Atlas Pipeline Partners: A Painful Lesson in MLP Investing

Before I invest my money in an investment, I work hard to do my own "due diligence" so I have no one else to blame but myself.

Part of that process involves getting opinions and analysis from people I believe are smarter than myself and have a fairly good track record.

Before I bought two helpings of Atlas Pipeline Partners LP (APL), I read everything I could get my hands on including the company's own web site. I wanted to understand the "key statistics", especially the balance sheet numbers.

Master Limited Partnerships (MLPs) can be very tricky to understand and analyze. That makes the "due diligence" process both important and more difficult.

Frankly, I've been terribly disappointed with the results of my investment in APL, and I'm humbled by the fact that even when we try to know what we are doing and what we are buying, we sometimes get "burned". Look at the awful 1-yr. chart below:

During these times it's even near-impossible to know where the bottom is with MLPs and energy companies like Enterprise Products Partners LP (EPD), ConocoPhillips (COP) and BP (BP).

Today's wretched economy and perilous stock market means both "danger and opportunity" for investors, but right now we are feeling the "danger" side and it is painful.

Many times there are forces beyond our control and unforeseen events that can make even the best "value" stocks plunge in the aftermath of a decent quarterly earnings report.

So it has been with APL, and the lessons I'm learning are myriad. First of all maybe we have reached a time where trailing stop-losses are more essential than ever.

Secondly, there are no opinions and analysis that are fool-proof, so don't invest in any company or human-directed enterprise where you can't afford to experience the results of "mistakes and miscalculations". Caution and circumspect are always essential.

When it comes to what to do now, I can't say it any better than one analyst has said it today. Chris Mayer who writes the newsletter Capital & Crisis explained to his readers his own frustration and lessons learned from APL.

Thank you Chris for allowing me this chance to share it and I hope it increases the number of readers who are interested in your work. For those of us who own APL, what you've written is more instructive than anything else I could find on the worldwide web today. Here's how Chris summed it up on March 5th:

Atlas Pipeline Partners

We got an earnings report from APL this week. APL owns and operates approximately 1,600 miles of natural gas pipelines in Appalachia. APL also owns 7,870 miles of gathering systems, a 565-mile interstate gas pipeline, seven processing plants and one treating facility.

You have to have a strong stomach to own APL. The stock has been cut nearly in half this week -- falling from $6 to about $3.30 as I write. There are a lot of things going on here. I will get into all of that more below.

But first, I want to say that I made two mistakes with APL initially. The first was that I compromised on my CODE system by admitting a company with such leverage -- APL has about a $1.5 billion in long-term debt, though none of it is due until 2013. It did not meet the “E” for excellent financial condition. I knew that. I rationalized it by looking at APL’s ample cash flows. And I was bullish on energy prices. Instead, energy prices tanked, and with them APL’s cash flows -- which gets to the second mistake.

The second mistake was not fully appreciating the commodity risk and complexity inherent in APL’s business. It is not as simple as pipelines would seem to be.

However, I’ve sorted through these things since we’ve owned it. And even though I don’t think we’ll see $40 per share for a long time, the current shares seem well below intrinsic value, assuming APL pulls through. I believe it will. While we wait, APL pays a sustainable distribution of 38 cents a quarter, or $1.52 per year -- assuming commodity prices fall no further . In a better commodity environment, APL has the potential to pay two or three times that.

A big part of APL’s cash flows is linked to the price of oil. That’s because a big part of its business is taking natural gas and turning it into natural gas liquids (NGLs) -- things like butane and propane. NGL prices tend to follow oil prices, averaging maybe 60% or so of the price of oil. Of late, that spread has widened even further, to little more than 50% of crude oil. This reflects lower demand from petrochemical companies and refineries -- the primary users of NGLs. Bottom line: This is hurting APL’s margins.

Lower natural gas prices also don’t help. Some of APL’s contracts give it 16% of the price of the natural gas that flows through its pipelines. Also, lower natural gas prices mean less drilling and fewer new wells connecting to APL’s pipelines.

And since APL has quite a bit of debt, the worry is that APL is going to have some financial trouble. The consensus is that APL will not meet its debt covenants. If that happens, the creditors come over the walls and extract their pound of flesh from the unitholders.

However, results from the latest quarter, guidance from management about APL going forward and a slate of impending asset sales mean that APL should meet all of its covenants and keep its creditors at bay.

Let’s take a quick look at each of these.

In the last quarter, APL generated distributable cash flow (DCF) of $75 million -- that’s after interest expense of $23 million. It’s also after some one-time gains. Back out the one-time gains and APL generated DCF of $37 million, or 80 cents per unit. This covered the distribution of 38 cents about twice. Volumes were up, and should be up again in 2009.

APL also wrote off all of its goodwill -- a noncash charge that led to the reported loss. Now book value is almost entirely made up of APL’s infrastructure assets with useful lives of 20-40 years. Book value per share is $16. That book value is a historic cost. The cost to build APL’s pipelines and processing plants today would be far greater than book.

Let’s turn to management’s guidance. Management anticipates $300 million in gross margin in 2009 -- even after the asset sales. If that turns out to be true, APL will be fine. The market doesn’t believe it. Management also maintains its current distribution of $1.52 annually is sustainable and “very likely to increase in the coming years.” It also said it expects to comply with all covenants with the asset sales.

Let’s move onto the potential asset sales, which include a 50% interest in APL’s Nine Mile processing plant, all of its Ozark assets and a portion of its Appalachian assets. These deals are not final. But management says we could expect to see them in a “few weeks.” APL also said that the deals would significantly delever APL.

Management did not give a dollar amount for these sales, so we can’t make too much of this right now. I don’t even want to speculate on how much these sales might raise. I suspect APL won’t get great prices in this environment, but we’ll see.

So what does it all mean and what do we do?

I’m leaving APL at buy, but realize it’s speculative. You have to have a strong stomach to own this thing. And if commodity prices go lower and stay there for a few months, APL is going to have problems. What ails APL is a heavy debt load and low commodity prices.

But it’s too cheap to sell at this point -- the distribution of $1.52 and the book value of $16 make the current price of $3.50 look absurd unless APL turns out to be a zero. Based on management’s guidance and the potential asset sales, I don’t think it will be a zero. Also, natural gas and NGL pricing has been destroyed. Any bounce here would greatly help APL’s business.

And for what it’s worth, Leon Cooperman, the longtime successful investor, added to his position in the fourth quarter. He is the largest stockholder and owns nearly 10% of the units.

The last lesson I'm learning from all this is "keep our investments very, very simple". Part of the big problem evidently with MLPs is that they have a more complicated internal structure and company set-up. It's not about how many units of natural gas or barrels of oil can they sell or move.

MLPs apparently involve a more complex web of relationships, covenants and other factors that are not part of the "nuts and bolts" of corporations like Pepsi (PEP) or Ensco International (ESV).

Analysts like Chris Mayer have a tough job and I'm convinced they do the best they can with the knowledge they are given. But even the sharpest minds (think Warren Buffett buying lots of Procter & Gamble (PG) or ConocoPhillips ) overlook certain factors that can be very costly to investors and to themselves.

On a day like today when the Dow closes below 6,600 and the Nasdaq below 1,300, we need all the encouragement and lessons-learned that we can find. So many "bargains" and "unprecedented opportunities" have turned into "quick-sand" that it's making us downright "gun-shy".

Hopefully we won't loose our resolve, we will separate our emotions from reality, and we will end up much smarter investors in the long-run.

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please remember investments can fall as well as rise. And they will! - Advamced Investor Technologies LLC accepts no responsibility for any loss or damage resulting directly or indirectly from the use of this content.

Disclosure: Long APL, COP, EPD, ESV.

Comments

[Tim Plaehn:]

Very good analysis. I echo your thoughts on APL. In this market it is hard to tell if a company is really in trouble or just part of the general sell off. I was encouraged by the Q4 news.

Mar 06 08:48 AM

[User 9876:]

Thanks for the insight and sound thoughts. This is really a "misery loves company" moment. My experience almost exactly mirrors Marc's, and I've learned some painful lessons. At this point, I plan to hold on and ride the storm out. If Boone Pickens' latest prognostication on oil/NG prices are accurate, APL will be ok.

