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Legacy Reserves - Unethical Or Just Business?

Apr. 02, 2018 9:24 AM ETLegacy Reserves Inc. (LGCY)61 Comments
OTT Equity Analysis profile picture
OTT Equity Analysis


  • Legacy Reserves unveiled its plans to become a C-corp.
  • This move was preceded by significant buying of its common stock by a single party.
  • There has been a history of instances where information appears to have been shared with a limited group of investors ahead of time.
  • Recap of the last couple of years as a Legacy preferred investor.


On March 26th, 2018, Legacy Reserves (NASDAQ:LGCY) unveiled its plans to become a C-corp (link). There were certainly a number of legitimate reasons for moving away from the MLP structure which will not be covered in this article. What's more important to most investors here is how each part of the capital structure fared in this transformation, and how that aligned with previous announcements and SEC filings from the organization.

As some of you who have followed the partnership for some time know, I have written a number of articles on the stock and pored through countless pages of reports, filings, and completed some of my own projections and modeling on its expected cash flow. The last such article was on 6/20/16 where I recommended an exit from the preferred shares based on the fact that the board elected to award the leadership team with cash retention bonuses. This was a clear signal to me at the time that leadership was concerned about the future value of its units that were being awarded as part of the compensation.

With all the intrigue around the "merger" and the involvement of Baines Capital, I feel compelled to share my story from the start to help you make a better investing decision.

2016 and the Dividend Suspension

My entry into LGCYP was in early January 2016, and at the time, it was already beaten quite hard.LGCYP Chart

If you take a look at the chart, you'll see there was some pretty heavy selling volume around January 15th in LGCYO. The LGCYP chart looks similar, but selling was spread out between January 12th and January 19th. It was a pretty tough time to hold. Imagine my shock on January 21st when the announcement was made that distributions would be suspended for all units. The selling

This article was written by

OTT Equity Analysis profile picture
Full-time Investor. Commodities, Long and Short.

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

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (61)

With oil over $70 a barrel, let's hope all legitimate oil companies stocks rise. Any stock not rising now, has to be questioned, starting with the leadership and the possibility of other unknown activities. If LGCY hits $10 again, it will be small miracle but with new leadership, it can happen and should happen. It's a strong solid company in the heart of oil country, Midland. Be strong again Legacy, be strong!!
I am looking at the Proxy statement.

Baines Creek owns 16.9%.
FMR LLC owns 11.8%.
Cary D. Brown owns 5.1%.
Dale A. Brown owns 4.0%.
Kyle A. McGraw owns 1.4%.

Cary and Dale Brown are still directors but no longer officers.

Kyle McGraw is still an executive officer.

It appears all of the executive officers have been involved with LGCY since at least 2012.

It is pretty startling that the executive compensation shot through the roof in 2015-17, despite the company bleeding profusely. Horne’s total comp was over $4.2 million in 2017, up from $2.082 million in 2015. Westcott raked in $2.6 million in 2017 up from $1.7 million in 2015. The others all had significant raises.

Pretty sweet gig being a director too. $146K to $206K in cash and unit awards.

Seems like all involved have hit this company pretty hard, heck even with the big price run it is still below $500 million market cap.

Would appreciate comments as to appropriateness of this compensation. Alternatively, even if not appropriate, is it in line with other distressed upstream E & P’s?

For comparison, I am familiar with a small regional bank that has a market cap of close to $800 million. Executive and BOD comp is but a fraction, and they were in no distress during financial crisis, because BOD and management is top notch.

Am I missing something??
hoddy profile picture
Thanks irish thats good info....what happened Wednesday? Did we get a ruling from the judge?
Patrick Irish profile picture
I haven't followed the court cases that have been filed. Maybe someone has a link so we can all watch the action? Anyone know where the suits have been filed? NYC perhaps because a lot of security lawyers are there?
hoddy profile picture
An injunction would be a win , recognizing our claims would be a win , acknowledgement of the tax issue where we were charged for phantom tax for something that wasnt really an obligation would be a win, certification and consolidating the claim with any firm other than one associated with the ny plantiffs bar would be a win.....
Patrick Irish profile picture
Hoddy - I talked to an attorney and he said the two firms who have filed are taking different paths. One claiming a CoC (change of control) and the other not claiming. If two good law firms can take opposite opinions, I'm guessing there will be lots of arguing.

