Legacy Reserves LP (NASDAQ:LGCY)
Bank of America Merrill Lynch Energy and Power Leveraged Finance Conference
June 3, 2014 10:50 AM ET
Dan Westcott - EVP and CFO
Jimmy Nguyen - BofA Merrill Lynch
Jimmy Nguyen - BofA Merrill Lynch
With us from the company we have Mr. Dan Westcott, Executive Vice President and CFO. Please go ahead.
Thanks Jimmy. It’s pleasure to being with you all this morning. As Jimmy said, my name is Dan Westcott; I am the Chief Financial Officer at Legacy Reserves. It’s my pleasure to present a company overview here with you this morning. Before I get started I want to address two quick points. One, I’d like to say thanks to BAML. BAML serves us on a number of capacities on the financial side of our business. They do a great job; the high yield group is no exception. So I want to say thanks to [indiscernible] and that whole group for hosting us here today and for the great service. Also want to thank Kelly for his research and Jim is here as well, thanks Jim for just a great relationship. Second point is forward looking statements. I know that, I am hopeful that that is a least exciting slide in our presentation today but as a public company that’s an important slide so I’d ask you to read it, take it seriously and treat it appropriately.
With that I’ll dive into the presentation of the company and then and that’s going to be real quick. What I want to spend most of our time on this morning is talking about our recent events and that’s namely our transaction with WPX. Throughout the slides I am hopeful that you come away with really four recurring themes; one is our assets are stable and low decline; two, we believe as an MLP growth should be predicated on acquisitions; three, we’re focused on alignment between management and our investors; and lastly we employed prudent financing. I think those four key tenants have really driven our seven year success and I can assure you that as a management team we’re working hard to continue those efforts.
So with that let me start off on page three, we are Legacy Reserves LP we’re based in Midland, Texas. For those of you who don’t know Midland that star down in West Texas that’s Midland that’s where our predecessor entities got start in early 80s, it’s where we’re headquartered and where we live. We’re in the heart of the Permian basin. Our ticker is LGCY; you know that, if you follow us we have three different high yield securities out there today. Trust me we’re hopeful to make that two securities by registering our most recent offering and given that as a fungible issuance but we’re focused on -- we are an upstream (ph) company, so we’re focused on long lived oil and gas reserves. And the key is, I said it earlier, but the key is that stable low decline production.
We’ve got a straight forward organizational structure management and insiders own 18% of the company and that 18% really drives our underlying thinking. Our interest is the same public interest out there and so we’ll talk here about our newly created IDRs and what that brings to the company but importantly management and the GP don’t own that security. So how we think about running the company is quite consistent with the public ownership. I mentioned at the beginning that seven year track record. We’re very proud of our track record but with that seven years we’ve made 131 acquisitions for $2.1 billion. Several of our peers can quote that same $2.1 billion but none of them can quote 131 transactions. We’re willing to do big deals just like they are but we’re also willing to do small deals and we find, we do that because we find good value there. We’ve posted 25% annual growth in both production and EBITDA and 45% distribution growth. Every quarter since our IPO, we’ve made a distribution we’ve always held the comps and have grown it and we’ve never decreased it but 29 consecutive distributions and the last 14 of those have been growing. Today Legacy trades at about an 8.1% yield and we like using that competitive cost of capital to continue to grow the business, again, growing it through acquisitions.
So let me talk about our most recent acquisition that’s the WPX transaction. We call this a strategic alliance and the reason I want to call it a strategic alliance is it’s not just an asset purchase. We’re buying interesting in the Piceance Basin; I should say our initial transaction with WPX is about 2,700 producing wells in the Piceance Basin. They are low decline natural gas wells we’re buying an escalating working interest. So what that means is in 2014, our working interest is 29% in 2015 that steps up to 37% and in 2016 that steps up to 41%. And each of those step-ups there is no additional consideration paid. We’ve prepaid for that. We’re paying about $355 million in cash and the difference here why this is a strategic alliance is that second form of consideration which is a newly created incentive distribution unit, it’s an IDR. We’re giving them 10% of our IDRs.
In a couple of slides, I’ll outline the kind of key differences between our IDRs and others but we think that those -- and we think that those differences are quite important. We’re giving WPX that 10%, we have also carved out for them another 20% that they can earn, they can also lose them if they don’t earn them but they can earn those and they earn those through future deals with us. What we’ve done is establish a corporate or a partnership security that we have issued to them and we can issue more to them if they do more deals with us. So we’ve effectively created a drop down story.
The other IDRs that are unissued remain at Legacy, so they’re not at the GP they’re at the LP and what that means is that there is no cost of those to the unit holders.
