The Screen That Saw the Eagle Rock Deal Coming
In last week’s issue of MLP Investing Insider, I took the wraps off a new specialized tool we are using to find undervalued energy investments. Unlike other screens, it includes some metrics very specific to the oil and gas industry. After explaining a little bit about how the tool works, I set it loose on upstream MLPs.
Here are the results of that screen, sorted in order of ascending EV/EBITDA:
All dollar measures are in billions unless otherwise noted.
EV = Enterprise value as of May 15
EBITDA = 2014 earnings before interest, tax, depreciation and amortization
SM = Standardized measure, the present value of the future cash flows from proved reserves as of year-end 2014
EV/Reserves = Enterprise value in dollars per barrel of oil equivalent (BOE) of proved reserves
% Gas = Share of natural gas in proved reserves
As I explained in last week’s issue, an EV/SM ratio of less than 1 would value an MLP at less than its projected future cash flows from proved reserves as of year-end 2014. Of course I also warned that these cash flow calculations were based on the average commodity prices in 2014, which were much higher than they are at present. Nevertheless, the different metrics give some indication of relative value among MLPs.
Our screen shows three partnerships with EVs lower than their standardized measure: Sanchez Production Partners (NYSE: SPP), Eagle Rock Energy Partners (NASDAQ: EROC) and Mid-Con Energy Partners (NASDAQ: MCEP). In addition, both SPP and EROC were trading at an EV/reserves ratio of less than $10/BOE.
These partnerships seemed to be trading at bargain levels attractive to larger competitors. Thus, it was not a huge surprise last week when Vanguard Natural Resources (NASDAQ: VNR) announced the acquisition of Eagle Rock Energy Partners at a 24% premium to Eagle Rock’s unit price prior to the announcement. Following VNR’s slight gain in the wake of the announcement, the offer values EROC at $3.07 per unit, which would represent further upside from the current price of $2.74.
To be clear, we weren’t making any formal recommendations in last week’s issue. Our goal was merely to identify MLPs that might be undervalued relative to competitors based on certain financial measures. EROC was attractive based on its EV/EBITDA, EV/SM, and EV/reserves ratios.
I should note that we do have a history with Eagle Rock. When I came onboard with Investing Daily more than two years ago, Eagle Rock was listed as a Buy in portfolios for both The Energy Strategist and MLP Profits. It wasn’t too long before we spotted the telltale signs of a failing management strategy, so Igor Greenwald and I issued a Sell on EROC from the portfolios two years ago this week, at a price of $8.85/unit.
Since then, the unit price of EROC has declined dramatically. The $3.05/unit acquisition price is of little comfort to those who have owned EROC for the past two years. Over the course of the decline, we were asked many times if it was yet time to buy EROC. But as I warned in November 2013 in The Unkindest Cut for MLPs:
“EROC management may not be up to the task of executing like competitors. On the other hand, many feel that EROC units are oversold, and may present a buying opportunity. It may indeed be the case, but I would point out that many were making this argument about EROC six months ago when units were still north of $8. Today they are at $5.49. Is this the bottom? It could be, but trying to catch EROC at the bottom is not the kind of game most MLP investors should be playing.”
So we certainly stand by our call for investors to avoid EROC. Yes, units appeared to be undervalued based on last week’s screen. And that is the purpose of the screen — to identify undervalued companies and MLPs for additional due diligence. But given EROC’s history, the only compelling reason for investors to take a position was in the hope it would be bought out.
And the only compelling reason to do so now would be if you believed VNR’s current price, and the 12% upside it implies for EROC were sustainable. We think there are better opportunities elsewhere.