No one wins if this is dragged out. If the lawyers find a way to slow this New Legacy plan down, I assume that brings everyone to the negotiating table. Then the question comes down to what price they will give the preferred to move on.
georgemccreedy profile picture
I got a proxy email for May 15th meeting and vote, so conversion is planned for May 16.
Raw Energy profile picture
I believe the May 15 meeting is the annual meeting for Legacy Reserves LP, and the proxy relates to votes for directors, etc., not the conversion.

The S-4 filed by Legacy Reserves, Inc. has not gone effective and is being reviewed by the SEC. It will likely have a separate vote at a later date, usually within 30 days of being declared effective by the SEC.
hoddy profile picture
its all about the pending decision regarding the action vis a vis class certification, and if judge awards injunction and recognizes the positions of the pref claims......we find out something wednesday.....
OTT Equity Analysis profile picture
Do you consider one outcome a win? Is the hope that the preferred will get a better deal? I would agree they definitely deserve a better deal. They should get a MUCH bigger slice of new legacy IMHO.
OTT Equity Analysis profile picture
LGCYP is now back to the price it was the morning of the announcement.

Overall, the stock continues to outperform many others I am watching and it seems to not be just Baines anymore. To be clear, I have moved on from this name and am not considering a position however, at least in the short term, I am surprised it keeps moving higher and it looks like it will continue to do so.
georgemccreedy profile picture
It is what it has been for the last couple years, a leveraged play on commodity prices. All that has changed is an injection of greed and sleaze from private equity now that it looks like profits are to be had. 270 million in debt to preferred holders is being forcibly exchanged for 16 million shares of common stock, so in effect management is saying these common shares have a value of $16.85. Management IS taking $27 million for themselves on the conversion instead of paying accrued distributions, that is wrong. This debt for exchange ratio (1 share common = $16.85 debt) should also be used to limit GSO to 20 million shares in exchange for their 350 million dollar debt, but somehow I suspect they are going to get a much better "sweetheart" deal. Lots of value being wasted on lawyers, with great potential risks. All being driven by avarice, and an unwise desire to stab partners in the back just as soon as some light starts coming through the dark clouds that have been overhead the last couple years. Not a good way to conduct one's self, or business IMHO. I know measures have to be taken to recapitalize, but think there are better ways to go about it. If they were dealing honestly, and in good faith they would offer some assurances or concessions to the equity holders being screwed, so that we all know we're on the same team. There are none. People like me are now worried about timing. We have to pick the right time jump off the train because we know the people driving it intend to crash our cars so that GSO can collect on their insurance policy.
Patrick Irish profile picture
I've been trading the preferred stock vs the common with the expectation they would trade in line with their ratio. Imo, the preferred should trade at a premium to that forced conversion ratio because there is a slight chance they will get more. But the morning of the announcement I think it was at a 10% discount to LGCY's conversion price. For the next week it went between 5% to 15% bouncing all over the place during the day. In the past two trading days that arbitrage got squashed and I'm mostly out of my long/short trade.
georgemccreedy profile picture
I hold both, so I'm being diluted in my common equity position to wipe out my preferred (Haha) perpetual equity position, while insiders and management make large profits. What sacrifices are they making ? Wanna bet if we dig down we find out GSO is counter-party to the hedges put in place as prices were steeply rising ? Wanted a long term investment, but now I have to hope, and wait for greater fools to come rushing in after the conversion, then I have to bail before GSO wipes them out.
buyvaluenow profile picture
Has anyone on this board contacted a law firm re: class action? Sadly, my finance services career prohibits me from trying to be a lead plaintiff or this is one I would actually try for....
Raw Energy profile picture
Two lawsuits have been filed so far. p. 20 of S-4
Patrick Irish profile picture
I'm surprised there was preferred holders out there who filed a lawsuit to stop this. I figured all preferred holders were too small to justify spending that kind of money. However, maybe this is a good bargaining ploy because if they hold up the preferred conversion for months then maybe management will want to settle at a better price to get it done. Its not like LGCY has a long timeline to raise money, right?
Raw Energy,

I ould not find any reference to non consenting holders of legacy 2020 bonds. However Legecy never sent me (holder of small amt of 2020 Bonds) a form to consent or withhold consent. Could that be Legacy's way of not having any bond holders withhold consent?
Raw Energy profile picture
According to the S-4 that was filed, they believe that 50.1% was enough to validly amend the note Indenture.