Mar 06 09:16 AM

[bluesmoke:]

Good article & comments. Although I don't own APL, I do own some royalty trusts that have suffered a similar fate. As with all investments my time horizon was 5 years minimum. At some point, I'm anticipating a rise in natural gas and oil prices. That combined with an increased demand in fertilizer ( which uses NG to make) should provide some lift. Famous last words. Until then I will let the income reinvest and wait it out.

Mar 06 09:51 AM

[Skip Olinger:]

I think your categorical condemnation of MLP's is a little extreme. Your point that you had better understand how a company makes its money is spot on. I sure did not understand this company's business. Another lesson is not to rely on other "smart guys" like Mr. Cooperman or Seth Klarman. It looks like Baupost punched out in 4Q of a substantial part of its holdings. Take a look at Linn Energy LINE, they have hedged 100% of current production out 3 years at approximately $80 bbl and $8 mcf. I think it is a much more straight forward business.

My brief analysis on APL is that no one including management realized how dependent the company was on NGL prices. Most of the profit from the company comes from the Mid Continent business they acquired a few years ago. Much of that business is under keepwell contracts where they get to extract the NGL's and sell them for their profit and have to maintain the NG flowing though. So this is not a simple business of just taking a toll on gas passing through its pipes. The company tired to hedge its NGL exposure when it made the acquisition using oil futures as a proxy for NGLs. This worked for a while until a hurricane shut down Gulf refineries for almost a year so there was no demand for NGLs and demand and prices dropped significantly. Therefore, the price relationship between NGLs and oil broke down. The company was left naked to a large amount of hedges that were rapidly going against it with rising oil prices last summer. The company raised $200M of equity to buy back the hedges at the top of the market. Perfect timing; just then oil prices fell like a rock. They basically threw the $200M out the window - bad luck. Now they appear unhedged for NGLs and are taking it in the shorts (technical term). You can only hedge out 6-9mos on NGLs vs 5 years with oil or gas. Now they are facing covenant breech and are forced to sell assets. If they can sell assets in this market the assets 1) have to high quality and 2) have to be sold a low prices. Not good for shareholders in the long run. The company said it is going to try to restructure its contracts to "fee based" going forward ie get a toll on the through put volume. Good luck. Oh, and as for the write down of the assets, to me that simply means they way way overpaid for a large acquisition whose business they did not understand. So it looks to me that this management has destroyed about $895MM of shareholder equity. Bad luck

What we pathetic shareholders are left with is Hope (which seems to be a reoccurring them these days and one that does not make a good basis for investment or running a country) Hope that they will be able to sell off good assets to avoid breeching their covenants. Hope that NGL prices return to more normal levels. Hope that they can rewrite contracts so the company is not so dependent on unhedgeable NGL prices. I hope management's luck changes.

Any comments or corrections on my analysis of the business would be appreciated.

Mar 06 10:20 AM

[La Marque:]

As a retail investor, I gave up on actual ownership of MLPs because of the tax reporting. Instead, I buy baskets of them by owning 2 different closed-end funds and APL is in one of them. Also it is the whole industry which is down and a CEF hedges losses.

Mar 06 10:28 AM

[jpau:]

I guess that would explain APL bringing in Dubay. Does this guy have what it takes to turn APL around?

Mar 06 10:41 AM

[Bruce909:]

The elephant in all of these natural gas companies is the big increases coming in imports of LNG to the east coast during the years ahead. How will this coming threat of low price imports affct APL. I have been watching APL for two years now but have not purchased yet. Any ideas?

Mar 06 10:51 AM

[jpau:]

Perhaps Marc or SkininCA can shed light on this, but if I understand this correctly, are the assets APL is attempting to shed, are they the assets most related to NGLs? Perhaps they are trying to migrate their strategy toward piping the bounty of gas that ATN is finding?


On Mar 06 10:51 AM Bruce909 wrote:

> The elephant in all of these natural gas companies is the big increases
> coming in imports of LNG to the east coast during the years ahead.
> How will this coming threat of low price imports affct APL. I have
> been watching APL for two years now but have not purchased yet.
> Any ideas?

