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IPAA’s 12th Annual Private Capital Conference
Exit Strategies – LLCs, MLPs Royalty Trusts
Rick Brice – Director, Energy Investment Banking
January 19, 2006
2
Exit Strategies – LLCs, MLPs and Royalty Trusts
Linn Energy, LLC IPO Overview
Pros and Cons of a Public Structure
Evolution of the Structure
US Royalty Trusts
Canadian Oil & Gas Trusts
MLPs
LLC Structural Advantages
Approaches to Valuation
Keys to Success
RBC Commercial
E&P Yield Vehicle Discussion Topics
3
Linn Energy, LLC IPO Overview
Initial Public Offering
$246,750,000Linn Energy, LLC
Joint Book-Running Managers
RBC Capital Markets Lehman Brothers
A.G. Edwards
UBS Investment Bank
KeyBanc Capital Markets
Raymond James
Initial Public Offering
$246,750,000Linn Energy, LLC
Joint Book-Running Managers
RBC Capital Markets Lehman Brothers
A.G. Edwards
UBS Investment Bank
KeyBanc Capital Markets
Raymond James
First E&P LLC, and IPO of 2006
Full size deal priced at the top of the range (11,750,000 units at $21.00 / unit)
Valuation
• 10.4x EV / 2006E EBITDA
• $3.85 EV / Proved Reserves (Mcfe)
Over one year from conception to pricing
8-day roadshow
• 9 cities
– 13 retail stops
– 35 one-on-ones
• 70% Retail / 30% Institutional
– Many times oversubscribed on both fronts
4
Pros & Cons of a Public Vehicle
Strong valuation and cost of capital advantage
Acquisition currency
Greater market awareness of acquisition appetite and capability
Financing flexibility
Direct incentive for management and employees and strong management retention tool
Enhanced liquidity options for sponsors
Public company requirements and cost
SEC IPO process and ongoing filing requirements
Sarbanes-Oxley compliance
Continuous communication with investment community
Increased overhead
K-1 filing issue
ProsPros ConsCons
5
U.S. Appetite for Energy Income Securities
The average foreign ownership of the six Canadian Trusts listed on U.S. exchanges is approximately 60%
Canadian only exchange listed trusts average approximately 28% foreign ownership
15%
49%
72%74%75%
85%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Provident PrimeWest Petrofund Enerplus Pengrowth Harvest
$2,481
$2,847
$2,317
$6,658
$4,032
Market Cap (C$)
$3,585
Source: Scotia research “Oil & Gas Royalty Trust” from October, and internal RBC estimates.
6
Linn EV $740 mil., with strong growth characteristics
Linn RLI of 29 years with payout ratio of 74%
6+ years of organic drilling growth + ability to make acquisitions
94% hedged to protect initial distribution, future volumes hedged to protect downside and participate in upside
Growth through leverage, less equity dilution
Growth capex – 29% organic growth + ability to make acquisitions
Acquisitions below radar of other suitors
First mover advantage
Linn Energy, LLC
Average RLI for the group (34) 8.1 years (12.9-4.1) with payout ratio of 68% (98%-32%)
Trusts have historically relied on acquisitions to sustain and grow acquisitions
Canadian acquisition market expensive and scarce
Tax withholding for US investors
Canadian Oil & Gas Trusts
Largest trust EV $2.2 billion, median of group $300 million, smallest $60 million, no growth structure
Average reserve life of 11 years
No ability to make acquisitions
No hedging
No debt
No growth capex
Last trust formed in 1999, starting to see conversions
US Royalty Trusts
LLC vs. US and Canadian Oil & Gas Trusts
7
(1) Source: RBC CM. Includes Apache, Anadarko, Burlington, Chesapeake, Devon, EOG, XTO, Denbury, Quicksilver, Pioneer, Southwestern, Vintage, Brigham, Encore, Penn Virginia, W&T, St. Mary, Stone, Remington, Petroquest, Meridian, Houston Exploration, Newfield, Forest, Cimarex and Whiting.
(2) Source: RBC CM. Includes San Juan Basin, Hugoton, Permian Basin, Sabine, Dominion Resources Black Warrior, Cross Timbers, Santa Fe, Williams Coal Seam Gas, Eastern American Natural Gas, Mesa, Marine Petroleum, LL&E and Torch.
(3) Source: RBC CM. Includes Enerplus, Penn West, ARC, StarPoint, Harvest, Bonavista, Pengrowth, PrimeWest, Provident, Peyto, Petrofund, Vermilion, Shiningbank, Trilogy, Paramount, Baytex, Advantage, Progress, NAL, Crescent Point, Enterra, Esprit Energy, Focus, Fairborne, Freehold, Daylight, Ketch, True, Sequoia, Thunder, Zargon, Vault, Bonterra and NAV.