Raw Energy profile picture
pp. 55+ have the disclosures on failed negotiations LGCY held with their banks, Fir Tree, their noteholders and possible equity participants before deciding to proceed with the unilateral conversion concept
Raw Energy profile picture
Also, gotta love the logic (NOT!) whereby LGCY elects not to pay $42 mm in unpaid preferred distributions but elects to trigger instead the COC provisions which accelerate $27 mm in compensation to mgt. relating to COC. Disgusting
hoddy profile picture
whats the status of class action claims, or better yet injunction prohibiting transaction?
Patrick Irish profile picture
What is the motivation for someone to hire a lawyer to stop this? The preferred is benefiting from this move but to a smaller degree. IF LGCY management's forced conversion of the preferred was done improperly (and its a big IF), then its better to sue after they created value to the company to recover the % they are owed.
OTT Equity & Raw Energy,

I called for and received the Solicitation Letter and docs from Morrow Sodali LLC, the firm Legacy hired to solicit the 2020 Bond holders for the right to vote to change the 2020 Bond Indenture for the change in Corporate structure. I hold the 2020 Bonds but never received the Solicitation.
The Consent Solicitation stated that Legacy, holder of 22.3% of the 2020 Senior Debt, had already received an agreement from 32.4% of the 2020 Senior Debt Holders for the changeson March 23. This represents 55.7% of the Senior Debt and all Legacy needs is 50.1%. They already had their approval for the Solicitation so why go to the expense of paying Morrow Sodali LLC to go through the motions? I guess Legacy has money to burn but no money to pay the Preferred Stock Holders past due dividends.

The change in the 2020 bond Indenture does not change any of the rights of the Bond holders to force any conversion of Bonds into Common Stock (as I read it, but I am not a lawyer).
Raw Energy profile picture

Thanks. The more votes LGCY receives from non-affiliated bondholders makes the voting of their own bonds less of an issue. i.e. if they receive 50.1% of non-affiliated bondholders' support, then a proper amendment would go through whether LGCY voted their own bonds or not. Obviously, they try to obtain the votes of holders of large positions first to ensure that they have enough votes before trying to get others to go along.

However, as big a reason might be to foreclose the right of any consenting bondholders to subsequently challenge what LGCY is proposing. Does it say that if you consent you waive any challenge rights to the amendment or anything similar? It might be better NOT to consent to the amendment in order to retain any such rights (including, potentially, the right to receive 101% of face currently if the proposal is not approved or is not valid). I would be very interested to see what they say about non-consenting bondholders, because usually to change a material economic term of the bond requires individual consent, from my experience (it is a contract right, and the right to receive 101% of face now rather than waiting 2 1/2 years to receive 100%, subject to all the economic risks that might entail, seems like it could be a material change).

The only change proposed relates to COC, as I understand it, not to any other provision(s).

All Baines had to do was read the Preferred Prospectus to find what the ratio of preferred to common on forced conversion is. It was no mystery.
Patrick Irish profile picture
The prospectus had the ratio and we knew lgcy was going C corp but what language says going to a C corp makes that a forced conversion? IANAL so maybe im missing it or dont understand the change of control section but i dont get it.
buyvaluenow profile picture
Some preferred holder should contact a class action attorney.
Patrick Irish profile picture
Its a very safe guess that a few preferred owners have done this. I agree a securities attorney should take a look at this "change of control" and see if management is pushing the limits or simply found a legal way to screw preferred holders. Also, people should contact the SEC about Baines buying before the announcement which was aggressive to the point that they may have known it was going to be converted at a ratio instead of the par value. I highly doubt Baines would have bought at these prices if the preferred got their $25 + suspended distributions converted over to stock.
georgemccreedy profile picture
So they announced they have voted the bonds that are not outstanding, to make sure no bondholders could call this a "change of control". I just don't see how the SEC lets that fly. There are parties that hold both bonds, and preferred. Legacy uses paid off debts to amend current bondholder rights that this IS NOT a change of control, while at the same time letting common shares (they control) vote to strip preferred rights, because in that equity class they are simultaneously claiming this IS a change of control.

