On November 12, Bill Simpson wrote an analysis of the Constellation Energy Partners (CEP) IPO. The IPO began trading on Nov. 15, when 4.5 million shares were priced at $21, the top end of its proposed range. The text of Mr. Simpson's original writeup follows:
Constellation Energy Partners plans on offering 5.2 million units at a range of $19-$21. Citibank and Lehman are lead managing the offering. Post-offering CEP will have 12 million units outstanding for a market of $240 on a pricing of $20. IPO proceeds (plus an additional $30 million in borrowings) will go to parent company Constellation Energy Group (CEG). Post-offering CEG will own 60% of CEP, essentially all non-public units. CEG will directly manage CEP's operations as well as control all the managing partnership units.
From the prospectus:
'We are a limited liability company that was formed by Constellation in February 2005 to acquire coalbed methane reserves and production. We are focused on the acquisition, development and exploitation of oil and natural gas properties, or E&P properties, as well as related midstream assets.'
Another limited partnership IPO, CEP's main business is natural gas exploration and production. CEP plans on buying a quarterly dividend of $0.4625 per unit quarterly, or $1.85 per unit per year. On a $20 pricing, CEP would be yielding a strong 9.25% annually.
Estimated proved reserves are 100% natural gas and located in the Robinson's Bend Field in Alabama's Black Warrior Basin. Proved reserves are 112.0 Bcf, 80% of which are classified as proved developed producing. Reserves have an estimated 25 year lifespan at current and anticipated production levels.
Robinson's Bend Field - The Black Warrior Basin is one of the oldest and most prolific coalbed methane basins in the country, with over 2,750 producing coalbed methane wells. These multi-seam vertical wells range from 500 to 3,700 feet deep, with coal seams averaging a total of 25 to 30 feet of thickness, per well.
CEP goal is to provide consistent cash flow and a growing annual yield to investors. To that end, CEP has hedged a large portion of anticipated future production. Currently CEP has hedged approximately 79% of expected production from October 2006 through December 2009. The policy going forward is to hedge 80% of up to five year expected production for each of their wells.
CEP will look to acquire complementary operations going forward as well as drilling low risk new wells on their Robinson's Bend field property.
CEG - The strength behind this offering is the back of CEG, Constellation Energy Group. CEG is a $12 billion market cap operation with $17 billion in 2005 revenues and $20 billion in assets. CEG operates in three energy segments, Merchant Energy, Regulated Electric, and Regulated Gas. Through these three segments CEG is engaged in numerous aspects of the energy industry, including oil and natural gas exploration and production, natural gas transportation, natural gas storage and physical and financial natural gas trading.
CEP's stated goal is to increase yield over time, and CEG will be the driver here. Reading between the lines in the prospectus, it appears CEG will specifically acquire and develop potential E&P properties with an eye to shifting them over to CEP once they begin producing.
A 9.25% annual yielding MLP with the backing of a $12 billion dollar energy conglomerate is appealing. CEG will not allow CEG to sink -- They will most definitely look to shift yield baring assets to CEG in the future. It is a safe assumption to assume these assets will growth CEP's annual yield.
Debt is minimal at $22 million.
1 1/2 X's book value at $20.
CEP is a small operation with an anticipated $35 million in 2006 natural gas sales.
Ability to make quarterly distributions - While CEP does hedge 80% of production going out 5 years, there is still commodity price risk. If natural gas prices enter into a prolonged slump, CEP would have difficulty paying yield. This is a key factor that differentiates E&P unit offerings from midstream asset unit offerings. The midstream asset (pipelines/terminals/storage facilities) unit offerings for the most part make revenue off the flow of natural gas not the underlying price. While CEP is hedging 80% of production, the yield will still be subjected to natural gas price risk. Note that this can work both ways - if natural gas prices rise, yield could be higher.
CEP is projecting to easily have enough cash on hand to pay the initial dividend. However in making projections, CEP is assuming natural gas prices for full year 2007 of $8.35 higher then current prices. They have hedged at over $9MMBTU, which currently looks like a very nice hedge price for them. At $8.35 average price of natural gas for 2007, CEP would actually have cash on hand to distribute $2.25 per unit in 2007.
It would appear if natural gas stays in the $5-$7 range for 2007, CEP would easily be able to pay annual yield, thanks in large part to hedging 90% of production over $9MMBTU's. If natural gas prices rise to $8 or above for most of '07, I would expect a much stronger yield here then the anticipated for the full year '07.
I usually shy away from E&P unit offerings due to commodity prices directly effecting yield. Also E&P operations usually need to continually invest in new properties and wells as annual production depletes reserves. The latter does not mesh well with the MLP structure set up to turn over all cash on hand quarterly to unit holders.
However, I like this deal. The 9.25% initial annual yield is very strong here. Couple that yield with the strength behind CEP, Constellation Energy Group and this deal works. I believe CEG will develop properties for CEP going forward, taking much of the risk out of future CEP acquisitions.
The risk here is of course a bear market in natural gas prices. If that occurs, CEP will have difficulty paying the yield and also difficulty hedging future production at a price strong enough to pay future yield. That is a real risk here and one reason why I suspect the initial yield is so strong at 9.25%.
Combination strong initial yield and parent company make this deal work in range and $1-$2 above.