(4) Source: John S. Herold. Includes Advantage, ARC, Enerplus, Enterra, Freehold, NAL, Pengrowth, Penn West, Petrofund, PrimeWest, Progress, Shiningbank, True, Viking and Zargon.
Reserve LifeReserve Life
2004 Drill Bit Reserve Replacement2004 Drill Bit Reserve Replacement
30%53%
157%
411%
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
LINE E&P Companies(1) Canadian Oil & GasTrusts(4)
U.S. Royalty Trusts(2)
8x11x11x
29x
0x
5x
10x
15x
20x
25x
30x
LINE E&P Companies(1) U.S. Royalty Trusts(2) Canadian Oil & GasTrusts(3)
Linn Energy vs.Other E&P Yield Securities
Linn Energy vs.Other E&P Yield Securities
Growth yield vs. shrinking yield
High reserve life = lower decline
Return on capital vs. return of capital
LLC vs. US and Canadian Oil & Gas Trusts
8
MLP Comparison – What is Linn Most Like?
Linn Energy is the first E&P company to utilize the LLC structure - there are no direct comps Linn Energy’s distribution stability and growth prospects are most comparable to small cap MLPs Linn Energy’s structure is exactly the same as Copano
Note: Market data as of 1/17/06. Source: RBC Capital Markets .(1) General Partners of Crosstex, Enterprise, Kinder Morgan and Inergy.(2) Alliance, Natural Resource, Penn Virginia.(3) Atlas, Boardwalk, Buckeye, Copano, Crosstex, DCP, Genesis, Global, Hiland, Holly, MarkWest, Martin, Pacific, Sunoco, TC, Transmontaigne, Williams.(4) Enbridge, Energy Transfer, Enterprise, Kinder Morgan, Magellan, Northern Border, Plains, TEPPCO, Valero. (5) Average of Coal, Small Cap Pipeline / Midstream, and Large Cap Pipeline / Midstream names.
7.2%
2.8%
4.7%5.1%
6.3% 6.4%6.8%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
Linn Public GPs(1) Coal(2) Copano MLPAverage(5)
Small CapPipeline /
Midsteam(3)
Large CapPipeline /
Midsteam(4)
Comparative Yields
9
MLP vs. LLC Side-by-Side Structural Comparison
Characteristic MLP Structure LLC Structure
Non–Taxable Entity Yes Yes
Tax Shield on Distributions Yes Yes
Tax Reporting Form K-1 Form K-1
Percent of Units Subordinated 40 - 50% None
Subordination Period 3 - 5 Years None
Early Conversion Option (Subordination Period) Yes NA
General Partner Yes No
Incentive Distribution Rights Yes; up to 50% No
Voting Rights No Yes
10
The LLC Structural Alternative
Superior structure – all investors participate in all cash flow growth.
New investors are equal partners with management / sponsors.
Unity of Interest Among All Investors
Unity of Interest Among All Investors
Facilitates faster distribution growth as a wider range of acquisitions are accretive, and an LLC is never required to address IDR Problem.
Investors entitled to vote on election of board and certain other matters.
Eliminates conflicts of interest, confusion surrounding multiple public entitles.
With significant ownership, management and sponsors are strongly motivated to increase distributions.
Enhanced GovernanceEnhanced
Governance
Same Tax Benefits
Same Tax Benefits
Faster Distribution
Growth
Faster Distribution
Growth
Strong Management Motivation
Strong Management Motivation
Tax characteristics same as MLP – tax shield, Form K-1.
Management / sponsor liquidity does not require a second public vehicle (i.e. General Partner entity), and no subordination provisions, significantly improve management / sponsor liquidity.
Liquidity for All Equity InterestsLiquidity for All Equity Interests
Current demand for E&P yield has driven valuations to very attractive levels.Attractive IPO
ValuationAttractive IPO
Valuation
11
Factors Affecting Valuation
Factors Affecting Valuation
Val
uat
ion
Val
uat
ion
Comparable Yield ProductsComparable
Yield Products
Valuation Methodology
Valuation Methodology
Market will assess value primarily based on the trading of comparable yield products (Canadian E&P Trusts, Conventional U.S. Royalty Trusts, MLPs, etc.)
Key benchmarks are current indicated yield and projected 1 year forward yield
Primary methodology employed by market is cash-on-cash yield
EV/EBITDA and IRR may be used as secondary measures, particularly by institutional investors
Stability and sustainability of cash flows (Long RLI preferred) Market capitalization and liquidity “Name” recognition/sponsorship Structural aspects, i.e. subordination, hedging, etc. Growth potential in distributable cash flow per unit Composition of distributions – taxable vs. tax-deferred Management track record Corporate governance structure
E&P Yield Vehicle - Approach to Valuation
Primary valuation metric for the asset class remains cash-on-cash yield. The yield required by investors will be significantly influenced by the perceived stability of the underlying cash flows.Primary valuation metric for the asset class remains cash-on-cash yield. The yield required by investors will be significantly influenced by the perceived stability of the underlying cash flows.
