Over the past few weeks, we’ve profiled two of the case studies that we’ll be presenting for our upcoming speech on “Distressed Debt Activism In The Age Of Electronic Media” at the 6th Global Forum on Investing in Distressed Debt. In our first profile, we chronicled the public debate on General Growth Partners (GGP) between the long camp, consisting of Bill Ackman’s Pershing Square Capital and Whitney Tilson’s T2 Partners, and the short camp, consisting of Eric Hovde’s Hovde Capital. In our second profile, we documented Birch Run Capital’s activism on behalf of equity holders in the Chapter 11 bankruptcy case of Energy Partners Limited (EPL).

In our third and final case study, we’ll discuss our own work on Eagle Rock Energy Partners LP (EROC), a distressed master limited partnership that underwent a financial restructuring earlier this year to lighten its debt load and avoid looming covenant defaults. We believed that the restructuring plan supported by the company’s financial sponsor allowed the sponsor to unfairly steal value from public equity holders. We set up a website at www.fair-eroc.com advocating our views. In the end, our activism didn’t work – although forced to delay its first ballot due to a lack of support, the company mustered a majority of yes-votes on the second ballot to complete their transaction. Our egos were hurt, but our financial returns were not; the stock jumped ~15% on the announcement, and overall our investment in EROC generated a nice return. All’s well that ends well.

Below is an annotated stock chart of EROC. Note that this chart doesn’t fully capture the total return generated by EROC equity holders who held shares through the recapitalization; they also received value in the form of warrants and rights as part of the restructuring. Based on our calculations, unitholders received $1.25 to $2.00 of value from the rights / warrants package, which equates to a 20% to 33% contribution to a holder’s total return assuming a stock price of $6.

Below we’ll describe the situation and our activism, as well as relevant conclusions worth discussing. In addition to the foregoing and www.fair-eroc.com, we wrote about our investment in Eagle Rock Energy in this post in January.

The Situation

Eagle Rock Energy Partners, LP is a master limited partnership engaged in midstream natural gas gathering and processing and upstream oil and gas development. Prior to its recap, it also held a set of mineral rights, but sold these to Black Stone Minerals as part of the restructuring.

EROC went public in 2006 when Natural Gas Partners (NGP), a $7bn energy-focused private equity firm, essentially sponsored the partnership as a monetization vehicle. NGP and management owned the publicly traded partnership’s general partner, all subordinated units, and about 26% of the common units. It completed more than half a dozen acquisitions over the next few years, saddling the company with ~$800m of debt. When commodity prices crashed in 2008, the company’s forecasted leverage spiked and the company was forced to cut its unit holder distributions in April 2009. The company was forecasted to violate its leverage covenants in the second half of 2010.

In order to delever the company, Natural Gas Partners proposed a series of recapitalization plans to shareholders, beginning in September 2009. The plans were thinly veiled attempts by NGP to salvage value for their entirely underwater subordinated units on the backs of common equity holders. When MLPs like EROC halt distributions to common holders, the subordinated units begin accruing arrearages; for all intents and purposes, these accumulating arrearages render the subordinated units worthless. NGP offered to cancel the subordinated units in exchange for a hefty fee, a backstop for a rights offering at deeply discounted pricing, and various other bells and whistles that gave little value to common shareholders but unnecessarily complicated the proposed recapitalization.

Our Activism

Having seen other MLP recaps similarly mistreat common holders — many of which are dividend-seeking retail investors — in favor of the MLPs’ sponsors, we decided to set up a website to encourage holders to vote No to the proposed restructuring.

Our website was at www.fair-eroc.com. On the site, which cost us $10 and a few hours of HTML formatting, we uploaded our excel scenario analysis, comparing three scenarios: (i) no recapitalization, (ii) the NGP recapitalization, and (iii) an alternative and more fair recapitalization that didn’t compromise common holders’ rights in favor of subordinated holders’. We also wrote about our investment in EROC on our website here.

We think that our website found its way to most EROC equity holders, as well as the research analysts who covered the company. We received calls from holders large and small, and also had extensive conversations with one of the company’s two largest unitholders, which was working with the other large holder to negotiate revised terms for the proposal.

In the end, however, unitholders voted in favor of the plan. We’re not exactly sure why – the restructuring was clearly less than ideal, and we’re confident that NGP would have sweetened the offer if holders had rejected the initial proposal. But it’s ok – the stock traded up when the transaction was announced anyway. It appears that investors preferred cleaning up the capital structure and re-instating a distribution in the near-term than waiting a few more months for a better deal.

Conclusion

For our part, the activism was worth the effort. Our website allowed us to develop contacts within the EROC shareholder base and encourage other investors to support our stance with respect to the company’s proposed restructuring. We’re sure that our site helped increase the proportion of voters who voted against the plan, even though we weren’t able to break the 50% threshold. Given that our activism simply involved publishing some of our research, publicizing our position was time well spent.

While our EROC returns didn’t benefit much from our internet activism, we’re confident that publicizing our views will allow us to boost returns in the future, particularly in complex situations where we can simplify confusing transactions to the broader investment community.