On January 6, Bill Simpson wrote an analysis of Legacy Reserves (NASDAQ:LGCY). The IPO began trading on Jan. 11, and raised $114 million. The 6 million unit offering sold for $19 per share, within an $18.50 to $20.50 forecast range.
The text of Mr. Simpson's original writeup follows:
Legacy Reserves [LGCY] plans on offering 4.3 million units at a price of $18.50 - $20.50. Note that LGCY filed an additional offering registration back in November. It appears the total number of shares that will be offered over in January 2006 will actually total 7.7 million units at a range of $18.50 - $20.50. Essentially all the shares in this offering will be coming from selling shareholders. There are no proceeds going to LGCY from this offering.
Wachovia will be lead managing the deal. Post-offering LGCY will have 25.4 million units outstanding for a market cap of $495 million in a $19.50 pricing.
LGCY was formed in 10/05 by combining various oil and gas properties in the Permian Basin of Texas and New Mexico. Controlling ownership post-ipo is made up of the original majority owners of those properties. Moriah Properties will own 32% of all outstanding units post-offering and along with Brothers Production will control the general partnership. Note that LGCY's general partnership will have no incentive distribution rights.
Note that in 10/06 LGCY held a private equity offering for accredited investors. The price of this offering was $17.25 per unit.
From the prospectus:
We are an independent oil and natural gas limited partnership, headquartered in Midland, Texas, focused on the acquisition and exploitation of oil and natural gas properties primarily located in the Permian Basin of West Texas and southeast New Mexico... Our primary business objective is to generate stable cash flows allowing us to make cash distributions to our unitholders and to increase quarterly cash distributions per unit over time through a combination of acquisitions of new and exploitation of our existing oil and natural gas properties.
Via acquisition, the formation of LGCY and exploitation of their properties, as of 12/31/06 LGCY has proved reserves of approximately 20.0 MMBoe, of which 70% were oil and 81% were classified as proved developed producing. Proved reserves to production lifespan is 16 years.
As a unit offering, LGCY will distribute essentially all cash on hand to unit-holders quarterly. LGCY plans on paying $0.41 quarterly to unit holders, $1.64 on an annualized basis. On a pricing of $19.50, LGCY would be yielding 8.4% annually. This is a strong initial yield. Keep in mind, however, that since LGCY is primarily an oil E&P operation, they've substantial yield reliance on the underlying price of oil.
LGCY is similar in structure and scope to two recent E&P ipos, Constellation Energy Partners (CEP) and Atlas Energy Resources (ATN). The biggest difference is that CEP/ATN focus primarily on natural gas exploration and production, while LGCY's is mostly oil. Also LGCY does not have the strong 'parent' relationships that CEP/ATN possess. At current prices ATN/CEP both yield approximately 7 1/2% annually. E&P unit offerings due tend to trade at a higher yield level than the traditional midstream asset unit ipos due to 1) the underlying resource price risk to yield and 2) E&P activities generally require a hefty amount of capital expenditures, which can affect future cash flows and in turn future yield growth.
Permian Basin - LGCY's properties are all located in the Permian Basin, one of the largest oil and natural gas producing basins in the U.S. The Permian Basin extends over 100,000 square miles in West Texas and southeast New Mexico and has produced over 24 billion Bbls of oil since its discovery in 1921. The top five producers in the Permian Basin account for 40% of production.
Hedging - Much like previous E&P unit ipos, LGCY does participate in hedging a significant amount of their forward production. As of 12/31/06, LGCY has hedged approximately 69% of expected oil and natural gas production through 2007 and approximately 61% of expected production from 2008-2010. This hedging does help protect the yield going forward, however with 30-40% of expected production next 4 years currently unhedged, there does remain commodity price risk for LGCY.
However, since LGCY hedges their oil production up to 4 years out, the company actually received a higher price in 2006 for unhedged production. Unhedged oil sales were over $60 per barrel, while total sales factoring in hedging were $49 per barrel. LGCY has actually hedged future production at much higher levels than overall in 2006. For example, 2007 hedged oil production is over $67 per barrel. In fact, LGCY has locked in such a large % of oil production through 2010 at $60+ per barrel, I would expect any drop in oil prices going forward to have little effect on LGCY's yield until 2011+.
Debt post-offering of $107 million. This will not impact LGCY's operations all that much. Debt servicing costs, however, will total approximately $0.30 per unit annually. I would fully expect LGCY to lay on greater debt going forward as they acquire additional properties in the Permian Basin.
Capital expenditures are expected to total roughly $10 million in 2007. This includes the costs of drilling 22 development wells.
LGCY has made numerous acquisitions, including the formation in October 2005. Due to the recent formation and these acquisitions, historical financials are not relevant here. Total net production will be 1,356 MBoe for the year ending December 31, 2007. LGCY is projecting cash levels to be strong enough to pay full dividend for 2007. Note, however, that LGCY has projected higher oil/natural gas sales prices on their unhedged production then current commodity prices. LGCY is projecting approximately $0.15-$0.25 more available cash on hand per unit in 2007 than current expected distribution of $1.64 annually. I think LGCY can easily make the full 2007 distribution, with a good possibility of a bit of an increase later in the year.
Much like similar offerings over the past year, the strong yield here makes this deal work. On a pricing of $19.50, LGCY will yield 8.4%. In an environment in which long term treasuries yield below 5%, LGCY's strong yield is enticing. Also LGCY has hedged a substantial portion of their oil production through 2010 at $60+ per barrel. That alone should mean a fairly secure yield going out a few years, even if oil prices fall. LGCY is not as strong a deal as ATN/CEP, due to the strong 'parent' companies involved in those deals.
However, I would put it in the class of 2006 E&P unit ipos Linn Energy (LINE), Breitburn Energy Partners LP (BBEP), EV Energy Partners (NASDAQ:EVEP). The current yield on all those ipos is in the 6 1/2% - 7 1/2% range. At 7% yield, LGCY would trade at $23 per unit. I would expect LGCY to trade in that $19 - $24 range over the next year or so and yield in the 7% ballpark.
Recommend in range due to strong yield. I'll be a buyer here on a muted pricing/open. Any initial pricing/open enthusiasm however will come close to pricing in that yield going forward. The higher the initial yield here, the more I'm interested; in other words, the lower the pricing/open, the more attractive LGCY looks to me.
LGCY chart since IPO: