The chart below describes the key factors contributing to EBITDA growth through 2020. EBITDA growth from new production in both the Permian Basin and East Texas are the largest contributors in both 2019 and 2020 ($160M and $409M) respectively. Note how the small decline rate of historical production allows new horizontal production to have a dramatic impact on EBITDA. They are not replacing EBITDA; they’re adding to it!
Below is a similar bridge showing production growth from 2018 to 2020. Again, note that new Permain and East Texas production are the dominant factors as they build on top of the stable base of conventional production.
We believe that the market has not yet realized the underlying value of Legacy’s assets and the incredible growth potential that its new strategy presents. As the company continues to deliver operationally, this hidden value should begin to be unlocked. Given the dramatic growth forecasted and Legacy’s nature as an equity stub, we think that using a forward EV/EBITDA multiple is the most appropriate metric for approximating fair value. Accordingly, our year-end estimates of fair value are based on a 6x multiple of next year’s EBITDA. (As a reference, the average forward EV/EBITDA multiple for 20 peer E&P companies as of 9/14/18 was 6.3, ranging from 3.7-9.9)
We estimate “fair value” of the operations to be roughly $14 per share by year-end, after giving effect to the conversion of the 2023 Notes (and greater than $50 per share by 2021 if they choose to follow a path similar to the one outlined above). However, we don’t know if or when the market will realize this value. What is the margin of safety? What is the “intrinsic” value?
The previous section presents a valuation based on the operating potential of the business. It is instructive to also consider the value of the existing operation and assets, regardless of growth opportunities as a downside protection and as an indicator of current intrinsic value. This section presents a net asset value (or liquidation value) of Legacy’s assets.
We conducted extensive research on oil and gas assets, looking at comparable sales of both PDP reserves and undeveloped acreage from 2015-2017. In the Permian we estimated the value of the acreage by county, using actual transactions in the vicinity of Legacy’s current assets. This required some assumption of the geology available in each county both in Legacy’s assets as well as in the comparable sales. These should be very conservative estimates of PDP and acreage value given the oil price environment and overall sentiment in 2015-2017. Current market pricing is likely higher.
Liquidation Value (assuming an orderly liquidation of assets):
Current Production (PDP reserves): $1,416m
De-risked Permian Acreage (56k net acres): $850m
Other Permian Acreage (Est. 194k net acres): $97m
Shelby County Acreage (13k net acres): $32m
Other Assets (pipeline/ infrastructure): $100m
Total Estimated Liquidation Value of all Assets: $2,495m
Net Debt (as of June 30, 2018): $1,319m
Net Asset Value: $1,176m
Net Asset Value per Share (~106.1m shares): ~$11.08/share (i.e. intrinsic value)
Equity Share Price (as of 10/17/18): $4.94/share
Net Asset Value / Market Cap: 2.2x
CATALYSTS TO UNLOCKING VALUE
As discussed previously, Legacy completely lost its investor base. A yield-generating MLP that does not pay a distribution does not have a home in the investment community (it was an orphaned security). All analysts stopped covering it. After transitioning its legal structure from an MLP to a C-corporation, Legacy will now be exposed to a much larger universe of potential buyers, most notably index funds which will be forced to buy. There are numerous indices (e.g. Russell 2000, S&P 600, S&P Total Market Index, Dow Jones Total Market Index, etc.) - and even more funds that track those indices.