Vanguard Natural Resources Takes Advantage Of LRR Energy's Problems To Acquire The Troubled MLP

| About: Vanguard Natural (VNR)

Summary

Vanguard Natural Resources will acquire smaller LRR Energy with a unit exchange and the assumption of debt.

LRE unit holders will see distributions reduced by over 60% - Ouch! However, LRE was on the verge of a borrowing base reduction which would have eliminated all distributions.

Based on Vanguard's earlier guidance, 100% of the LRE asset free cash flow will be accretive to the VNR distribution rate, pointing to distribution growth later in 2015.

For the upstream MLPs to survive and then thrive through the current low energy commodity price environment, acquisitions to pick up low cost production assets are a necessity. Yesterday, April 20, Vanguard Natural Resources LLC (NYSE:VNR) announced an agreement to acquire publicly traded LRR Energy, LP (NYSE:LRE). VNR investors could see an almost immediate boost in distributions when the deal closes -expected in Q3 2015. LRE investors will see a cash flow reduction.

The agreed transaction will provide LRE unit holders with a tax-free exchange of 0.55 of a VNR unit for each LRE unit. Vanguard will also assume $288 million in debt. The exchange rate is at a 13% premium to the LRE and VNR unit closing prices on April 20. The deal has been approved by the Boards of both partnerships and the Conflicts Committee of LRR Energy. Final approval is subject to a vote of unit holders, and Affiliates of Lime Rock Resources, which owns over 30% of LRE, have agreed to support and vote in favor of the transaction.

LRR Energy Bails Out

The fact that this deal reduces the cash distributions earned by LRE investors by 61% is a strong indicator that LRR Energy would no longer be able to maintain the $0.50 quarterly distribution the partnership had been paying. With its 2014 fourth quarter earnings release and guidance, the company had already announced that capex spending for 2015 would be reduced to a maintenance only level. Also, LRR Energy had drawn $240 million of its $260 million credit facility. With some sort or deal, it is likely that the credit limit would be lowered with LRE's Spring borrowing base review. If that happened, distributions would be suspended. Here is what CFO Jaime Casas said during the Q4 earnings conference call:

Regarding our revolving credit facility borrowing base the next redetermination is scheduled for May. Based on the current price environment in our year-end proved reserves, our borrowing base maybe reduced below the current outstanding amount of $240 million at the next redetermination. We are actively looking at public and private financing alternatives to reduce borrowings in our credit facility in advance of the spring redetermination process and to increase our liquidity position.

It seems that LRR Energy was forced by financial circumstances to make this deal.

Since there will be two quarterly distributions before the acquisition closes, I am curious what the LRR Energy Board of Directors does with the payout rates. It seems that a good move would be to lower the LRE distribution to be in line with what LRE unit holders will receive after the exchange into VNR units. The math puts that level at a quarterly distribution of $0.194 per LRE unit. With the unit price now tied to the VNR value, it would not surprise me if LRE paid out just a token distribution for the next couple of quarters and preserved cash on the balance sheet.

Author's note: I was pointed out to me that I missed the LRE distribution announcement of April 20, where the distribution rate was reduced to $0.1875. My analysis was without knowing about the already announced reduction.

Vanguard Poised to Grow Distributions

Vanguard claims the absorption of LRR Energy will be immediately accretive to distributable cash flow and that general and admin expense synergies will provide additional free cash flow benefits. With the LRE unit holders taking a 60% distribution haircut, the claim of increased net cash flow seems to be valid.

Using the 2014 Q4 numbers from each partnership, the number of VNR units outstanding will increase by 15.3 million or 18% to 99.2 million. Vanguard's debt load will increase by 15%. For the fourth quarter, Vanguard reported distributable cash flow of $73.9 million and LRR Energy reported $13.7 million. The additional LRE cash flow would increase the VNR DCF by 18.5%. That is almost a rounding error in accretive cash flow. However, for the full year 2015, Vanguard has guided to DCF of $147 million, or about $37 million per quarter. This is less than half of the 2014 Q4 DCF and the LRE DCF contribution may be much higher than 18%.

On the positive news front, the current VNR distribution rate requires $35 million in cash flow per quarter with the new units issued to LRE investors included. Based on its 2015 guidance, Vanguard has 1.06 times DCF coverage on the increased unit total before any cash flow contribution from the LRR Energy assets. With the price of crude oil trending higher so far into 2015, if the trend continues by the 2015 fourth quarter, Vanguard could be in the position to significantly increase its distribution rate. In this case, the troubles and LRR Energy have resulted in a very good acquisition for Vanguard Natural Resources. With its current 8.8% yield, VNR provides an attractive current income investment with strong potential for distribution growth in late 2015 or early 2016.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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