"It appears, on balance, that this is a fair transaction. It offers NGP a way to convert some long dated opportunities into shorter dated ones. It gives unit holders more short term upside while sacrificing a higher risk/ reward over the next few years. It also creates a catalyst as a result of the rights offering and the resumption of distributions. As valued today, these transactions moderately increase the value of EROC units to current holders."
"There are also some disadvantages:
*EROC loses a low risk line of business with upside
*The opportunity to assume the risk and reward of the debt pay down over the next 12-18 months is removed.
*These transactions will not be evaluated strictly on their benefit to unit holders, see conflicts of interest below."
Secondly, assuming the stock trades where it is at 4.70, when the rights are separated, the stock trades ex rights and is now worth $3.93. The rights are worth $.77 and the warrants are anybody's guess. Plug that into your valuation model. My guess is that an equity offering won't be available to most current investors unless they have a relationship with the lead underwriter so you have to subscribe for extra rights shares. The company takes $35million of its hard fought cash to pay as a fee for this "backstop" and gives another 8 million shares or about 7% of the newly outstanding shares to management as a bribe. All told this is massive dilution to resolve a problem that is being resolved right now with NG rising again. They want to do a deal because they think the bottom has been reached and don't want to miss their chance to steal the prize. Wake up man!!! NGP is NOT trying to help us!!
"The rights are worth $.77 and the warrants are anybody's guess. Plug that into your valuation model"
You're argument is that the valuation should be based on market price.
Instead my valuation is based on intrinsic value in turn based on discounting future distributions. I'm not suggesting that the rights will trade at their intrinsic valuation but a buyer with a reasonable timeframe could reasonably expect that to be worth that much over time if they exercised them.
Your rights valuation assumes the stock is trading at 6.90. In order for the rights to be "worth" your valuation we would need to see an additional 2 point rise from here. The correct way to value rights is: Value of 1 Right = Stock Market Value - Subscription Value divided by Number of Rights needed to Buy 1 Share of Stock. So right now it is .35* (4.7-2.5)= $.77. So correct you numbers to reflect reality. If the stock moves up or down, so will the value of the rights and you can adjust your values, but otherwise you might as well assume the stock is trading for 30 and give the rights an even higher more ridiculous value. We know the stock value now so why not use that.
Plan.Maestro, thanks for the comments. I'm interested in your thoughts on the magnitude of the valuation. In fairness my valuation is based on a relatively low base case based on most recent financials rather than a normalized version. The hedges in place over the next few years largely limit the upside and downside but further out I've just assumed a 3% distribution growth so no real growth.
Most importantly for those evaluating the deal, the assumptions pre and post deal are the same. As you've pointed out, it at least gives some comfort that the deal is OK and is a catalyst.
I bought some more at the open & I'm looking forward to seeing how the rights trade. I expect they'll trade at a discount providing a decent arbitrage opportunity.
I don't disagree with your analysis, except that I really don't agree with your evaluation of the subs.
Honestly, even if your analysis is right, EROC has better things to do with its money than to retire obligations that won't be ITM for 13 years per your estimate.
Right now the cash flow goes only to the common units. Converting the subs is what gives MOST of the dilution in this deal.
I'd be willing to get rid of the arrearages if the subs were exchanged for some security OTHER than common units (possibly just straight up warrants with a strike price above $12.50), but EROC should not be sacrificing cash OR dilution at the current price to retire these subs.
"I don't disagree with your analysis, except that I really don't agree with your evaluation of the subs.
Honestly, even if your analysis is right, EROC has better things to do with its money than to retire obligations that won't be ITM for 13 years per your estimate. "
You're right! EROC have much better things to do with their precious cash. EROC are buying back very long dated liabilities at a relatively small discount to current fair value.
I guess that's the price we're (as unit holders) paying for this deal. We're not paying 36.5M in cash for this deal, that's a fair payment for the subs. Instead what we are paying is the poor use of cash to buy back the subs. In turn for that "payment" we get everything else that NGP is offering.
Without the repurchase of the subs I don't think NGP would make the deal so the whole thing has to be viewed as one offer. Some of it good for holders and some of it good for NGP.
I also don't like the size of the management rights. I never do!
Aside from Plan's work, that's the most cogent piece I've seen on this. And I hate it, it puts a spike in the #1 reason I bought this, the prospect for future yield. I'd gladly trade a short-term gain for long-term cash flow. Besides, if we do nothing and in 2011 distributions are like $1.60 a share, where do you think this stock will be trading? I'm agin it.