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Review of a Long-term Holding: Breitburn Energy (BBEP)

May 11, 2012

It’s time to review some of my long-term holdings and see whether they are on track to deliver the returns I anticipated or whether they should be eliminated from the portfolio. One of my longest term holdings is Breitburn Energy Partners LP (BBEP) which I first purchased during Fall 2008, the height of the financial crisis. The investment case was, as  always, simple; the partnership had just eliminated its distributions due to liquidity concerns and the unit price had plunged, yet with its forward hedging of production, the company actually had adequate liquidity to remain solvent for a number of years. As I recall something like 3/4 of the partnership’s projected production for the next three years was price hedged. Despite this, Mr. Market marked down the units so that they were priced at less than half of book value.  Then he marked them down further, and by the time I made my last purchase in January, the units were selling at about 1/3 of book value.

Since then, of course, the distributions have been reinstated (beginning in May 2010) and then have been increased slowly each quarter thereafter to the current distribution rate of $1.82 annually. This rate, however, is still below what it was pre-crisis.

There have been several secondary unit offerings over the past year, two by prior owner Quicksilver Resources and one benefitting the partnership. This has kept the unit price under pressure, and as of yesterday units traded at $17.40 or about 20% below the price they fetched a year ago. The latest secondary offering also diluted the book value down to about $20.55 per unit as of the end of Q1, also some 20% below last year’s level. My original target was to sell my units somewhere between 95% and 100% of book value. When the unit price briefly touched $22.00 last April, I sold 1/4 of my position assuming the unit price would continue its ascent. Wrong. With the market selloff BBEP unit prices backed off under $20 and remained there for the balance of the year.

BBEP suffers from the usual conflicts of interest in a GP/LP structure. The GP’s incentive is to increase the assets under management to maximize his fees. He pays the LP holders off with an attractive dividend yield to let him put his own interest first. So it is at Breitburn. The partnership purchased assets from Cabot last summer, bridged the acquisition with cheap borrowed money then floated their secondary in February to pay off the loan. During the first quarter they made another acquisition and just yesterday announced a further acquisition of assets in the Permian Basin.

As for operational results, they appear to be OK. Not stunning, but OK. In the latest quarter production was up over the same quarter a year ago and higher average oil prices more than offset the softer prices in the natural gas market. FCF seems to keep increasing and distributions continue to edge higher. The recent asset purchases point to higher future capital investments, confirmed in the last quarterly press release, which hopefully, though with some lag, will result in a commensurate increase in production levels (and FCF?).  Will the acquisitions result in further secondary offerings and dilution? I can hardly predict, though if history is any guide, probably yes. All this, however, is a bit outside my competence.  I have noted before that my original investment thesis has been realized, the distributions have been reinstated and the price of the units has doubled. So what am I doing still holding this investment? The truth is I have been unable to ‘pull the trigger’ and sell the position at less than 95% of book and with the units yielding more than similar MLPs. They appear to be still relatively undervalued.

At the current price the IRR of my investment in BBEP is about 33.5%, which I consider an acceptable rate, though it would have been significantly higher had I sold my entire position last year at this time. Given the dilution to book value since I purchased (from $24 to $20.55), I am now lowering my sell target to $20-$21 per unit and hope Mr. Market will accommodate me by year-end.

Yes, I know, had I had more discipline, this could have been a better investment. What can I tell you? I’m still trying to improve my execution.

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2 Comments
  1. rlp2451 permalink

    Breitburn owns the GP,does not have IDRs, and so does not “suffer from the usual conflicts of interest in a GP/LP structure.”

  2. Sorry, what I was referring to is that the GP/LP structure requires payout of fcf and therefore the only way to grow the partnership is to do a secondary equity offering if you’ve bumped up against borrwong limits. When the units are selling below book value doing a secondary is not necessarily in the interests of the existing unitholders (as they are being diluted) unless the returns on the incremental equity are greater than the returns on existing equity. Management, on the other hand, is often compensated on the size of the company they are running, not just on growth of fcf per unit. In any case, the unit price generally takes a hit on the announcement of a secondary, and partnerships that engage in serial secondaries often see their unit price penalized for long periods.

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