This analysis of LRR Energy was provided to TradingIPOs subscribers in advance of its IPO. On November 11 the company announced that its initial public offering of 9.4 million shares was priced at $19 per share.
LRR Energy (LRE) plans on offering 10.8 million units at a range of $19-$21. Wells Fargo (WFC), Raymond James (RJF), Citi (C), and RBC are leading the deal, Baird, Oppenheimer and Stifel co-managing. Post-IPO, LRE will have 22.4 million total units outstanding for a market cap of $448 million on a pricing of $20.
Lime Rock will own all non-floated units including the General Partnership. Lime Rock manages $3.9 billion of private capital for investment in the energy industry.
All IPO proceeds will go to parent Lime Rock as consideration for the LRE's properties. There is nothing out of the norm with that. However, in addition to the IPO proceeds, LRE will also go into $156 million debt to pay off Lime Rock. I've always stressed that the MLP structure is not ideal for E&P's. Why? Well, the E&P business requires hefty capital expenditures to replace production, including new exploration and acquisitions. In addition to capex, the MLP also needs to yield large enough to entice buyers. To be successful an E&P MLP must have very strong and consistent cash flows to cover both the yield and capex. Debt on the books on IPO is a hindrance that I do not like to see as not only does the operation need cash flows to cover capex and yield, now they need to service debt as well. The stronger E&P MLPs have come public with clean balance sheets. Not the case here as Lime Rock has opted to suck out $156 million and place that debt on the back of the public LRE.
From the prospectus:
Formed in April 2011 by affiliates of Lime Rock Resources to operate, acquire, exploit and develop producing oil and natural gas properties in North America with long-lived, predictable production profiles.
Initial properties located in the Permian Basin in West Texas, Mid-Continent region in Oklahoma/East Texas and the Gulf Coast region of Texas.
30.3 MMBoe proved reserves, with 84% proved developed. 691 net producing wells as of 3/31/11. 57% of revenues from oil/NGL's, 43% natural gas. Note that LRE does operate 93% of their proved reserves.
13.5 years reserve-to-production lifespan. As is common in this sector, LRE will need to acquire and/or discover additional reserves as they deplete current proved reserves. 55% of total reserves are in the Permian Basin.
Hedges - LRE plans on hedging 65%-85% of annual production 3-5 years out on a rolling basis.
Issue - LRE had a lackluster 3rd quarter with daily average production 8% lower than the first 6 months of 2011. LRE blames both a greater than expected nitrogen presence in a gas field as well as gas plant mechanical failure.
$156 million in debt. Debt went into parent's pocket.
Yield - LRE plans to distribute $0.475 per unit to holders quarterly. At an annualized $1.90, LRE would yield 9.5% annually on a pricing of $20.
Forecast - 12 months ending 9/30/12. $106 million in revenues with sequential drops each quarter. Expect Lime Rock to offer LRE a dropdown acquisition sometime before 2013 to be paid for either via more debt, a share offering or a combination of both. $18 million in capex expected. Note that LRE is forecasting a 117% coverage ratio the first 4 quarter public. Even with the debt on the books and declining production, cash flows should be strong enough to pay distribution and expected capex.
Note that LRE has 52% of oil production through 6/12 hedged strongly at $105.37 per barrel. In addition 52% of natural gas production is hedged at $6.46, well above current prices. Once these hedges drop off, expect the coverage ratio to decline from the 117% above.
The natural gas hedges alone are strong enough that without them, LRE would not have enough cash available to pay the full distribution through 9/30/12.
Quick look at LRE and a few other MLP E&Ps:
- LRE - Pricing of $20 would yield 9.5% with $156 million in debt.
- LINE - 7.5% yield, pretty debt laden.
- BBEP - 9.6% yield, debt on the books.
- PSE - 7.4% yield, excellent balance sheet.
- VNR - 8%, has loaded up on debt to grow post-IPO.
- QRE - 9.3%, some debt on books.
- LGCY - 7.3%, some debt.
- ENP - 8.7%, pretty solid balance sheet.
Simply on yield and balance sheet, ENP and PSE would be the two most attractive. LRE is a pretty average looking deal in this space. Should get done around range due to attractive yield (9.5% on a $20 pricing). Keep in mind a chunk of that yield is due to very strong natural gas hedges and it remains to be seen if LRE can fund full distributions once those fall off. In addition, the 9/30 quarter was a disappointment. Slight recommend due to strong yield, nothing to get too excited about.