12
Long reserve life
Organic growth
Strong acquisition story
Proven track record
Management credibility
Sustainability – through market cycles
Incentive to raise distribution
Hedging program, margin protection
Keys To Success For Linn Energy / Investor Inquiries
Low risk, low cost drilling
Operating control
Control prices and costs
Borrowing, short cycle time etc
Tax Shield 90%+
Diversification
Premium pricing
13
What are the benefits of an LLC structure as opposed to a C-Corp or MLP structure for an IPO?
The LLC model creates a “yield supported” higher valuation vs. a C-Corp., and removes a layer of taxation.
The LLC Model vs. the MLP model eliminates need for general partner and makes a marketing distinction from general partner Incentive Distribution Rights, which are typical for MLPs. Cash flows are shared by all owners equally and each unit counts as one vote.
How is cost of capital cheaper?
No hidden GP “Load” – making acquisitions more accretive to unit holders long-term versus a MLP IDR structure
The yield supports a premium valuation.
What is it about today’s environment that makes it right for a yield oriented E&P structure?
Low interest rates combined with strong commodity prices.
RBC (which has expertise in the Canadian trust market) has seen an increase in the U.S. ownership in Canadian trusts, signaling that a market exists.
What are the primary hurdles to an E&P LLC?
Registration and marketing.
Asset profile: the entity should have relatively long lived reserves, stable cash flows and low capex requirements.
Which is preferred to the keep cash flows constant with a declining reserve base, growth through acquisitions or exploitation?
Either is a viable method to maintain/grow the reserve base and production level, however, acquisitions will be used to grow more rapidly.
Q&A: Preliminary Issues Addressed
14
How do cash distributions flow to the partners (tax vs. return of capital)?
Cash is paid quarterly while the K-1 is distributed once per annum.
E&P cash flow is “MLP qualified income.” Therefore, any distributions in excess of net income are treated as a return of capital
What is the appropriate hedging strategy?
An aggressive hedging policy should be maintained to mitigate effects in near-term commodity price fluctuation. Collars and puts that protect the downside and allow participation in the upside should be considered. 3-4 years hedging on PDP volumes should be considered.
How will perceived increased commodity price exposure be perceived by the market?
The market seems to make little adjustment based on distribution risk. Absolute distributions and growth track record are much more correlated to resulting yield. Gathering and processing MLPs are among the lowest yielding MLPs, as the market has chosen to focus more on their aggressive growth than their commodity price exposure (POP, POL, Make-whole contracts).
Does the LLC mode work outside the Appalachia Basin
Yes, basins with long-lived reserves, predictable production profile, and low capital expenditure requirements are excellent candidates for a tax efficient E&P vehicle.
Q&A: Preliminary Issues Addressed
15
RBC Commercial
Patrick "Rick" Brice, Director, has over eleven years of experience with Exploration & Production companies and Master Limited Partnerships, having joined the Corporate Finance Department of RBC Capital Markets in Houston in June 1994. Mr. Brice graduated magna cum laude from Southern Methodist University with a B.S. in economics and a B.B.A. in finance.
Patrick "Rick" Brice, Director, has over eleven years of experience with Exploration & Production companies and Master Limited Partnerships, having joined the Corporate Finance Department of RBC Capital Markets in Houston in June 1994. Mr. Brice graduated magna cum laude from Southern Methodist University with a B.S. in economics and a B.B.A. in finance.
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Rick BriceEnergy GroupDirector
Phone: (713) 403-5642Email: rick.brice@rbccm.com
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$191,000,000
Penn VirginiaResource Partners, L.P.
has acquired assets ofCantera Resources Holdings LLC
RBC Capital Markets acted as exclusive financial advisor to Penn Virginia
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March 2005
$191,000,000
Penn VirginiaResource Partners, L.P.
has acquired assets ofCantera Resources Holdings LLC
RBC Capital Markets acted as exclusive financial advisor to Penn Virginia
Resource Partners, L.P.
March 2005
BRIGHAMExploration Company
Co-Lead ManagerNovember 2005
$103,500,000
Follow-On OfferingCommon Shares
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Co-Lead ManagerNovember 2005
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Follow-On OfferingCommon Shares
Lead Book-Running ManagerJanuary 2006
Initial Public Offering
$246,750,000
Linn Energy, LLC
Lead Book-Running ManagerJanuary 2006
Initial Public Offering
$246,750,000
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Lead Book-Running ManagerJanuary 2006
Initial Public Offering
$246,750,000
Linn Energy, LLC
Sole Book-Running ManagerOctober 2005
Initial Public Offering
$115,000,000
Tortoise North American Energy Corporation
Sole Book-Running ManagerOctober 2005
Initial Public Offering
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16
Final Thought
In the 90s everyone wanted to be like Mike…. Now in 2006, everyone wants to be like Mike…
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