Consider Breitburn Energy Partners Bonds

| About: Breitburn Energy (BBEPQ)

Summary

The large number of oil bankruptcies in 2016 create unique bond buying opportunities for those with an appetite for risk.

Of the 3 companies in bankruptcy court, Breitburn is the only one capable of paying back higher lien debt in full with long-term $70 oil.

Breitburn’s bonds are currently trading below Linn's and Halcon’s.

Recent insider stock purchases in January signal that Breitburn management had a lot of confidence in the company before Wells Fargo pulled the plug.

The bonds look good.

After one and a half years of low oil prices, the much anticipated wave of energy bankruptcies has arrived. Cut off from credit markets, unable to raise more equity, and out of options, many of the smaller, highly leveraged E&P companies have no choice but to fold. While shareholders in bankrupt companies will almost certainly get wiped out, value remains for those willing to invest higher up in the capital structure. By taking a look at some of the companies that have bonds available to trade on the open market, we can estimate the net present value of the enterprise and the bonds. To determine intrinsic value, this article will discuss the following topics: NPV assumptions, data tables, and insider transactions. Companies studied in this article include Breitburn Energy Partners (NASDAQ:BBEP), Linn Energy (NASDAQ:LINE) and Halcon Resources (NYSE:HK).

Calculations

It is impossible to estimate the net present value of an upstream oil company without making assumptions on future oil prices, company decline rates and cost of goods sold. Assumptions made for these calculations include operational, administrative and capex expenditures similar to Q1 2016, 10% annual production decline (consistent with management guidance in Q1 2016), 5% annual net cost decline (consistent with operational expenses as a ratio to total company expenses), higher lien debt paid in full, and hedges liquidated to pay down higher lien debt. Other assumptions include:

  • 2016 50$/bbl oil, 2$/mbtu gas, 5$/bbl NGL
  • 2017 60$/bbl oil, 2.4$/mbtu gas, 6/bbl NGL
  • 2018 onwards 70$/bbl oil, 2.8$/mbtu gas, 7/bbl NGL

Key Cost/Production Assumptions per Company

BBEP

LINE

HK

Annual Oil production (MMBBL)

9,750

10,960

11,096

Annual Natural Gas Production (MCFT)

40,500

161,735

8,320

Annual NGL Production (MMBL)

1,850

7,677

1,387

Annual Operating Costs(Millions)

380,000

613,000

124,000

Annual Administrative Expenses(Millions)

60,000

130,000

160,000

Interest Expense

40,000

104,000

40,000

Annual Capex(millions)

60,000

320,000

210,000

Source1: ~Q1 2016

BBEP Q1 2016

LINE Elephant Analytics

HK Q1 2016

Source2: EOY 2015

BBEP EOY 2015

LINE EOY 2015

HK EOY 2015

Click to enlarge

Based on the assumptions stated above, net present value for 25 years was calculated via excel spreadsheet using the equations below:

  • Annual NPV=((Revenue-OPEX-ADEX-INTEX)/(1.05^Y))
  • Total NPV is calculated by summing up all NPV's for 25 years using the assumptions above.

A sample spreadsheet used to crunch the numbers can be seen in this link:

The actual spreadsheet calculations for each case can be seen by clicking on the links at the bottom row of the table "NPV Calculations Spreadsheet Links".

Base Case (ex 50$/bbl 2016 60$/bbl 2017 70$/bbl 2018+)

BBEP

LINE

HK

NPV Base Case

1.48B

0.287B

1.514B

Higher lien Debt

1.85B

2.8B

1.97B

Liquidated Hedges

0.56B

1.2B

0.22B

Money left for Bonds

0.20B

-1.31B

-0.23B

Unsecured Bonds Outstanding

1.15B

5B

0.91B

Unsecured Recovery

18%

-26%

-25%

Unsecured Trading Price 5/21/2016

10%

14%

24%

NPV Calculation Spreadsheet Links

BBEP Base Calculations

LINE Base Calculations

HK Base Calculations

Click to enlarge

Bond recovery rates were calculated by taking the difference between enterprise value (including hedges) and higher lien debt. In the base case above, the only company with positive value leftover for unsecured creditors is Breitburn Energy Partners. While Linn and Halcon are able to break even under conditions of increasing oil prices, its net income over 25 years will not be enough to cover secured creditors.

