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Legacy Play in MLPs
06/12/2014 8:00 am EST
Our latest feature is an energy exploration and production master limited partnership, with properties primarily situated in the Permian Basin, Mid-Continent, and Rocky Mountain regions, explains Khoa Nguyen in Big Yield Hunting.
Midland, Texas-based Legacy Reserves LP (LGCY) is focused on long-lived oil and natural gas properties with stable, low-decline production.
The MLP recently announced a fairly transformative deal that will better diversify its resource base across both gas and liquids, while greatly increasing production and boosting cash flows. The deal should generate substantial cash flows to support the current distribution, while also creating the potential for future distribution growth.
Legacy formed a strategic alliance with WPX Energy (WPX) through a pending acquisition in northwest Colorado's Piceance Basin for $355 million in cash plus a portion of Legacy's newly created incentive distribution rights (IDRs).
The acquisition includes 2,730 low-decline natural gas wells. The deal's innovative structure includes an escalating working interest for Legacy, keeping production flat during the first three years, with a 10% annual decline rate thereafter.
It's a complicated structure, but the end result is that Legacy's production and reserves will rise significantly, without overly diluting unitholders. And there's the possibility to acquire more accretive assets down the road.
Though the complexity of the transaction may deter some investors in the near term, a high and rising distribution should lead to further appreciation in the unit price, which has already jumped as much as 15.7% since the announcement.
In other words, it's exactly what we're looking for from a Big Yield Hunting pick: a fat distribution that's well supported, with the prospect of future distribution growth as well as moderate price appreciation.
Unlike some acquisitions in the MLP space, the structure does not overly dilute unitholders. The deal also provides a significant incentive for Legacy's new strategic partner to drop down additional accretive assets to the MLP in the near future.
With the cash flow potential from additional drop-downs, Wells Fargo forecasts the distribution to rise by 4% annually over the next five years. The current quarterly distribution of $0.595 offers a forward yield of 8.6%.
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