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IPAA’s 12 th Annual Private Capital Conference Exit Strategies – LLCs, MLPs Royalty Trusts Rick Brice – Director, Energy Investment Banking January 19,

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Presentation on theme: "IPAA’s 12 th Annual Private Capital Conference Exit Strategies – LLCs, MLPs Royalty Trusts Rick Brice – Director, Energy Investment Banking January 19,"— Presentation transcript:

1 IPAA’s 12 th Annual Private Capital Conference Exit Strategies – LLCs, MLPs Royalty Trusts Rick Brice – Director, Energy Investment Banking January 19, 2006

2 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 3 Linn Energy, LLC IPO Overview  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 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 Pros Cons

5 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 Source: Scotia research “Oil & Gas Royalty Trust” from October, and internal RBC estimates.

6 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 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 Life 2004 Drill Bit Reserve Replacement 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 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. Comparative Yields

9 9 MLP vs. LLC Side-by-Side Structural Comparison CharacteristicMLP StructureLLC Structure Non–Taxable EntityYes Tax Shield on DistributionsYes Tax ReportingForm K-1 Percent of Units Subordinated40 - 50%None Subordination Period3 - 5 YearsNone Early Conversion Option (Subordination Period)YesNA General PartnerYesNo Incentive Distribution RightsYes; up to 50%No Voting RightsNoYes

10 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  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 Governance Same Tax Benefits Faster Distribution Growth 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 Interests  Current demand for E&P yield has driven valuations to very attractive levels. Attractive IPO Valuation

11 11 Factors Affecting Valuation Valuation Comparable Yield Products 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.

12 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 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 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 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. Rick Brice Energy Group Director Phone: (713) 403-5642 Email: Comprehensive Product Offering Full Service Capabilities Customized to Clients’ Needs

16 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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