During these uncertain times, silence is rarely a good thing from struggling oil and gas E&P (exploration and production) firms. Yet that is what shareholders of Mid-Con Energy Partners (NASDAQ:MCEP) have had to contend with. After engaging in a 1-for-20 reverse stock split following an announcement about it on March 20th, the management team at Mid-Con went dark. Prior to that, on March 12th, the firm announced that due to the COVID-19 pandemic, it would be delaying the release of its first quarter earnings results to some unspecified point in the future.
Between the firm’s leverage and the sudden and violent downturn in energy pricing we saw earlier this year, there were questions over the company’s ability to survive. In truth, a bankruptcy filing could have occurred, especially if energy pricing had remained depressed, but instead of that management came out with an interesting series of developments aimed at creating shareholder value in the firm in the long run. The company is not entirely out of the woods yet, but with new leadership and a plan in place, the picture is looking better than it has in many months.
Some bold moves
The developments entered into by management can best be summed up as three distinct, but important, events. The biggest of these relates to the company’s preferred shares. Back in 2016, the firm took in $25 million from outside investors and issued to them Series A Preferred units. In 2018, the firm repeated the process with $15 million in exchange for virtually identical Series B Preferred units. These units each carried an annual distribution (payable quarterly) of 8%, or $3.2 million, but this figure would rise to 10% if the firm could not pay out the distributions in cash.
Preferred shares can be tricky because they never are one-size-fits-all. For instance, if management had made the units convertible into common upon a certain date, the threat of dilution or solvency concerns would be limited. However, the company agreed to give the holders of the Preferred the right to redeem these in exchange for cash at their aggregate par value of $40 million after five years (from the date of the Series A issuance). This means that for years now, the company had a coming maturity of what behaved like debt that would have been payable on August 11th of 2021.
Combined with $74 million in debt on its books, it was very possible that the end could have come for Mid-Con, but instead of going under the company struck a deal with its preferred holders. The firm issued them common stock now, plus they also bought, using an unspecified number of shares, the GP (general partner) interest from its GP holders. In all, this resulted in the issuance of 12.76 million common units (at a price of $3.12 per unit), on top of the 1.55 million previously outstanding and in the hands of common shareholders. The end result here is a significant amount of dilution for common shareholders, but the tradeoff seems worth it. The company is now off the hook for $40 million in principal payments due a little over a year from now, plus it no longer has to lose the $3.2 million in distributions it was paying each year.
The second change entered into by management was a redetermination of its borrowing base. Previously, the company was allowed to borrow up to $95 million under its credit facility, but this has now been reduced to $64 million. Management, unfortunately, has not provided an update on what debt looks like today, but we know that as of the end of last year, the debt on hand totaled $68 million and by February 28th of this year it had grown to $74 million. As part of this arrangement, management intends to sell off some non-core assets in order to reduce debt by at least $10 million by the next redetermination in November of this year. In prior articles, I have discussed the high PV value on the firm’s assets and detailed how the company might easily reduce debt and do so with little to no impact on cash flows.
The last big change entered into by Mid-Con was its decision to engage Contango Oil & Gas (MCF) as a service provider for it. Instead of the current operational team running the business, Contango will be taking over operations. In exchange, the company will receive $4 million per year in a fixed management fee, plus it will receive $2 million in annual deferred fees. Despite this, the move is slated to save Mid-Con around $6.5 million in costs per year compared to its 2019 fiscal year. Contango, as part of the transaction, is also receiving warrants giving it the right to buy stock in Mid-Con at a price of $4 per share, but the number and nature of these warrants beyond this has not been disclosed. That does create some uncertainty.
As part of these changes, management has pretty much stepped away from the firm. Its CEO has resigned and a new Board of Directors has been put in charge. This is probably for the best given everything that has occurred and it will give the company a fresh start. In light of the tough energy environment, management has also decided to suspend its capex budget so that it can preserve capital. This move is generally a painful one for E&P firms, but Mid-Con’s low-decline assets should help prop cash flow up as a result. In all, this will only be temporary and once energy prices rise higher, the business will be in a better position fundamentally.
Takeaway
Based on the data provided, it looks clear to me that while the dilution from this recapitalization is painful for common shareholders and certainly not preferable to the firm paying off the preferred units, it’s certainly value-accretive and is better than going through bankruptcy. Depending on the size and impact of its hoped-for asset sales, the company could go on to make a nice rebound, both in terms of share price and from a fundamental perspective, in the months to come, but the ultimate path it takes will be in large part dependent on what happens with oil and gas prices.
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