Shares of BreitBurn Energy Partners (BBEP) and of its Series A preferred units fell significantly on April 14th after news broke that management was suspending distributions and interest payments on debt in an effort to review "strategic alternatives" that it could implement in an attempt to strengthen its balance sheet. This draws a parallel with Linn Energy (LINE) / LinnCo (LNCO), which previously announced that it, too, was exploring such alternatives. In what follows, I will dig into the data and show that, while there is certainly risk here (something I've pointed out in past articles), the picture for Breitburn may not be the same as with Linn.
According to BreitBurn's press release, the company is immediately stopping payment on its Series A and Series B preferred units. For those of you who have not been following too closely, the company has been paying $16.50 million in cash out toward the Series A units each year but the Series B units have been given like-kind units in lieu of cash since they were first issued last year. This means that the business will save $16.50 million in cash annually from not paying out the cash but it will ultimately have to pay out either cash or the like-kind units to the holders of its Series B units.
This is something I've been pushing for a while since paying out distributions during tough times is the same as throwing cash off a bridge. However, what I am not happy about and was not expecting was for the company to stop paying interest payments on its Senior Notes. This month, BreitBurn will forego $33.5 million in interest on its 7.875% Senior Notes due in 2022 and $13.2 million on its 8.625% notes due in 2020. Because of this decision, BreitBurn has entered into a 30-day grace period whereby it can choose to make said payments or risk being pushed into default by its lenders.
On a fundamental level, this picture is a bit confusing for two reasons. First and foremost, BreitBurn is expected, at current energy prices (oil at $42.01 per barrel and natural gas at $1.986 per Mcf), to generate strong cash flow this year totaling $196.08 million. This is net of planned capital expenditures of $86 million (which the company does not have to spend if it allows production to drop) and is net of all interest expenses planned and other operating expenditures. Next year, as you can see in the graph below, the picture looks far less appealing, with cash flow expected to be just $18.61 million before falling off a cliff in 2018 and 2019.
In addition to BreitBurn set to be cash flow positive during this year and next year, which should allow it to survive without too much trouble for at least a good portion of the rest of this year (until its October re-determination at least), the company could also face legal challenges associated with this move. The reason behind this is that management has a fiduciary responsibility to its shareholders to act in their own best interests. While I'd say that cutting the preferred distributions are, indeed, acting in the best interest of its investors, BreitBurn cutting that payment just before defaulting on debt when they should have cut the payments sooner and allocated it toward debt reduction seems like an obvious breach of that fiduciary responsibility to me.
This may be different than in the case of Linn
Fortunately, months ago I trimmed my stake in BreitBurn by quite a bit and a fall to zero by the company won't have a material impact on me. However, even if it were to have a major impact on me, I wouldn't sell just yet because I'm thinking the situation is quite a bit different compared to what we saw with Linn earlier this year. In that case, management was notified by its auditors that the company was going to be labeled a going concern because it did seem likely that the business would breach its covenants in the foreseeable future. This, in turn, triggered the need for a waiver for the company's credit facility and immediately put other asset classes at risk.
In BreitBurn's case, management has made no such indication that it would breach credit facility covenants given the current outlook. Rather, the potential breach comes from a voluntary move to suspend interest payments on other debts (but not the credit facility), which could result in default if those payments are not made within the next month. As you saw in the previous graph, BreitBurn has the cash flow necessary to meet these payments and would otherwise be back in compliance with its lenders should they be made.
What this means, to me, is that BreitBurn is likely playing a game of hardball with its credit facility lenders in an attempt to keep its borrowing capacity at a reasonable level. Failure to reach proper terms with those lenders would mean that BreitBurn elects to not pay on its Senior Notes and will, instead, default. There is likely more value in the long run, given the poor energy environment (but improving fundamentals) by allowing cash flow to continue to be generated for as long as possible as opposed to defaulting and going under immediately.
At this moment, I'm still quite cautious on BreitBurn and I do believe this move by management is bizarre and uncalled for but that it may be a ploy to negotiate on better terms with its lenders. It does introduce increased risk into the picture but I'm also not too worried given my more limited exposure. As of this moment, I'm not intending to sell the stake I have in the firm but this could very well change based on my observations over the next few days, especially as I consider the likelihood of a debt restructuring should that route become probable.
Disclosure: I am/we are long BBEP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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