On the financing side we got the banks to approve a $950 million borrowing base, I’ll walk through our cap structure here in a minute. We also got our debt-to-EBITDA covenant raised to 4.5 times through June of ‘15. I can assure you that was a preventative measure. We certainly don’t plan on using that. In fact we’ve said quite vocally we didn’t need to do that but we chose to do it for optics. I can tell you I am the CFO, I feel a lot better when I get that release, I sleep better, we like to operate with lots of room under our covenants and we’re able to do that in this transaction.
So as I move to the right hand side of the page, 276 Bcfe approved reserves, 83% gas, the balance is mostly NGLs. At 63 million cubic feet a day of production, that’s a 12 year RP. The math here the green bar, this is what is called the Piceance valley, it’s the heart of the Piceance basin. You ask where that is, the gray is an outline of states, so we’re talking about Garfield County, Colorado that’s the far west side of Colorado. We’re right in the heart of the Piceance basin.
What we did WPX, is we bought a minority interest in the oldest wells in the basin, so all of these wells were drilled prior to 2009. The reason we like all I said it from the beginning, the primary driver of our growth is acquisition. The reason why we like old wells is because old wells tend to decline at lower rates than new wells. So we’re buying 2,700 producing wells in and around that green area.
So what does this do for us as a company, if you look out on a pro forma basis? Well first of all we announced two transactions in March; we announced the Cap Rock field in southeast Mexico in Chaves County and we announced Sheridan County acquisition up in Montana. Those three acquisitions are represented here in the middle column that acquisition column. On the left hand side of the page you have got a couple of bar charts on the right hand side is again that same map of our properties set.
So on our proved reserve side, we’re moving from 88 million barrels to 143 million barrels, which is about from 75% Permian to 50% Permian. On the commodity mix we’re moving from 70% liquids to 54% liquids. And on our production base we’re moving from about 19,500 barrels a day to over 30,000 barrels a day. So from a credit perspective what I see in that is both scale and diversification. Something that we think are great benefits to the company and to our investors.
On the right hand side that Garfield County again that’s in far western Colorado. All of that -- the vast majority of that diversification stems from this one county. We think this is the great addition to our portfolio and as you can see this is our map, we like to say it’s kind of an, we call the heart of the country; it’s a bit of an oblong heart. But we want to grow the company through this middle corridor of the country and wouldn’t be surprised if we move a state or so east or west. I think moving outside of that fairway will require a very strategic view a big view but we’ve stayed in the heart of this country, because we feel like we know it well.
We’re using this term strategic alliance and you ask why did you guys do this? Why not just do an asset deal? The strategic alliance really stems from our desire to have increased visibility of future acquisitions. We’ve heard from investors, we understand you want to grow from acquisitions but the acquisition market sure does seem hot, are you guys going to be able to continue to do this. And our bubble has been -- we’ve been in this business for a long time. Since being a public company we’ve made 131 of them, it’s not like it just became hard this business has always been hard.
But recognizing that investor concern and trying to add that benefit we step back with the clean slate and said what can we do to add visibility to our acquisition opportunities there? And that’s where we came up with this IDR structure. We were able to do a deal with WPX; we’re hopeful that WPX is the first of a few partners. The structure we created we can use the same structure with other third parties and we think that’s an important aspect. WPX is a world-class operator. We’re moving in the Piceance -- the Piceance Basin economic can vary dramatically across operator. WPX produces about 700 million cubic feet a day of gas in the Piceance, so I mentioned earlier we’re buying 63 million cubic feet a day. That’s less -- that’s around 9% of their production of the basin. So we’re really riding their coattail from an operatorship perspective. And we think that there is more bites of that apple.
We view these assets as high quality assets. I mentioned the first tenant of our strategy is stable load of client production. These assets offer just that. They declined about 10% per annum and we think the terminal decline rate is far below that. If you add in the escalating working interest, we’re effectively holding production flat over the next couple of years, a great benefit for an MLP. It’s no secret the gas is cheaper than oil to operator. This is about a $1.22 per Mcf operating cost, so very beneficial or accretive to our LOE per BOE basis. And I’ve talked a lot about size and scale, this acquisition adds a lot to our company in those respects.
Lastly, we would never do if it weren’t -- they weren’t attractive economics. If you look at our initial 2014 guidance put out in March and compare that our new guidance that’s put out, you see there is room for lot to accretion here. Most people have been able to do that math pretty easily. We think there is both immediate and long-term accretion from these assets and are excited to be able to, to show the market that wants to close the transaction.
We’ve talked in the past about gas versus oil. It’s no secret that the oil curve right now is very steep. It’s difficult to win oil weighted acquisition opportunities and hedge them. The price of which you need to underwrite is often unhedgeable and that makes us uncomfortable.
