BlueKnight Energy Partners, LP is a “limited” holding at CoveStreet in that the Limited Partnership Structure limits its inclusion in non-taxable accounts. But it’s a good and ongoing tale of conflicts we often face in the analysis of public companies.

“Are they stealing with us or stealing from us” is a box check in our investment process. We analyze the proxy statement for compensation incentives, we analyze the history of capital allocation decisions to decide whether acquisitions add value or merely bulk, whether share repurchase is real or just stock comp mop-up, and whether they occur at tops of valuation when management feels flush and are pulled at cheap valuation because fear and emotional rigor mortis has set in. We also carefully look at “voting control” issues as far as different classes of stock and who owns what. As we have noted in the past, we are NOT fans of unequal voting rights because the number of management teams that have it is distinctly larger than those who legitimately command it.

Some brief history. In 2016, Blueknight was a mess as publicly-traded Limited Partnerships often are. They are usually “sold” to people who want yield, further dumb things are done to manufacture a growing yield, something externally bad tends to happen and the LP finds itself overlevered and paying a dividend they can’t afford. The dividend is cut, unhappiness ensues. Oh, and the General Partner of the LP tends to write itself into a document that favors the GP over the LP.

So a massive Mississippi family – the Ergons – who do business with Blueknight – was the white knight. It was complicated – read this.

Note this part:

“Ergon has had a long-term desire to help build a world-class midstream Master Limited Partnership and believes its investment in Blueknight will help achieve that goal. We believe that we are an ideal sponsor to help support and facilitate the growth of Blueknight through our experience in the ownership of pipelines, terminalling and storage facilities, and other similar assets. We expect Blueknight to be a growth vehicle on its own with support from Ergon.”

Well, we all know things change. The issue was that the structure of the “rescue” meant that Ergon owned the GP and was the majority owner of the preferred, but did not own a controlling equity interest in the LP. IF you wanted a BKEP to be a growth vehicle, you had to figure out a way to remove/refinance/convert the preferred stock in order for the cash to flow to the equity units. But given where interest rates were/are, a preferred stock that pays a 71 cent dividend is not an easy thing to give up for the benefit of others. And there was still the mess of the “energy” side of the business, which had nearly bankrupted the company. So, Ergon offered a fix in 2019:

“Ergon would acquire all the outstanding Common Units and Series A Preferred Units of the Partnership not already owned by Ergon and its affiliates for a cash purchase price of $1.35 per Common Unit and $5.67 per Series A Preferred Unit.”

So much for the public equity as a growth vehicle. While I doubt many people who owned the stock at 30 still own the stock today, the offer was met with predictable outrage and even the “Conflicts Committee” of the company couldn’t sleep at night. The deal was pulled.

So they did as a public company what they would have done as a private company: change management and sell the disaster of an energy business in BlueKnight which cleaned up the balance sheet, leaving it with an asphalt terminal and storage business that is solidly profitable, solidly cash-flowing with long term contracts and interesting growth possibilities, both in demand and the conceptual ability to trade assets with Ergon, who is massive in the asphalt world.

We got involved post the pulled deal and the announcement of the energy sale in both the preferred stock and the common. We figured that we would get paid to wait for either: a better deal; huge economic improvement in the company with conceptual desire for an infrastructure deal in Washington which would greatly benefit asphalt demand; and the possibility that Ergon would structure a doable and somewhat fair deal to “remove/refinance/convert the preferred stock in order for the cash to flow to the equity units.” IF done reasonably, it could be/have been a big stock.

Groundhog Day. “On October 8, 2021, Ergon submitted a non-binding proposal (the “Proposal”) to acquire all of the outstanding Common Units and Series A Preferred Units not already owned by Ergon and its affiliates at a cash purchase price of $3.32 per Common Unit and $8.46 per Series A Preferred Unit.”

Which prompted this response from the largest shareholder in the common units.

We will sum up for you: Weasel Move.

We are simply bystanders here given the diminutive size of our dog in the fight, but we are here to verbally cheer on those who defend shareholder rights and spend the time and money on behalf of others. In the words of Carl Icahn, “A lot of people have died fighting tyranny, the least we can do is vote against it.”

The ideal move here is for Ergon to convert preferred units into common at a reasonable ratio, which would create a very high yielding equity that would trade a LOT higher than $3.32. And then look at other asphalt-related assets at Ergon that can be dropped down at “reasonable” prices to the LP and grow it intelligently.

In the words of the great seer Wayne Campbell, “…and monkeys might fly out of my butt.”