Natural Gas Partnership IPO: Highlights from Eagle Rock Energy Partners' S1 Filing (ERE)

Eagle Rock Energy Partners filed an S-1 with the SEC yesterday. Note that this is a limited partnership IPO, which is somewhat different from a corporate IPO. Proposed ticker: (ERE). All excerpts are from the full SEC filing:

Company Description

We are a growth-oriented Delaware limited partnership engaged in the business of gathering, compressing, treating, processing, transporting and selling natural gas and fractionating and transporting natural gas liquids, or NGLs. Our assets are strategically located in three significant natural gas producing regions in the Texas Panhandle, southeast Texas and Louisiana. We intend to acquire and construct additional assets and we have an experienced management team dedicated to growing and maximizing the profitability of our assets[...]

We commenced operations in 2002 when certain members of our management team formed Eagle Rock Energy, Inc., an affiliate of our predecessor, to provide midstream services to natural gas producers. Since 2002, we have grown through a combination of organic growth and acquisitions. In connection with the acquisition in 2003 of the Dry Trail plant, a CO2 tertiary recovery plant located in the Oklahoma panhandle, members of our management team formed Eagle Rock Holdings, L.P., the successor to Eagle Rock Energy, Inc., to own, operate, acquire and develop complementary midstream energy assets. Eagle Rock Holdings, L.P. has benefited from the equity sponsorship of Natural Gas Partners, one of the largest private equity fund sponsors of companies in the energy sector, which since 2003 has provided us with significant support in pursuing acquisitions, including its equity investment of approximately $191 million to help facilitate our acquisition of the Texas Panhandle Systems and other assets.

Key Financial Data

Operating revenues: $509 million for 2005; $109 million in Q1 2006. Purchases of natural gas and NGLs: $394 million for 2005 and $100 million for Q1 2006. Operating income: $30.7 million for 2005 and an operating loss of $12.97 million for Q1 2006.

Net cash from operating activities: $39.07 million at the end of March 2006; $45.9 million at the end of March 2005.

Debt: Expect average debt level through June 2007 to be $413.8 million, comprising $400 million facility at Libor+2.5% and $13.8 million outstanding on revolving credit facility.

Cash Distribution Rate:

Upon completion of this offering, the board of directors of our general partner will adopt a policy pursuant to which, provided we have sufficient available cash, we will declare an initial quarterly distribution equal to the minimum quarterly distribution of $0.3625 per unit per complete quarter, or $1.45 per unit per year. The minimum quarterly distribution will be paid no later than 45 days after the end of each fiscal quarter, beginning with the quarter ending September 30, 2006. This equates to an aggregate cash distribution of $15.7 million per quarter or $62.8 million per year, in each case based on the number of common units, subordinated units and general partner units outstanding immediately after completion of this offering. If the underwriters’ option to purchase additional common units is exercised, an equivalent number of common units will be redeemed from Eagle Rock Holdings, L.P. and the Private Investors. Accordingly, the exercise of the underwriters’ option will not affect the total amount of units outstanding or the amount of cash needed to pay the initial distribution rate on all units. If we issue all of the Deferred Common Units in June 2008 (the earliest time at which such units would be issued), our aggregate cash distribution following such issuance would be $16.0 million per quarter or $64.0 million per year.

Key Competitors

1. Enbridge Inc. (ENB) in East Panhandle system
2. Duke Energy Field Services (DUK) in West Panhandle system
3. Anadarco Petroleum (APC) and Enterprise Products Partners (EPD) in Southeast Texas and Louisiana

Notable Issues To Watch For

The natural gas market is highly volatile as noted in detail by the company:

We are subject to risks due to frequent and often substantial fluctuations in commodity prices. NGL prices generally fluctuate on a basis that correlates to fluctuations in crude oil prices. In the past, the prices of natural gas and crude oil have been extremely volatile, and we expect this volatility to continue. The NYMEX daily settlement price for natural gas for the prompt month contract in 2004 ranged from a high of $8.75 per MMBtu to a low of $4.57 per MMBtu. In 2005, the same index ranged from a high of $15.38 per MMBtu to a low of $5.79 per MMBtu and, in the first three months of 2006, the same index ranged from a high of $9.87 per MMBtu to a low of $6.31 per MMBtu. The NYMEX daily settlement price for crude oil for the prompt month contract in 2004 ranged from a high of $56.37 per barrel to a low of $32.49 per barrel. In 2005, the same index ranged from a high of $69.91 per barrel to a low of $42.16 per barrel and, in the first three months of 2006, the same index ranged from a high of $68.35 per barrel to a low of $57.65 per barrel. The markets and prices for natural gas and NGLs depend upon factors beyond our control. These factors include demand for oil, natural gas and NGLs, which fluctuate with changes in market and economic conditions and other factors, including:

• the impact of weather on the demand for oil and natural gas;

• the level of domestic oil and natural gas production;

• the availability of imported oil and natural gas;

• actions taken by foreign oil and gas producing nations;

• the availability of local, intrastate and interstate transportation systems;

• the availability and marketing of competitive fuels;

• the impact of energy conservation efforts; and

• the extent of governmental regulation and taxation.

Our natural gas gathering and processing businesses operate under two types of contractual arrangements that expose our cash flows to increases and decreases in the price of natural gas and NGLs: percentage-of-proceeds and keep-whole arrangements. Under percentage-of-proceeds arrangements, we generally purchase natural gas from producers and retain an agreed percentage of the proceeds (in cash or in-kind) from the sale at market prices of pipeline-quality gas and NGLs or NGL products resulting from our processing activities. Under keep-whole arrangements, we receive the NGLs removed from the natural gas during our processing operations as the fee for providing our services in exchange for replacing the thermal content removed as NGLs with a like thermal content in pipeline-quality gas or its cash equivalent. Under these types of arrangements our revenues and our cash flows increase or decrease as the prices of natural gas and NGLs fluctuate. The relationship between natural gas prices and NGL prices may also affect our profitability. When natural gas prices are low relative to NGL prices, under keep-whole arrangements it is more profitable for us to process natural gas. When natural gas prices are high relative to NGL prices, it is less profitable for us and our customers to process natural gas both because of the higher value of natural gas and of the increased cost (principally that of natural gas as a feedstock and a fuel) of separating the mixed NGLs from the natural gas. As a result, we may experience periods in which higher natural gas prices relative to NGL prices reduce our processing margins or reduce the volume of natural gas processed at some of our plants.

Underwriters
Joint book managers: UBS, Lehman Brothers, Goldman Sachs

Use of Proceeds:

We intend to use the net proceeds of approximately $230.8 million from this offering, after deducting underwriting discounts and fees and offering expenses, to:

• replenish approximately $35.0 million of working capital that will be distributed to certain subsidiaries of Eagle Rock Holdings, L.P. and the Private Investors prior to the consummation of this offering; and

• satisfy our obligation to reimburse Eagle Rock Holdings, L.P. and the Private Investors for approximately $195.8 million of capital expenditures previously made on our behalf.

Offering Details
Offering 12.5 million units (14.375 million if the underwriter option is exercised). Total units post IPO will be broken down so that 28.9% will be in the public market, 11.3% private investor units, 57.8% Eagle Rock Holdings LP, 2% General Partner interest. The expected raise is approximately $300 million.