Mid-Con Energy Partners: Dirt Cheap
- Like Legacy, Mid-Con Energy Partners looks like an incredibly cheap company at this time.
- Lower debt than Legacy, plus a high standardized measure, supports this view.
- In most cases, it wouldn't be unreasonable for shares to trade a few times higher than where they are today.
It’s undeniable at this point that the oil market is fast on its way to rebalancing and that the risk for investors in this space is in the hands of the bears at long last. Many energy companies have already seen their market caps appreciate as investors search for value in a market that is otherwise remarkably pricey. One of the few names that has not risen materially, though, is Mid-Con Energy Partners (NASDAQ:MCEP), a micro-cap E&P operator with modest debt and attractive cash flow prospects if energy prices move any higher.
A look at the assumptions
In another article, I wrote about the prospects offered by Legacy Reserves (LGCY), an E&P operator that has seen its shares soar thanks to major buying from a small investment firm and due to management’s decision to change the company’s status from a pass-through entity to a C-Corp. In that piece, I showed that shares should be worth far more than where they are at today, and management later released an analysis similar to mine showing material upside.
Mid-Con isn’t so much different. Both are small E&P operators that have fallen out of grace with investors. Both have preferred stock that can be converted into common in order to lighten their loads and simplify their balance sheets. Both are pass-through entities that could benefit from a transition into a C-Corp if done the right way. However, there are some differences that need to be considered.
While both have debt, the picture with Mid-Con is far better. As of the last statement on the matter, management said that total debt is $90.2 million, all of which is credit facility debt. Legacy, on the other hand, has $1.37 billion in debt. In all, prior to making the announcement on switching to a C-Corp, Legacy’s debt made up around 78% of its enterprise value. For Mid-Con, that figure is 55%. Another difference is that, while Legacy’s Standardized Measure did rise materially from 2016 to 2017, Mid-Con’s rose enough that its value, despite being calculated at lower oil prices than what we are seeing today and despite two accretive acquisitions not being factored into its numbers because of timing, is higher, at $207.21 million, than the company’s enterprise value of $163.40 million.
Because of the similarities between the companies, it makes sense for a similar analysis to what I conducted with Legacy being applicable to Mid-Con. However, I would make the case that, while I will use the same range with Mid-Con as I did with Legacy, that the former should be worth a higher multiple than the latter. The lower level of debt, clear-cut conversion of preferred stock on a one-to-one basis, and the positive free cash flow this year of $21.19 million (assuming $70 per barrel of oil and $3 per Mcf of natural gas) warrants a premium to what Legacy is trading for.
Mid-Con looks extremely undervalued
As of the time of this writing, shares of Mid-Con are trading for $1.42, valuing the company at $42.77 million. Preferred stock, because it is convertible one-to-one and there are 21.43 million units outstanding between Class A and Class B, should be worth today another $30.43 million (par value of $40 million though). Debt is another $90.2 million, which brings us to the aforementioned enterprise value of $163.40 million.
Given how low the company’s enterprise value is relative to its Standardized Measure, you would expect for there to be a problem with the business, but I can’t find anything significant. Its credit facility was recently extended another two years through 2020 and increased from $115 million to $125 million. What’s more, free cash flow at $21.19 million and projected EBITDA of $39.99 million for this year, is robust.
The big question, though, is what are shares worth? In the table below, I looked at the first scenario of interest. In it, I assume that the business is worth somewhere between 5 times EBITDA and 10.56 times EBITDA (this number being drawn from NYU Stern’s conclusion on the average EV / EBITDA multiple for profitable E&P firms). In this first scenario, I assume that the company’s value is split in accordance with who is entitled to what. This means lenders get any such value in the business first, up to the $90.2 million outstanding, while preferred investors are eventually redeemed and made whole at $40 million.
*Created by Author
This leaves, at 5 times EBITDA, $69.75 million worth of value for the company’s common shareholders to collect. Today, that would translate into a per-share value on the business of $2.32, which is 63.4% above where shares are currently trading for. At the high end, with a multiple of 10.56, the common stock should be worth $292.09 million, or about $9.70 per share. That’s 583.1% above Mid-Con’s share price.
Of course, this isn’t the only way to look at the business. In the next table below, I looked at a different scenario. In essence, I valued the company as though, between now and the fifth anniversary of both the Class A and Class B preferred units, management buys back said units for cash (either by utilizing its excess cash flow or by selling off assets). While this outcome is unlikely, the firm’s preferred investors do have the right, on the fifth anniversary of the effective dates for both classes of stock, to force management to redeem them for cash.
*Created by Author
Assuming this does transpire and if the company’s value should still be between 5 and 10.56 times EBITDA, we are looking at even greater upside potential. By my math, at 5 times EBITDA, shares should be worth $3.64 apiece, or 156.3% above today’s price. At the higher end, 10.56 times EBITDA, the value is around $11.03 per share. That represents a premium over today of 676.8%.
The last scenario I looked at involves the most conservative, and probably most likely, outcome. Shown below, you can see a table that illustrates what would happen to the company’s share price if its preferred units are all converted into common instead of being redeemed. Under this scenario, and not factoring in the possibility of management using its strong cash flow to continue growing over the next couple of years, shares should be worth between $2.13 and $6.44 apiece with EV / EBITDA multiples of between 5 and 10.56. That represents upside of between 50% and 353.5%.
*Created by Author
Does any of this make sense?
One thing that’s important to keep in consideration is the fact that EBITDA is not an ideal financial measure. Interest is a real expense and depreciation and amortization should roughly be canceled out by capex in order to keep production flat. A better measure, I believe, is the price / operating cash flow of the business. Well, in the tables shown below, you can see what this figure is for Mid-Con.
*Created by Author
In the first set of figures, you can see that, at between 5 and 10.56 times EBITDA, Mid-Con should be trading for between 2.1 and 8.8 times operating cash flow. In the other set of figures, you can see that this number is between 3.3 and 10. The first set is the first scenario looked at in this article, namely that you deduct the value of debt and the par value of preferred from the enterprise value, leaving common to collect the rest. The second set involves management either paying off the preferred between now and their five year anniversaries, or watching the preferred holders convert into common. All of these outcomes show Mid-Con with a perfectly acceptable (and sometimes even very cheap) trading multiple.
Mid-Con is an out-of-favor company right now, but I don’t understand why. Based on my figures, shares of the E&P operator look incredibly cheap and they could easily rise materially. In the event that oil prices rise to $70 per barrel and stay there, cash flow is attractive and the business has tremendous upside. For me personally, with Mid-Con as my second-largest holding, I am waiting for shares to rise to around $8 or so before I’m interested in selling (unless the picture changes one way or the other).
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
This article was written by
Daniel is an avid and active professional investor. He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.
Analyst’s Disclosure: I am/we are long LGCY, MCEP. 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.
I am likely to buy more shares of MCEP in the future.
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