It is, or it is not.
The entire Baines situation is extremely sketchy. If indeed Baines has thrown 100% of their assets into LGCY; alarm bells should be hammering inside SEC offices. I mean seriously.
SEC only goes after people that gets a story on the front page of the WSJ.
dylanlarose1 profile picture
OTT, you mention one of the risks about this investment being that Baines could stop buying. The stock has been taking a loss these past few days. Has anyone else noticed that on March 28th Baines, for the first time since early January, did not buy any commons during a trading day? These past few days their volume has been week with what they're buying. I thought that they would stop buying at a target price, but it almost looks like they are peatering out of extra capital to invest. I never figured out their strategy for buying. Their buys mostly looked like random prices and volumes, and would Baines sometimes let the stock fall after paying a premium on it the day before. why do that? Why not keep a limit order open in an effort to buy more in the dip, They know that they can control the bottom?
OTT Equity Analysis profile picture
As far as Baines goes, one of my observations was the urgency in which they were buying. They ran the price up quickly and exhausted the volume of sellers. I think their average price is probably still quite low, but you are right, why buy one day at $5 and then not at $4.30. It's likely they are hoping the stock will maintain it's price without them and are testing things out. They are probably not going to start being negative on paper until it heads under $2.50, so they probably feel pretty safe.

I think Baines still knows a lot more about what's going on and the next steps. It's going to be interesting, but they do have the rest of the market to contend with. They can control things as long as they keep laying down cash, which raises their average cost.

Like I said earlier, there are places to put your money that provide a lot more predictable returns. I don't really think the common represents a lottery ticket at these prices because there is so much to play out and there will certainly be some dilution at a lower price than the market.

So maybe there is a whole ton of dilution at the $3 level ... ish? I think it just limits your upside. It could still be really good upside, but not as much as I think some might suggest.

It all depends on your risk tolerance.

Preferred investors were frustrated because they had $6 of capital on the line with the very real downside case being 0, I don't think I would have held on if I felt the max upside was $9. That risk/reward is just not a good one.

On the common, the downside could still be zero, although not that likely. Other have said it would take fraud to get this (the common) to zero, I think it could just be some very stubborn debtholders that could cause that.

What is the upside? I think that's what you have to ask yourself. I don't think $20/share for the common is realistic once it all plays out, but heck, I didn't think $5 was a real scenario.

Interested in others opinions.
OTT. Thank you for your analysis.

I haven’t paid as close of attention to the debt issues as I should have, but I do think people are discounting the effect of $60-65 WTI on this company, as well as what happens if WTI heads to $70-80 in the next 6-12 months.

The story with LGCY is their unconventional Permian acreage. However, they still have a lot of conventional oil production and a doubling of the oil price makes a huge difference with regard to cash flow.

The oil price is the big wildcard, and a drop back into WTI $40s puts LGCY in a world of hurt.

Just do the numbers on oil production with $25 LOE and $8 of G & A + severance at $40 well head v $60 well head, and again at $80 well head.

My concern is insiders/management taking to much at the expense of retail common and preferred holders, in particular preferreds.
OTT Equity Analysis profile picture
Shallow Sand - I do agree that the oil and gas price makes a huge difference. We will see LOE's creep back up I think, but you are 100% correct.

I haven't updated my cash flow model for all the changes with GSO etc. It was especially difficult when details were light from the organization. Being out of the name now I don't really have the motivation to update any of that, but I am sure Daniel has projections he'll share at some point.

GSO is definitely going to get their payday and they already have to some degree.

I am definitely an oil bull overall and agree there are some solid prospects here.

Management did extremely well with their bond buybacks, they managed to escape their obligation to the preferred. The big question (as you raised) comes down to what piece of it the retail investor will end up with?

