"Hit the Ground, Failing"
Southcross Energy Partners (SXE) dropped precipitously after reporting on its first full quarter as a public company, and in so doing illustrated some of the risks in newly minted second tier Master Limited Partnerships.
During the first full quarter of operations several bad things happened -- a failure to get the Bonnie View fractionater running on schedule, and a fire at its Gregory facility. Perhaps its just a run of bad luck, but SXE seemed to experience more than its share of operational challenges.
The conference call revealed both the operational weakness of the company, and the financial fragility of the MLP structure. Reading through the conference call, one is struck that the company has experienced both income statement and balance sheet woes -- troubling and surprising a few scant months after an IPO.
On the earnings side, management commented on earnings:
fourth quarter results were below expectations, primarily due to difficulties we encountered in the start of our new Bonnie View fractionation facility and several other events I'll cover later.
This necessitated a capital call to the general partner, Charlesbank, and negotiations with lenders in order to remain within lending covenants:
In connection with this amendment, Charlesbank provided $10 million of additional capital support that is already been set aside into a cash collateral account for the general partner for the benefit of the lenders under our credit facility. We are also working with our lenders to amend our credit facility to include more lenient financial covenants and exchange for additional capital that will be invested into the Partnership over the next 45 days.
If that sounds a bit ominous -- well it should. What management is telling you is that they've missed their operational goals, and their financial gearing is so precarious that the delay of one project has necessitated a capital call to the GP, and a reworking of agreements with lenders ... and that these agreements haven't actually been brought to fruition.
Listening to the nuance in the call, the comments of the company underline the hypothetical nature of SXE's prospects
While we're still working to finalize this arrangement, we will be - we believe we will be able to accomplish it and provide adequate capital for the business maintain and grow distributions and achieve our financial targets laid out here.
The in line substitution of "we believe we will be able" for "we will be" tells you what you need to know here, which is that they have to hedge that statement. Of course, they "believed" something very different a few months ago, too -- and so did their investors.
To underline the seriousness of the situation, one might look at the recent Form 12b-25 "Notice of Late Filing" in which the Company explains why their 10-K will be late:
Southcross Energy Partners, L.P. (the "Partnership") is unable to file its Annual Report on Form 10-K for the year ended December 31, 2012 by the prescribed filing deadline (April 1, 2013) without unreasonable effort and expense because management of the Partnership's general partner has devoted, and continues to devote, substantial time and resources related to negotiations with its lenders in order to secure more favorable financial covenants.
In case you're in any doubt, that's a very bad thing to say in any event, and especially troubling with a newly public company. When you go public in November, and by March you're in negotiations with lenders, something has gone terribly wrong.
I'd listened to the roadshow and been generally impressed with the SXE story. It's building out midstream capacity in the attractive Eagle Ford play, gathering and processing of natural gas and oil from this extremely exciting area. Eagle Ford has the great advantage of being located very close to the nation's petrochemical infrastructure. The team had good experience, David Biegler, the CEO and other members of the team have been in the industry for decades.
So what's gone wrong so quickly? My estimation is that the company mistakenly made itself vulnerable to the timetable for completion of complex industrial infrastructure, and which was very too aggressively financed by a sponsor, Charlesbank -- an investor without much energy expertise. With a different timetable on day one, and better financial planning, a delay need not have resulted in this disappointment. Delays happen, but the vulnerability to it seems to be a failure of company design.
The company came public at $20, first print at $22, and was recently trading at $25 before this disappointment hit the tape, and the fell to $18.73 (as of Friday, April 5). This is an ugly story that raises questions about management; a cardinal rule of managing your IPO is "have your first quarter in the bag", and these guys have failed it, egregiously.
Last Thursday, the company presented to the Morgan Stanley Eagle Ford Energy Summit, a tricky brief, given what's just occurred. The company presentation summarizes its position with bullet points
Overcoming slower earnings ramp during 4th quarter 2012 and 1st quarter 2013
Supportive private equity sponsor with significant industry expertise
When you think about what that means, it's pretty ugly. Income estimates are wrong from what it told investors only three months ago and when I hear "supportive sponsor", what I hear is "a company that's in trouble on its own balance sheet."
So what is Southcross really about? Who are these guys and should you be thinking about this as a potential opportunistic bargain, or should you be worried? With a company so new to the public markets, my first question is:
So who are these guys, anyway?
