Parsley ETP Model_$11.00 per Share_With Formulas.xlsx
An article by • Published Dec 8, 2020
Parsley Energy, A Mysterious Spreadsheet, Governance and Why Energy Investors Can't Have Nice Things
> $100 million in change-of-control payments related to a Tax Receivable Agreement between Parsley Energy and certain LLC owners (management team) have had sloppy and inconsistent disclosure
Father buying son's company in the PXD for PE deal raises governance questions
Future hypothetical tax savings are calculated to determine these substantial payments
Energy investors continue to face heads-you-win, tails-I-lose dilemmas
On October 10th, 2020 Parsley Energy, Inc. $PE and Pioneer Natural Resources Co. $PXD whereby PE would be acquired by PXD.
Scott D. Sheffield is PXD's President and CEO. His son, Bryan Sheffield, is Executive Chairman and Chairman of the Board of Directors of PE. Bryan is a 7.6% beneficial owner of PE stock and entered into a Voting and Support Agreement.
On October 19th, 2020 PE executed a "" which included the following language
3. Payment. The Parties agree that, on the Closing Date (as such term is defined in the Merger Agreement) (the “Closing Date”) immediately after the Effective Time (as such term is defined in the Merger Agreement), the Company shall make a payment to each TRA Holder listed on Annex B, and that, notwithstanding anything to the contrary in the TRA, each such payment shall be calculated in a manner consistent with the methodology utilized in the spreadsheet entitled “Parsley ETP Model_$11.00 per Share_With Formulas.xlsx” provided to Parent on October 20, 2020, a summary example of the output of which is attached hereto as Annex C (in calculating such payments, utilizing, for the avoidance of doubt, only those categories of inputs and assumptions set forth in such spreadsheet, but making necessary updates to the relevant amounts, percentages, rates and dates set forth therein) (such methodology set forth in such spreadsheet, the “Calculation Methodology,” and the amount of the payment to each TRA Holder calculated using such methodology, the “Termination Payment” and collectively for all of the TRA Holders, the “Termination Payments”).
Parsley ETP Model_$11.00 per Share_With Formulas.xlsx calculated that due to the the change of control language in the Tax Receivable Agreement () (Bryan) and his affiliates, approximately $5.8 million will be paid to Mr. Gallagher (CEO), approximately $4.7 million will be paid to Mr. Dalton (CFO) and approximately $8.2 million will be paid to Mr. Hinson (Co-founder, SVP Corp. Affairs).
The Tax Receivable Agreement ("TRA") is explained well in Pioneer's recent related to the deal.
Parsley entered into the tax receivable agreement in connection with its IPO, which IPO was completed using an “Up-C” structure. In an Up-C structure, certain founders continue to hold their economic interests in an operating company subsidiary of the IPO issuer that is taxed as a partnership, while the public is offered shares in a publicly traded parent corporation.
The units in the operating partnership are exchangeable for shares of the publicly traded corporation, and such exchanges, when completed, result in an increase or “step up” in tax basis of the operating company’s assets, which can be used to reduce corporate taxable income for the benefit of all stockholders.
The tax receivable agreement generally provides for the payment by Parsley to each TRA holder of 85% of the net cash savings, if any, in U.S. federal, state and local income tax or franchise tax that Parsley actually realizes (or is deemed to realize in certain circumstances) in periods after its IPO as a result of certain increases in tax basis and certain benefits attributable to imputed interest associated with the exchanges, with Parsley retaining the benefit of the remaining 15% of these cash savings.
Pursuant to the terms of the tax receivable agreement, however, if Parsley experiences a change of control (as defined under the tax receivable agreement, which includes the mergers), Parsley is required to make an immediate lump-sum payment equal to the present value of hypothetical future payments that could be required to be paid under the tax receivable agreement (determined by applying a discount rate equivalent to the one-year London Interbank Offered Rate plus 3%).
To be clear, PE has always disclosed the TRA. It was estimated at in the May 12, 2014 IPO S-1/A. Curiously, however, just over two weeks later, on May 27th, PE . Parsley ETP Model_$11.00 per Share_With Formulas.xlsx must be sensitive!
Noticeably, PE has paid +/- $0 in cash taxes and has had cumulative net income of negative $3.8 billion since 2014. In 2020 before the merger the company wrote off the TRA liability as a result of tax valuation allowance adjustments resulting from large reserve impairments. They are sitting on large NOL carry-forwards as a result of the impairments.
And yet Bryan Sheffield gets a change of control payment > $100 million as a result of his father buying his company and language allowing for payments on deemed, hypothetical future tax savings related to an Up-C merger structure.
“Hypothetical Tax Liability” means, with respect to any Taxable Year, the liability for Taxes of (i) the Corporate Taxpayer and (ii) without duplication, Parsley Energy, but only with respect to Taxes imposed on Parsley Energy and allocable to the Corporate Taxpayer, in each case using the same methods, elections, conventions and similar practices used on the relevant Corporate Taxpayer Return, but (i) using the Exchange Tax Basis as reflected on the Exchange Basis Schedule including amendments thereto for the Taxable Year and (ii) excluding any deduction attributable to Imputed Interest for the Taxable Year. For the avoidance of doubt, Hypothetical Tax Liability shall be determined without taking into account the carryover or carryback of any Tax item (or portions thereof) that is attributable to the Exchange Basis Adjustment or Imputed Interest.
Perhaps its plausible Parsley's ability to shield itself from cash taxes regardless of profitability is a result of the Up-C structure utilized, but more likely IDCs are driving the tax shield. Look no further than PXD, who has net received $5 million in cash taxes benefits since 2014 despite $2.8 billion of cumulative positive net income.
PE did change the TRA discount rate late in the IPO process and was sloppy in drafting of the document relating to the TRA payment calculations
PE filed its initial Form of Tax Receivable Agreement as an attachment to the April 11, 2014 S-1. The S-1 and the TRA were in conflict. The initial S-1 left calculated payment amounts blank and suggested future estimated payments were discounted back at one-year LIBOR+100 basis points ("bps")
For example, if the Tax Receivable Agreement were terminated immediately after this offering, the estimated termination payment would be approximately
$ million (calculated using a discount rate equal to the LIBOR, plus 100 basis points, applied against an undiscounted liability of $ million).
Meanwhile, the Form of TRA suggests payments should be discounted back at a different and higher rate
“Early Termination Rate” means the long-term Treasury rate in effect on the applicable date plus 300 basis points.
The S-1/A filed on May 5, 2014 followed the same conflict: L+100 bps in the S-1/A and long-term treasuries + 300 bps in the Form of Tax Receivable Agreement
The -S-1/A filed on May 12, 2014 finally referenced L+300 bps as the discount rate but no Form of Tax Receivable Agreement was attached
The Prospectus/424B4 filed May 27th also referenced L+300 bps as the discount rate, but throughout references the TRA. The form of TRA filed with the SEC at that point still contemplates long-term treasuries +300 bps
Only on June 4th, 2014 did PE file the TRA (dated 5/29/14), with one-year LIBOR + 300 bps included as the discount rate, after the IPO had concluded
The last minute and sloppily disclosed change in lowering the discount rate likely ensured tens of millions in additional payments due to PE management (L+100 is lower than long-term T+300)
Interestingly and confusingly, PE has carried the TRA liability on its balance sheet at a much lower amount than announced payments
Consistent with the idea disclosure has been poor, its unclear the correlation between the balance sheet liability carried related to the TRA, the accounting impact of the 2020 write-off of the liability and the calculated payments