While the base case offers a realistic estimate of what these bonds are worth under the circumstances of increasing oil prices, oil prices are notoriously unpredictable. For this reason, it is also important to study alternative scenarios. Although nobody knows for sure where oil prices are going, "experts" such as OPEC and the IEA have predicted prices to be anywhere between 50-70 dollars. Taking a look at the low(50$) and high (70$) scenarios we can get a feel for future recovery rates. Such scenarios can be seen in the cases below:

Conservative Case (50$/bbl 2$ NG 10$NGL 2016+)

BBEP

LINE

HK

NPV Base Case

0.146B

-1.88B

0.178B

Higher lien Debt

1.85B

2.8B

1.97B

Liquidated Hedges

0.56B

1.2B

0.22B

Money left for Bonds

-1.13B

-3.48B

-1.57B

Unsecured Bonds Outstanding

1.15B

5B

0.91B

Unsecured Recovery

-98%

-70%

-171%

Unsecured Trading Price 5/21/2016

10%

14%

24%

NPV Calculation Spreadsheet Links

BBEP Conservative Calculations

LINE Conservative Calculations

HK Conservative Calculations

Click to enlarge

Aggressive Case (70$/bbl 2.8$ NG 14$NGL 2016+)

BBEP

LINE

HK

NPV Base Case

1.755B

0.720B

-1.78B

Higher lien Debt

1.85B

2.8B

1.97B

Liquidated Hedges

0.56B

1.2B

0.22B

Money left for Bonds

0.47B

-0.88B

0.035B

Unsecured Bonds Outstanding

1.15B

5B

0.91B

Unsecured Recovery

41%

-17.6%

0.03%

Unsecured Trading Price 5/21/2016

10%

14%

24%

NPV Calculation Spreadsheet Links

BBEP Aggresive Calculations

LINE Aggresive Calculations

HK Aggresive Calculations

Click to enlarge

At first glance, the conservative 50 dollar base case scenario appears incredibly bearish for all three companies, while the aggressive 70 dollar scenario appears incredibly bullish for BBEP but bearish for the other companies. That being said, even in the conservative case, BBEP and HK bondholders will end up owning equity in a company that is making money, in contrast to the LINE bondholders who will end up owning equity in a company that is still losing money. While equity liquidation will likely allow for some bondholder recovery, the long term effects for any of these companies, should oil prices stay near 50$/bbl while natural gas stays at 2$/mcft for 25 years, seem to be unfavorable.

While there appears to be little future for Linn at current price levels, Linn is a natural gas producer that can still turn a profit in a bull market for natural gas. Should prices rise to 3$ NG and 15$ NGL base case (up from 2$NG and 10$NGL), the situation turns positive.

Case For Linn Energy (50$/bbl 3$ NG 15$NGL 2016 70$/bbl 4.2$ NG 21$NGL 2017+)

LINE

NPV Base Case 3$ NG 15$ NGL

2.86B

Higher lien Debt

2.8B

Liquidated Hedges

1.2B

Money left for Bonds

0.515B

Unsecured Bonds Outstanding

5B

Unsecured Recovery

10%

Unsecured Trading Price 5/21/2016

14%

NPV Calculation Spreadsheet Links

LINE Special Case

Click to enlarge

While these prices are significantly higher than today's strip, the recent approval for NGL exports and a strong international market where others pay 10$/CFT could turn this scenario into a reality. Under these conditions, Linn would sell natural gas for 3$ in 2016, 3.6$ in 2017 and 4.2$ in 2018.

Insider Transactions

Insider transactions are one of the most under-looked aspects of stock research. If an executive of a large company is willing to spend his or her hard earned money to buy his or her own stock, it is probable that the company's stock is undervalued. In fact, University of Michigan Professor Nejat Seyhun found that the companies in which its own executives buy shares tend to outperform the market by 8.9% over the next 12 months.

While all three of these companies are currently bankrupt, taking a look at insider transactions during the months prior to bankruptcy can provide insight regarding the state of the company. Over the last few months, Breitburn Energy Partners experienced some insider buying. From January 4th to January 7th in 2016, Hal Washburn-CEO and Gregory Brown-CAO purchased a total of 80,000 shares for around 60 cents per share. While they may have been wrong in underestimating the ability of credit facility lenders to pull the plug, Hal has a B.A. in petroleum engineering from Stanford University and smart people from top universities have historically been good entrepreneurs (i.e.,: Facebook (NASDAQ:FB), Hewlett Packard (NYSE:HP), Chesapeake (NYSE:CHK) etc..). These people may not be so wrong about the intrinsic value of the company.

Regarding other companies studied in this article, Linn energy and Halcon Resources both did not experience any insider buying within the past 2 years. Michael C. Linn, the founder of Linn energy, ended up selling 500,000 shares in November 2015 for around 2$/share. With only 40,000 shares remaining, he essentially liquidated his position before the company went bankrupt.

Conclusion

Breitburn, Halcon, and Linn are three energy companies undergoing bankruptcy restructuring. Based on net present value calculations, Linn energy bonds have some value as a tool to speculate on future natural gas prices, while Halcon Resources is a decent company the bonds have a lot of the upside already priced in. Although Breitburn has it's own issues to deal with, the current oil price environment is about survival, not growth. Breitburn's low-decline wells are well suited to generate positive cash flow and NPV at 50$ oil with little to no cap-ex. Despite the fact that Breitburn is the only company on this list that is able to generate enough profit to leave secured lenders unimpaired, the bonds are trading at a severe discount compared to the competition (BBEP 10% LINE 14% HK 24%). This, combined with the bullish insider buying and lawyer statements, signifies that Breitburn as an enterprise could still have value for those willing to invest more in the capital structure.

Disclosure: I am/we are long BBEP 2020 BONDS CUSIP 106777AB1.

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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