Southcross is combination of management that's been around natural gas in Texas for decades, with financial engineering by Charlesbank.
Chairman and CEO David Biegler and many of his team have spent their recent years at Estrella Energy LP, and another name which appears with frequency is Enserch. Neither produced much happiness for investors.
What's troubling about the company pedigree is the frequency with which one sees the name "Dynegy" in the biographies of the company principals, the now bankrupt company that Businessweek once characterized as an "Enron wannabe".
Its noteworthy that in the face of the most recent disappointments, the management went to the Dynegy bench for reinforcements -- the most substantive announcement of changes in response to the disappointments was the April 2 announcement of the addition of Bruce Williamson to the Southcross Board. Williamson was the CEO of Dynegy from 2002 to 2011. He helped the company avoid bankruptcy in 2002, but was at the helm for the mess in 2011.
So SXE management have many decades of experience with natural gas in Texas, but they don't have a great track record of making money for investors; perhaps they'll do better this time.
Who are Charlesbank?
Charlesbank is a Boston investment firm, whose origins lie at Harvard Management Group, Harvard University's in house financial managers. A look at the pedigree of the partners reveals elite Boston financial establishment institutions -- names like Bain, Boston Consulting, Harvard Business School occur with great frequency.
Experience with the oil patch, by contrast, is in short supply. Here are the bios of the Charlesbank partners who are directors of Southcross:
Jon joined Charlesbank in 1998 from the Harvard Business School, where he was an entrepreneurial studies fellow after graduation. Jon also worked as a banking associate at Brown Brothers Harriman. He was appointed a managing director of Charlesbank in 2006.
Jon serves on the boards of Blueknight Energy, Cedar Creek, Peacock Engineering, Southcross Energy, United Road Services and Zenith Products. Educated at Harvard, he received a BA in government and sociology, cum laude, an MBA with distinction and an MA in public administration.
Jon lives in Cambridge, MA, with his wife and three children and serves on the Corporation Board of the Belmont Hill School, which he attended. Jon has a number of athletic interests, including playing ice hockey year-round and watching his beloved Red Sox chase the Yankees every year.
Samuel P. Bartlett
Sam joined Charlesbank in 1999 from Bain & Company, where he worked in the private equity and general practice areas. During his time at Bain, Sam worked on corporate strategy and private equity projects in the United States, Europe and South Africa for clients in the personal computer, consumer products, transportation and industrial products industries. He was appointed a Managing Director of Charlesbank in 2011.
Sam serves on the boards of CIFC, Horn Industrial Services and Southcross Energy. He is a magna cum laude graduate of Amherst College, with a BA in history.
Sam lives in Winchester, MA, with his wife and two sons. He enjoys spending time in Stowe, VT, where he and his wife are avid hikers, mountain bikers and skiers
Sound like nice, smart guys. Does not sound like the guys who I'd have watching my oil patch investment. "Boston oilman" rolls off the tongue just as readily as "Texas Clam Chowder". One wonders why guys from Texas raised their capital in Boston -- there's plenty of money from very experienced oil patch investors to be sourced in Houston. Me, when I see folks getting funded by out of domain investors, I worry "they couldn't raise money from people who actually know the business".
In the very brief period of time that Southcross has been public, it has managed to encounter both financial and operational difficulties which would lead a prudent investor to have concern.
My conclusion: avoid this company. Sometimes good, well run companies with great management have a lousy quarter, a miscue, some adverse event that will readily pass.
Looking at SXE, it's having miscues on both financial and operational fronts, its investor/sponsors seem inexperienced at oil patch investing, and while its energy guys have lots of experience, it comes with a worrying Dynegy pedigree. Moreover, with delayed filings and lender negotiations, there's more news in the pipeline. At a minimum, as an investor I'd want to wait to see the results of their lender negotiations and the delayed 10-K before considering a purchase.
Eagle Ford is an attractive opportunity and while SXE tells a good story, given its difficulties I'll be looking for better companies with exposure to it. At some price, SXE becomes interesting, but given the reverses that the company has suffered, and the question marks concerning the company's operations and financing, the markdown from IPO price would have to be greater than the present 7% to interest me. Avoid at this price, and until more information is available about just what is being renegotiated with lenders.