Mid-Con Energy Partners: Reduced Cost Structure Due To Management Agreement With Contango And Preferred Unit Conversion

Summary

• Mid-Con converted its preferred units into common units, eliminating the issue of preferred unit redemptions for cash, but increasing outstanding common units by over 800%.
• Contango is going to take over management of Mid-Con's assets, saving Mid-Con $6.5 million per year.
• Borrowing base was reduced by 33%, with a further reduction expected in November.
• Mid-Con's situation is improved, but it remains heavily leveraged, with a need to continue reducing debt.
• Common units need near $60 WTI oil to have a significant further upside.
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Mid-Con Energy Partners (NASDAQ:MCEP) announced a number of significant moves. Preferred unitholders (led by Goff Capital) converted all the preferred units into common units. CEO Randy Olmstead resigned from the company and most of its Board of Directors resigned and were replaced by new directors. Contango Resources is now serving as the operator of Mid-Con's assets, resulting in estimated savings of $6.5 million per year.

These moves help improve Mid-Con's longer-term outlook, although as its credit facility borrowing base was reduced by 33%, it will still be in debt reduction mode going forward.

Conversion Of Preferred Units

The $40 million in preferred units were converted into common units at a conversion price of $3.12 per unit. This contributes to Mid-Con's outstanding common units increasing from 1.55 million to 14.31 million. The conversion price was well below the original conversion price ($43.00 for the Series A and $30.60 for the Series B, adjusted for the reverse split).

The conversion of preferred units to common units addresses the question of how Mid-Con was going to deal with the August 2021 redemption date for the preferred units. It also saves Mid-Con the $3.2 million in annual preferred unit distributions and likely allows for Mid-Con's credit facility maturity to be extended from its current May 2021 due date.

This move is a positive for Mid-Con, although the large increase in outstanding common units limits the chances that longer-term holders of Mid-Con's common units (such as from 2019 or before) can make back their money.

Arrangement With Contango

Mid-Con also entered into a Management Services Agreement with Contango Resources. Contango will operate Mid-Con's assets for a flat services fee of $4 million per year (plus reimbursement of certain costs and expenses), a deferred fee component of $2 million per year, and warrants to purchase Mid-Con common units at $4.00 per unit.

Mid-Con estimates that this arrangement will result in $6.5 million in cash savings per year going forward. Thus, between the elimination of the preferred distribution and these savings, Mid-Con will see its cash flow improve by around $9.7 million per year.

Borrowing Base Reduction

These savings should help Mid-Con with its borrowing base issues. Mid-Con's credit facility borrowing base was reduced from $95 million to $64 million as part of its June 2020 borrowing base re-determination. This 33% reduction reflects the effects of the oil price crash, but should be reasonably manageable for Mid-Con due to its reduced cost structure.

It appears that Mid-Con's borrowing base is expected to be reduced further in November 2020, as it mentions that the credit facility amendment "aims to achieve $10 million in debt reduction through the next regularly scheduled re-determination of the borrowing base on or around November 2020."

Mid-Con has not released updated information about what its outstanding credit facility borrowings are, but I am assuming that it is around $64 million. It would then need to reduce its credit facility borrowings to around $54 million due to the expected further borrowing base reduction in November 2020.

Debt Reduction And Valuation

The effect of the cost savings (along with Mid-Con's) halt on capex for the rest of the year should allow it to generate close to $10 million in positive cash flow during 2020 at current strip prices. As it started 2020 with $68 million in credit facility debt, this would get it to around $58 million by the end of 2020. If Mid-Con's borrowing base gets reduced to $54 million in November, it would have a $4 million deficit (assuming no working capital changes), although it also mentioned the possibility of divesting non-core assets for further debt reduction.

Mid-Con's situation is improved considerably by its lowered cost structure and the elimination of its preferred units. However, it is still significantly leveraged and will be mainly focusing on reducing debt until the oil reaches the mid-$50s or higher.

At $50 WTI oil, Mid-Con's year-end forward leverage is projected to be around 3.4x. This decreases to 2.6x at $55 WTI oil. Mid-Con's common units probably still require $60+ WTI oil to have a decent upside. A 4.0x EBITDAX valuation at $60 WTI oil would make its common units worth around $3.55 per unit.

Conclusion

Mid-Con's series of moves eliminate the uncertainty around what will happen with its preferred units and also reduces its annual cash expenditures by close to $10 million. This should help Mid-Con continue to reduce its debt, which will be necessary due to its reduced borrowing base (with a further reduction expected for November).

Mid-Con's common units still probably need $60 WTI oil to have a significant upside though, as it remains heavily leveraged and also increased its common unit count by over 800% with the preferred unit conversion.

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.

Comments

[Boomshakalakah]

Everyone say congratulations Daniel Jones!

[darwon]

Daniel probably made a few thousand dollars, and Goff just walked away with 90 million dollars out of the 100 million increase in market cap. What's new...we get a few crumbs and the man gets 90 million. The system is fucked.

[wizard59]

what did they discover in the MCEP oil fields? GOLD?

[Elephant Analytics]

This is a good opportunity for anyone to get out of MCEP now. $9/unit gives it a 7.0x EBITDAX multiple at $60 WTI oil.

That's mainly a paper gain for Goff though. Harder for him to realize that gain, although I guess there could be enough gamblers to take a decent part of his stake off his hands if he tried to sell.

[twfry]

Considering they did not have to convert until 2021H1 this was an absurd bankruptcy that wiped out the common, and yes it was a bankruptcy, but one that left the debt in place. The preferred equity just took over 90% of the common for pennies.

[Patrick Irish]

What choice did they have? If they waited until 2021 and didn't have the money, would they lose 100% of the company?

[twfry]

They effectively lost the company today.

Management simply bailed and walked off leaving it to the preferred. They could have continued to follow the existing plan. If oil recovers (which it will likely by EOY) they would have had options to deal with the preferred.

[Patrick Irish]

I wonder if it was partially fatigue. I talked to the Jeffrey Olmstead at a conference a year or so back and asked them about the preferred. The other guy with him (CFO?) said it was the smartest question they got all day implying nothing else mattered. They told me some of the preferred investors were willing to negotiate but others wanted to basically hold out for more. Well I don't know what they wanted when oil was at $60 but I assume they wanted most of the company. All they had to do was wait as time was on their side.

Imo, the preferred was always in control of the equity returns. I think they could have held out for even a larger % but eventually wanted to take control so they can work on bigger problems. Specifically, this operation needs to prove to the bank it can pay them back.

I'm sad for anyone still in this because I held it for years thinking it could eventually get itself out of the debt. Its just not possible in any reasonable amount of time imo. I don't even envy the preferred holders as they have quite the work ahead to show their common is now worth something.

[QR Seven]

Looks like we all just got pushed further into the sinking sand.