We like to hedge our exposure. We’ll talk about that in a couple of slides that we like to hedge our exposure to reduce cash flow volatility and doing so in oil marketed deals it’s just a tough game right now. We talked to folks at the beginning year we want to get more into the gas business so that we can hedge that exposure and we’ve done just that.
I am on Slide 7 talking about IDR. So we get a lot of questions about the IDRs and I’ll hold my hand up and say, I could pretty quickly get very nerdy on this. The IDRs are passion of mine and useful tool for our company. What we’ve done here is on the left-hand side of the page, we try to say how are these IDRs similar to what’s in the marketplace and on the right-side we’re saying how are they different. If you guys know MLPs, you know IDRs. We have one level of -- one set of distribution splits for our partnership. One single level of partnership, so if we do another deal with WPX the payment of those IDRs still hinges upon that single set of distribution split.
If we do another deal with another strategic alliance with the third party again we revert back to the same set of distributions split. We have a MQD set at $0.59 a quarter, the first tier is 15% above the MQD and the second tier is 25% above the MQD. Those you familiar with MLPs, that’s consistent across the board. Now let’s switch over to how they’re different. They’re different in three regards scope, economics, and alignment. From a scope perspective, we look at folks that had IDRs and said, gosh we really like that they have a drop down store. How can we -- what can we do? How can we have that? When we look at that and said, why can’t we have multiple. It’d be great to have one but let’s try to create something where we can have multiple. Right now, we only have one and that’s with WPX, but we’re hopeful that part of that we can partner up or ally with other folks and create a second and third or fourth.
Second element is favorite economics. If you notice in the distribution splits down here at the bottom table, we don’t have a high -- our highest split stops at 23%. Most IDR construct stops at 48% meaning they just have another level. By stopping at 23%, we reduced our cost of capital. Keeping out cost to capital competitive, allows us to stay in the market, allows us to do more M&A and issue equity that’s ultimately accretive to unitholders. We have a reset mechanism which is very common within most modern day MLPs that allows us to reset the MQD once we get in the high split. And then we’ve got a conversion right which is an attractive feature that I won’t go into here because it’s probably not the right form. But again, it limits dilution from the IDRs.
The last point there is that vesting in forfeiture. What that does is promote teamwork. It says you can vest into more IDRs if you do more deals with me. If you don’t do more deals with me, you may lose what you what is currently unvested. The last point is focused alignment. When Legacy was thinking about going public we looked at all of the structures available. And one of the key problems that we had with IDRs in general is that often the guys running the company, the general partnership the management had a different set of incentives than those of the limited partners because management and IDRs -- because management and the GP don’t own the IDRs our alignment is with the LP. So we don’t own any of the IDRs conversely the IDR holders don’t own any of the GP. So WPX doesn’t have control here. They have an economic interest but they don’t have control. The IDRs dilute both the LPs and the GPs that’s a nuance that is not common at all in most structures. And then the IDRs are earned again as I said earlier they are earned through actual drop downs not perspective drop downs. So hopefully that addresses a bunch of the typical IDR questions. Happy to answer any questions afterwards, but we think this is a great tool. We think it’s beginning to be understood in the marketplace and we’re hopeful that we can continue to use it to grow the company.
Let me talk to you more about that company history. I mentioned that at the beginning of the page but I think seen it just on slide three. But I think seen it is pretty powerful. We’ve grown production from a less than 5,000 barrels today to over 19,500 barrels a day over the last couple of years. That’s 25% compound annual growth. On the EBIDA side we’ve experienced similar growth from about 70 million a day to 270 million a day. So, the strategies that we have been employing have worked. When I show Cary, Cary Brown is our Chairman and CEO and I show Cary that slide or when we present this slide he says yeah that’s real interesting but what does that mean to my quarterly distribution. You can grow assets all you want that’s good in all but what does that mean for me.
Slide nine really addresses that point head on. So this is every quarter since we have been public. The bar graph is our quarterly distribution and the line chart there is WTI price. So, what you’re seeing or what I think you’re seeing is a pretty volatile oil price and a very consistent and growing distribution. And we’ve been able to deliver 29 consecutive distributions the last 14 of which are growing and we think with these last three acquisitions the Caprock field, Sheridan County and WPX, we think that our goal what we’d like to do get a lot of questions about future distributions. What we like to do is make the right hand side of this chart look more like the left hand side of this chart from a growth perspective. We think we can do that with the acquisitions we’ve just made.