LGCY units are recovering well today compared to most other names I watch.
I would like to accumulate a position in LGCY puts prior to the debt for equity exchange, however I'm going to hold off simply because I think there is a good chance WTI moves to $80 over the next couple of months. Instead, I've just been bringing my position in MCEP common back up towards what I used to own prior to taking profits during the Jan 2017 run-up.
OTT Equity Analysis profile picture
There are definitely some other plays with less moving parts and surprises. MCEP falls into that category in my opinion.

With Baines still in the mix and the oil price environment the way it is, it's like shorting the chinese market; You could do really well one day, only to find the government is buying the next day.
I would like to hear other opinions but the change of control provision gives preferred shareholders the option to receive common shares, not the obligation.

The idea was to make it expensive for an unsolicited offer to take over the company.
Raw Energy profile picture
LGCY's interpretation and the wording of the PA makes an exchange into "units" subject to a COC redemption put for holders, but not a merger, which is an "Alternative Consideration)" (i.e. stock) and can be accomplished by a 50.1% vote of common holders, since pfd holders have no voting rights.
OTT Equity Analysis profile picture
I did find the article in which Daniel referred to making his switch. It is at https://seekingalpha.c... (you'll need pro access).

However, here is the comment. It was in response to a question around Daniel's switch from the preferred to common.

"Yeah, I did this actually right before the end of 2017. I read through the Preferred documents for when they were issued and spoke with investor relations and what they told me is that the Preferred could be converted at 1.962 times the common units but without the accrued distributions added in. It's really convoluted but I had probably 3 calls with investor relations involving this and that's what I took away from it. :("
The Preferred Prospectus had the exchange ratio of Peferred to Common spelled out. Is there anything similar in the prospectus for the 8% 2020 Bonds?
Is there a scenario where the Bond Holders would be forced into exchanging Bonds for Equity?
If there is can you point it out?

OTT Equity Analysis profile picture
"Is there a scenario where the Bond Holders would be forced into exchanging Bonds for Equity? "

As far as I know, there will have to be a vote that allows this, others will know more. Given that management only owns 22%, I'd say they are a safer place than the 2021 notes.
Raw Energy profile picture
There is a MUCH more detailed description of what happens to bonds. Basically, they get 101% of face, which gives holders a specific dollar expectation.

However, here LGCY has acquired s significant position in its bonds that it intends to vote (i.e. interpreting that those bonds are still outstanding for legal purposes even though they are considered retired for accounting and tax purposes). In addition, LGCY obtained agreements with other note holders to waive their rights to demand COC payments and/or to amend out the COC provision in the notes, which might require 2/3 vote (which LGCY now effectively "controls" already) IF the terms can be amended in such a material and adverse way to non-consenting holders without their consent.
Have you seen this "buy your own debt and hold for voting rights" method used before? I get the on its face legal argument being used here. But if this was allowed it seems many companies would have used it before. Heck companies could when issuing new debt issue and buyback 51% of a given offering and then have voting control to accept lower payouts.

The fact that I've never seen it before tells me there are issues with this strategy.
Raw Energy profile picture
Thanks for expressing the viewpoint of many LGCY pfd holders. The transaction will obviously get much scrutiny after the S-4 is filed to disclose the relevant terms and discussions surrounding the transaction.

As one point of clarification, Baines by owning >10% is considered an "insider" at LGCY, and my understanding is that it generally cannot sell its common units without paying to LGCY any profits earned on any purchases and sales matched within any 6 month period (Sec. 16, also known as the "short swing profits" rule). There are very limited exceptions, but in any event changes would have to be filed on Form 4s just as their purchases have been. IMO
OTT Equity Analysis profile picture
Appreciate the added color Raw Energy.

This story is FAR from over.

I have two conflicting viewpoints here:

1. Common investors should bail while the price is inflated, leaving Baines and management holding the bag. This money should be put in other names that have a good upside exposure to rising oil and gas prices

2. Management could get their way and keep driving this higher. The common is definitely better off than it was before this move.

I chose option 1 the day this was announced, which is why you'll see I don't own anything in my disclosure. I respect others that choose a different path.

Be prepared for more twists and turns either way.
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