Mar 06 11:12 AM

[notsosmart:]

good times all are right.bad times no one knows anything.homework & due diligence dont matter if management cant figure it out. the supposedly smartest people in our society caused this mess & the same folks cant fix it.its vegas combined with ponzi.

Mar 06 12:07 PM

[Skip Olinger:]

Good question. I am getting ahead of myself. I would like to do a bit more investigation before doing a full write up. However, APL's original attraction was that they had a percentage of proceeds contract with Atlas Energy Resources ATN where they got 16% of the sales price of the NG sold by ATN in exchange for building out the gathering pipelines to get their gas to market. And they still have that contract. The problem is that this represents a very small portion of their current revenues. They bought this much bigger operation in the Mid Continent with the keep well contracts that over shadow that favorable, easy to understand arrangement. I believe they said they were selling an asset in Appalachia as well as their Ozark pipeline and something else. Appalachia is their home turf and a growth area. It is where the Marcallas Shale is located and if you listened to the ATN call the same group of guys were jumping up and down about how great the future is there for NG and how much growth will take place at ATN. The Ozark pipeline is a regulated interstate pipeline and therefore it makes it money on tolls, just like you would think. So I am initially concerned about their selling these assets as they, I believe, have good growth and fee income, both goals they say they are pursuing.

Bottom line, it ain't good when a company has to sell assets to avoid default. Things are probably worse than they appear in the 4Q statements. But at this point the analysis is simply can the company survive. If it does the upside will take care of itself. If it does not, kiss your $2 good bye. I held my position all the way down so I am going to do more research. I'll keep you posted.

My big lessons here: use stop losses, know how a company makes money, and beware leverage, especially now.


On Mar 06 11:12 AM jpau wrote:

> Perhaps Marc or SkininCA can shed light on this, but if I understand
> this correctly, are the assets APL is attempting to shed, are they
> the assets most related to NGLs? Perhaps they are trying to migrate
> their strategy toward piping the bounty of gas that ATN is finding?
>

Mar 06 12:57 PM

[bradiop:]

Good article and great advise about understanding investment before investing.
I own a couple of MPL's and think you may be characterizing all MPL's poorly in light of a specific attribute of APL. APL had its revenue and margin highly tied to commodity prices. Sopme MPL's revenue and margins are not at all or not very highly tied to commodity prices and their business model is they get paid fixed prices on volume of product shipped and not tied to commodity prices.

Again thanks for great insight.
regards,

Mar 06 03:58 PM

[manusceo:]

One of the problems with MLP's has been hedge funds having to sell to meet redemptions or wanting to sell these as a result of lower commodity prices although many of the MLP's are pipeliners and commodity prices don't matter much.

Mar 06 05:57 PM

[henarl:]

Good article. I subscribe to Capital & Crisis so I had read Chris Mayer's piece on APL. Altho I don't own APL, I do have the following MLPs: KMP, OKS, LINE, MWE, and I recently sold PAA (at a profit). Those that I still have are down, along with the market in general, but I believe this is just a case of throwing out the baby with the bathwater. These are all excellent income holdings. KMP, OKS, and PAA are solid companies - LINE & MWE not so much but better than APL.
APL is now down to $2.65 and, at that price it might be a real good speculative gamble and I may buy a couple of thousand shares.
Yes, reporting taxes on MLPs is complicated but not impossible. They each send a schedule K-1 with all of the info you need in very concise and easily deciphered manner. Once you get used to it it's not a big problem and any tax professional can easily handle it.

Mar 06 06:21 PM

[upn42:]

Good analysis.I thought the company said 1.5 for the coverage ratio ? Don't believe the banks want to run a pipeline company or try to sell one so if APL makes some progress in sales the banks may waive ,at least for a short period of time ,a covenant violation.APL trades as if the bank is battering down the doors.WAY OVERSOLD based on applicable metrics and fundamental analysis


On Mar 06 10:20 AM SkipinCA wrote:

> I think your categorical condemnation of MLP's is a little extreme.
> Your point that you had better understand how a company makes its
> money is spot on. I sure did not understand this company's business.
> Another lesson is not to rely on other "smart guys" like Mr. Cooperman
> or Seth Klarman. It looks like Baupost punched out in 4Q of a substantial
> part of its holdings. Take a look at Linn Energy LINE, they have
> hedged 100% of current production out 3 years at approximately $80
> bbl and $8 mcf. I think it is a much more straight forward business.
>
>
> My brief analysis on APL is that no one including management realized
> how dependent the company was on NGL prices. Most of the profit from
> the company comes from the Mid Continent business they acquired a
> few years ago. Much of that business is under keepwell contracts
> where they get to extract the NGL's and sell them for their profit
> and have to maintain the NG flowing though. So this is not a simple
> business of just taking a toll on gas passing through its pipes.
> The company tired to hedge its NGL exposure when it made the acquisition
> using oil futures as a proxy for NGLs. This worked for a while until
> a hurricane shut down Gulf refineries for almost a year so there
> was no demand for NGLs and demand and prices dropped significantly.
> Therefore, the price relationship between NGLs and oil broke down.
> The company was left naked to a large amount of hedges that were
> rapidly going against it with rising oil prices last summer. The
> company raised $200M of equity to buy back the hedges at the top
> of the market. Perfect timing; just then oil prices fell like a rock.
> They basically threw the $200M out the window - bad luck. Now they
> appear unhedged for NGLs and are taking it in the shorts (technical
> term). You can only hedge out 6-9mos on NGLs vs 5 years with oil
> or gas. Now they are facing covenant breech and are forced to sell
> assets. If they can sell assets in this market the assets 1) have
> to high quality and 2) have to be sold a low prices. Not good for
> shareholders in the long run. The company said it is going to try
> to restructure its contracts to "fee based" going forward ie get
> a toll on the through put volume. Good luck. Oh, and as for the write
> down of the assets, to me that simply means they way way overpaid
> for a large acquisition whose business they did not understand. So
> it looks to me that this management has destroyed about $895MM of
> shareholder equity. Bad luck
>
> What we pathetic shareholders are left with is Hope (which seems
> to be a reoccurring them these days and one that does not make a
> good basis for investment or running a country) Hope that they will
> be able to sell off good assets to avoid breeching their covenants.
> Hope that NGL prices return to more normal levels. Hope that they
> can rewrite contracts so the company is not so dependent on unhedgeable
> NGL prices. I hope management's luck changes.
>
> Any comments or corrections on my analysis of the business would
> be appreciated.

Mar 06 06:34 PM

[Deegan:]

As buyers of shares in a MPL or any corporation, we have to believe management when they give us information. That is what we rely on when we do our homework or due diligence. Anyone that believes the tax reporting for MLPs are so difficult it overrides their decision to buy MLPs of course should not own it. However, I do my taxes with Turbo tax and don't find it that difficult. After doing my due diligence I bought APL and will keep it, come what may. It booked out over $15. At this price I will probably buy another couple of thousand shares. If the stock tanks, so be it. In case you hadn't noticed, the entire country including this industry have slowed down. The question is, will the economy turn around before the company is overwhelmed by debt?

Mar 08 12:04 AM

[Civilman:]

I own 30k shares of APL. I am very disapointed with both the reduction in income and reduction in share price. What will the future income of APL be? I have no idea. I did just buy another 15k shares @ 2.66 to cost average down. It was a gamble and I cannot defend my actions.

One thing I have learned that makes me feel better about the share price is the Short Interest. It appears as though it is not just hedge funds selling, but the Short ETF's shorting the heck out of the stock. Today there is over a five tradings days of volume that is shorted. I think the rise of the share price over the last few days is not necessarly "investors" but short covering. I am not planning on selling as I bought APL for income and tax deferal. Thank you to all who shared your thoughts as I have learned a lot from you. Let's all hope the earnings do continue and management does not step in pooh.

Mar 13 08:41 AM

[secmaven:]

The managers of APL, and especially the new CEO, do not want to lose their high paying jobs and will work hard to keep this partnership in existence. With a capital account value per share of over $15.00 reflected in the hard costs of impossible to replace assets given EPA considerations survival of the enterprise would seem to be in the cards. As as been pointed out if the interest on the debt is being paid a technical violation of the loan covenant is not going to bring a foreclosure action. This regulated business serves too many customers to be shut down even for a day by a bank looking to dismember it in an asset sale.

Mar 17 09:33 PM