When I see this I see a track record I see longevity I think you get ask yourself well how have been able to do this. We’ve been able do this for a couple of two reasons or for two key reasons one is hedging. We’ve been able to hedge on a costless (ph) basis over this time period and really mitigate cash flow. So what you’re not going to see in this first lower point is the elimination of commodity price exposure. We’re an oil and gas company if you’re going to invest in high yield or in equity in this company you’re going to assume some of that exposure. We’re not trying to kid ourselves and say we don’t have that exposure we’re trying to take out some of that cash flow volatility. We want to be able to support our borrowing base and deliver those distributions. We do that through a rolling stair step if you will of hedges. So we start off at about 85% about 85% of our near term productions hedged and as the years progress, we taper off that hedging so we’re about 85% and we go on a for 18 months, 24 months, and then we step down to 60%, 40% and 20%.
It’s a strategy that we have employed since our inception it’s worked really well for us and the reason for that is the further on the curve you get the less liquid that market is particularly after Mr. Dodd and Mr. Frank. But that’s the world that we’re in and the strategy we’ve employed it’s worked really well. We do hedge with our bank group so from a margin perspective it keeps us going there. The other reason we’ve been able to do so one reason we’re willing to do that hedges the other reason we’re willing to do that is really a prudent capital structure. So, what you’re seeing here is our capital structure on the left hand side is as of March 31st and on the right hand side is a pro forma basis so we’re assuming the closing of the Caprock acquisition, the Sheridan County acquisition and the WPX transaction. And what I pointed to in order of sequence is firstly this $550 million of 6 and 58 notes that’s pro forma for our most recent issuance two weeks ago.
And then secondly I’d point you to liquidity. So we have yet to raise equity for these transactions. Pro forma for the deals we have more liquidity than we did prior to the deals, so almost $490 million of liquidity under our borrowing base. We feel like that liquidity is very important in running our business and we’re making acquisitions, so we need to have the fire power to make those acquisitions quickly.
The third point is preferred equity, so in April we raised 57.5 million of preferred equity, that’s an 8% coupon as a perpetual security we like a lot, we think it’s got a place in our capital structure and we would like to grow that issuance, quite frankly we’d like to issue more of that paper to support our overall capital structure.
As you think of us, our financing plan is really aimed at three separate objectives. We’re trying to minimize our cost of capital, we’re trying to maximize our liquidity and we’re trying to minimize our risk. So as you think about what securities are we issuing, how are we managing this business, we’re really trying to balance those three aspects.
So let me wrap up, I think we got a couple of minutes here and we take Q&A, but I said it from the very beginning we have a stable low decline production base. We think that’s paramount for MLP. We have an experienced aligned and incentivized management team, the ownership, how we make our money is the same way the LPs make their money. We think that’s an important alignment and something that we’ve been focused on for a long time.
We have that strategic alliance with WPX; we think there is a lot of inventory within WPX that makes sense for us to buy in the future. Those deals will need to be agreed upon in the future, they have not been agreed upon but we think we have the right incentives in place to bring both parties to the table and make some deals happen.
Within that alliance I think the WPX transaction in that alliance is great but I think what’s just as exciting is the structure can be used elsewhere and we certainly want to use it. Fourth point is our track record; I said this point a couple of times so we think it’s an impressive track record one we’re very proud of. And then lastly is financing, we’re talking about costless hedging and that’s an important aspect within MLP but costless hedging and prudent financing.
So with that I think we got three minutes or so left, if you guys have question we’ll be happy to address them now, I know we got a series of one-on-one today but happy to address any question you guys may have.
You mentioned that you expected WPX transaction to close by the end of this month. Do you anticipate any integration issues there?
No we don’t. That process has gone really smoothly, it was a negotiated transaction. So we have been working with them for the better part of six months and don’t expect anything outside the normal course, where we’re going through the kind of standard post signing pre-closing and then we’ll have that kind of standard post closing true ups.
And I guess as a follow up to that, I guess to what extent does the WPX deal impact your ability to kind of pursue other acquisitions along the way?
Great question. So we view WPX and this as normal course plus, we don’t think that future deals with WPX will replace or supplant our normal acquisition strategy. So I view this as an absolute net increase to our acquisitions.
Are there any, are private or public companies for which this structure would make sense?
It would not make sense for anyone else to do what we did. But it would make sense for us to do it with more people, with being [indiscernible] there. But yes there is certainly interest to do this with other parties; we’ve had some of those discussions. We have said that WPX was not our first trial at this, we tried with another party who turned us down, we’ll see hasn’t given up hope; we tend to be pretty persistent.
Do we have any additional questions from the audience?
Jimmy Nguyen - BofA Merrill Lynch
Thanks so much Dan.
Thank you Jimmy. Appreciate you guys.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!