Few things infuriate me as much as companies that advertise themselves to mom and pop investors as safe places to put money when, in realty, they can feel bankruptcy knocking on the door. When I was writing for Seeking Alpha in the early 2010s, there was a company called Linn Energy that billed itself as a monthly dividend income company for retirees that paid out dividends of 12-15%.The idea was, “Hey, give us $10,000, and you’ll collect $125 every month.” For retirees starved for income in the low-interest environment, it sounded tempting. And for those who were tempted, they got burned and lost all of their investment when Linn Energy filed for bankruptcy on May 11, 2016.
But the same story repeats itself every boom and bust cycle in the oil industry. In November 2019, the Wall Street Journal profiled Kimbell Royalty Partners and several other mineral/oil royalty stocks in the article “The Underground Way to Earn a 10% Yield in Oil Stocks.”
Kimbell, for those of you who are unaware, is a Fort Worth, Texas company that owns direct mineral interests throughout the major American basins (Permian Basin, Mid-Continent, Terryville, Appalachian Basin, Eagle Ford, etc.) and collects a fee from operators in the major drilling basins throughout the United States.
If you visit the Kimbell website, you will encounter these claims:
- We offer investors a compelling risk-adjusted cash yield through direct mineral ownership in over 13 million gross acres with more than 94,000 wells, without any associated operating costs or capital expenditures.
- Kimbell benefits from continued development of our acreage by leading operators, at no cost to us…
If you click the link to their Spring Investor Presentation, you will also encounter the claim: “Mineral interests are generally senior to all claims in the capital structure. In many states, mineral and royalty interests are considered by law to be real property interests and are thus afforded additional protections under bankruptcy law.
They include the claim that a direct mineral interest in a drilling basin takes legal priority over senior secured debt, senior debt, subordinated debt, and equity. There is even an additional claim that the working interest owner is entitled to 75-85% of production revenue and bears 100% of development cost and leasing expense.
When you read this investor presentation, you are specifically given the impression that your mineral royalty interest in Kimbell carries minimal risk. After all, the working interest owner, be it an oil supermajor or an exploration and production energy company, bears all the costs of drilling the oil while Kimbell gets to sit back and collect 15% to 25% of the production revenue without having to incur any cost to do so. It sounds like the perfect energy investment, especially since it has paid mouth-watering double-digit dividends since its 2017 IPO. If the working interest owner goes bankrupt, the mineral interest owner rides through the bankruptcy and can collect production revenue through the next operator that buys up the working interest in bankruptcy court.
Like many a tempting royalty interest investment, the devil is in the details. With Kimbell specifically, the devil is in the company’s most recently filed 10-K with the SEC.
On page 42: “As of December 31, 2019, we had approximately $100.1 million in borrowings outstanding under our senior secured credit facility. In connection with the Springbok Acquisition, we paid a deposit of approximately $9.5 million on the cash portion of the purchase price, which was funded by borrowings under our senior secured credit facility. We intend to borrow an additional $85.5 million under our senior secured credit facility in order to fund the remainder of the cash portion of the purchase price for the Springbok Acquisition, which is expected to close in the second quarter of 2020…”
On page 90: The long-term debt is $100,135,477 with all of it due within the next three years.
On page 83: The net losses in 2019 were $158 million.
On the Appendix F-6: Cash and cash equivalent, end of year, $14 million.
Page 14: “We have a $225.0 million secured revolving credit facility with an accordion feature permitting aggregate commitments under the secured revolving credit facility to be increased to up to $500.0 million, subject to the limitations of our borrowing base, which is currently $300.0 million, and the satisfaction of certain conditions, including obtaining additional commitments from new or existing lenders.”
In short, even though Kimbell was paying out double-digit dividends throughout the past few years, it was losing $158 million last year with oil trading between $57 and $64 per barrel. Most of the losses were a result of the financing and high-interest rates for the debt. It only had $14 million in cash entering this year, and only has the capacity to reach for maybe $300 million in additional credit. With production revenue collapsing, it is entirely possible that Kimbell could be looking at losses in 2020 that exceed the amount of money available under its credit facility.
In the investor presentations, Kimbell brags about the low-tax rate of its dividends/distributions to shareholders. The negligible taxation is because the payments have been more akin to a return of capital than a taxable dividend payout out from profits, and the lower tax rate was only available because Kimbell was decapitalizating itself with the payments.
Even with oil at $50 or $60, it was still looking at operational difficulties because it had $100 million in debt, $14 million in cash, and was losing $158 million. If oil stays in the $20s or $30s, I anticipate that the revolving credit facility will be exhausted by this summer and the company will be looking at bankruptcy. In my opinion, it would take oil prices above $80 per barrel to arrive within the next 3-5 months and stay there for these current Kimbell investors to survive with their equity intact.
This is all a shame, though, because the royalty assets are perfectly fine. If I were working for Seth Klarman or something, I’d want to show up in the Texas bankruptcy court to bid on the sale of these royalty interests once the debt is cram-downed and the equityholders and many of the debtholders are deservedly wiped out. The core business of collecting royalty income over a multigenerational period is lucrative, but in Kimbell’s case, it took out so much debt acquiring the direct mineral rights in the first place that the burden is too great to bear at $20 per barrel oil for an extended period of time. With a poor balance sheet, all of the bragging on the company’s website about the capital-light, advantangeous-place-in-the-capital-structure business model is rendered moot.