14/08

    20.29

     

    (4.54)

     

    -18.3%

     

    96,920

     

     

    30 days

    03/05/08

    21.11

     

    (3.72)

     

    -15.0%

     

    79,414

     

     

     

     

     

     

     

     

     

     

     

     

     

    30-day Average

     

    $21.59

     

    ($3.24)

     

    -13.1%

     

    $69,188

     

     

     

     

     

     

     

     

     

     

     

     

    It does not seem likely, or appropriate, that BreitBurn would be required to pay exemplary damages in this case.  First, the courts seem to be increasingly reluctant to award exemplary damages.  Second, it is hard to fathom how forcing the LP defendants to pay exemplary damages would achieve the intended purpose of exemplary damages - to punish the wrongdoer and deter others from similar wrongdoing.  Over 98% of BreitBurn's common units are held by entities (including Quicksilver) other than management and the Board of Directors.  How would effectively transferring wealth almost exclusively from the common unitholders, none of whom had the right to cast a single vote in the election of the Board of Directors, to Quicksilver punish the wrongdoer and deter others from similar wrongdoing?

    If exemplary damages were awarded, the amount of the damages would be capped based on the level of compensatory damages.  Texas has a statute that limits exemplary damages to the greater of i) two times the amount of economic damages plus an amount equal to any noneconomic damages found by the jury, not to exceed $750,000; or ii) $200,000.  Assuming Quicksilver successfully argues for compensatory damages of $105 MM, a worst case scenario, exemplary damages would be capped at $210 MM resulting in total monetary damages of $315 MM.  Even if we assume that such an unlikely and disastrous outcome is certain, the resulting intrinsic value of the Common Units still provides a significant margin of safety against the risk of permanent loss at current prices.

    Our expected value for total monetary damages payable by BreitBurn should Quicksilver succeed in arguing its allegations of fraud - an outcome that we view as quite unlikely - is $25 MM, comprised of $25 MM of compensatory damages and no exemplary damages.  The decline in the price of the Common Units on the day of Provident's announcement provides the most reasonable indication of the value lost from the loss of BreitBurn's relationship with Provident.  Clearly, this is not a precise calculation.  On one hand, the one-day decline only reflects some probability of Provident disposing of its investment in BreitBurn, as the strategic review had just commenced.  On the other hand, the one-day decline was also undoubtedly significantly influenced by technical factors related to the announcement of the potential sale, which should not be taken into consideration when evaluating the value to BreitBurn of its relationship with Provident.  This approach would place the total value to BreitBurn of its relationship with Provident at $73 MM.  Intuitively, that strikes us as a somewhat high amount given that the sources of value to BreitBurn from the relationship were vague.

     

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