IPO Preview: Enduro Royalty Trust

| About: Enduro Royalty (NDRO)

Based in Austin, Texas, Enduro Royalty Trust [proposed symbol (NYSE:NDRO)] scheduled a $330 million IPO with a market capitalization of $825 million at a price range mid-point of $25 for Wednesday, August 10, 2011. The full IPO calendar for the week of August 8 includes 12 scheduled IPOs trying to raise almost $2 billion.

ABOUT OIL TRUSTS -- These trusts often attract investors with their relatively high yields. This makes the shares sensitive to interest rates, as share prices are likely to decline in periods of rising interest rates, and to rise when interest rates fall.

Royalty trusts in the United States and Canada usually involve oil and gas fields or mines which are at or past their production peak, and will gradually decline in output as well as revenue.

CONCLUSION -- Stay away from this transparent arbitrage by sophisticated industry insiders.

NDRO is an oil trust put together by industry veterans who are playing an arbitrage game. They are buying properties from sophisticated industry insiders and then re-packing their recent ‘acquisitions’ for the unsuspecting public market. For example, two of NDRO’s properties come from Denbury Resources (DNR, $6.6 billion market cap) and ConocoPhillips (NYSE:COP), $95 billion market cap.

35% lower return rate -- NDRO’s projected rate of return of 7.1% is paltry compared to oil trusts from SanRidge Energy (NYSE:SD) -- such as SanRidge Mississippian Trust (NYSE:SDT) which IPO’d April 6, 2011, is up around 27%. At SDT’s IPO price range mid-point, it was expected to pay in the range of 11%, or 55% more than NDRO. Conversely NDRO expects to pay 35% less and SDT’s price range mid-point.

SD is also expected to IPO with week with another oil trust, SandRidge Permian Trust (proposed symbol PER), with underlying properties in the Permian Basin in Texas NDRO also has underlying properties in the Permian Basin ... PER’s expected payout at the price range mid-point is about the same as SDT’s: 55% higher than NDRO.

P.T. Barnum -- It seems to us that NDRO is believing its own press releases. P.T. Barnum wouldn’t approve. "You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time." Who, however, said, "You can fool too many of the people too much of the time?"

Purpose of this IPO -- This is basically a financial transaction to create net worth for the oil executives (and perhaps the investment bankers) putting this deal together.

The project annual distribution rate is 7.16% for the 12 months ended September 2012, which is a little higher than master limited partnerships. NDRO, however, is a trust whose assets will be depleted yearly although NDRO executives plan to acquire other producing assets to deplete over time.

NDRO is similar to a Master Limited Partnership. MPL's have more value if the general partner is a well-regarded entity in the business who is economically motivated to increase the partnership’s value. A recent example is OilTanking Partners.

Arbitrage -- NDRO, on the other hand, buys producing oil properties that are depleting, then re-packages them for sale to the public at a (hopefully for NDRO) higher value. The sellers are all very sophisticated players in the business so don’t expect the public to get an especially good deal, after the NDRO middlemen extract their slice of the pie.

Precluded from acquiring replacement properties -- NDRO is excluded from acquiring other properties.

The reserves attributable to the Underlying Properties are depleting assets and production from those reserves will diminish over time. Furthermore, the trust is precluded from acquiring other oil and natural gas properties or net profits interests to replace the depleting assets and production. Therefore, proceeds to the trust and cash distributions to trust unit holders will decrease over time.

But $99 million of the use of proceeds is for more acquisitions? There may be a good reason for the inconsistency but that reason is not obvious.

PROJECTED CASH DISTRIBUTIONS -- For the 12 months ending September 2012 are $1.79 per trust unit, which is a 7.16% projected return. S-1 pages 13 & page 47.

ENDURO SPONSOR -- Enduro Sponsor is a privately-held Delaware limited liability company engaged in the production and development of oil and natural gas from properties located in Texas, Louisiana and New Mexico. Enduro Sponsor was formed on March 3, 2010.

Management of the Enduro Sponsor mostly are executives form Encore Acquisition Company. Encore Acquisition was a private company that owned the Predecessor Properties prior to March 9, 2010, at which time Denbury Resources (DNR, $6.6 billion market cap) acquired the properties in connection with its acquisition of Encore Acquisition. Enduro Sponsor then acquired the Predecessor Properties on December 1, 2010.

Encore Energy Partners LP (NYSE:ENP) a master limited partnership who general partner was owned by NDRO executives (through Encore Acquisition Company) from February 2007 until March 2010.

The trust units do not represent interests in, or obligations of, Enduro Sponsor, which will own 60% of the Trust post-IPO.

UNDERLYING PROPERTIES -- The Underlying Properties were acquired in three separate transactions and are located in two different geographic regions: the Permian Basin and East Texas/North Louisiana.

Enduro Sponsor’s oil and natural gas properties in the East Texas/North Louisiana region were acquired from Denbury Resources Inc. in December 2010.

Enduro Sponsor’s oil and natural gas properties in the Permian Basin of Texas and New Mexico were acquired from Samson Investment Company and ConocoPhillips Company in January 2011 and February 2011, respectively. CON has a market cap of $95 billion.

As of December 31, 2010, approximately 99.3% of the wells on the Underlying Properties were operated by the Third Party Operators. As a result, Enduro Sponsor has limited ability to exercise influence over, and control the risks or costs associated with, the operations of these properties.

Estimates provided in the S-1 filing assumed that crude oil and natural gas production is sold in 2011 and 2012 based on assumed NYMEX prices of $100.00 per Bbl in the case of crude oil and $4.50 per MMBtu in the case of natural gas.

Enduro Sponsor has entered into hedge contracts with respect to approximately 69%, 70% and 57% of expected production of oil and natural gas production for 2011, 2012 and 2013, respectively, from the total proved reserves attributable to the Underlying Properties in the reserve reports.


The trust units may lose value as a result of title deficiencies with respect to the Underlying Properties.

Enduro Sponsor may transfer all or a portion of the Underlying Properties at any time without trust unit holder consent, subject to specified limitations.

Enduro Sponsor may sell trust units in the public or private markets, and such sales could have an adverse impact on the trading price of the trust units.

After the closing of the offering, Enduro Sponsor will hold an aggregate of 19,800,000 trust units, assuming no exercise of the underwriters’ option to purchase additional trust units. Enduro Sponsor has agreed not to sell any trust units for a period of 180 days after the date of this prospectus without the consent of Barclays Capital Inc. However, it seems reasonable to assume that the underwriters may collaborate with NDRO's selling shareholders to short some stock prior to the end of the lockup.

The amount of cash available for distribution by the trust will be reduced by the amount of any costs and expenses related to the Underlying Properties and other costs and expenses incurred by the trust.

The trust will indirectly bear an 80% share of all costs and expenses related to the Underlying Properties.

TRUST DISSOLUTION -- The trust will dissolve upon the earliest to occur of the following: (1) the trust, upon approval of the holders of at least 75% of the outstanding trust units, sells the Net Profits Interest, (2) the annual cash available for distribution to the trust is less than $2 million for each of any two consecutive years, (3) the holders of at least 75% of the outstanding trust units vote in favor of dissolution or (4) the trust is judicially dissolved.

USE OF PROCEEDS -- NDRO expects to net $303 million, which is allocated to repay secured credit line of $184 million; to pay a $20 million distribution so sole member of EnduroSponsor (?); and $99 million for future acquisitions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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