Atlas Pipelines: I'm Out of Here

I am writing this as a follow up to a good piece written by Marc Courtenay ("Atlas Pipeline Partners: A Painful Lesson in MLP Investing") and another piece written by Tim Plaehn ("Atlas Pipeline: Hang in There"). I have used information gathered from Atlas Pipeline's (APL) 2008 10K, the 4Q press release, the 4Q call, two institutional analyst reports and some previous discussions with the company. I come to a more pessimistic conclusion than Mr. Courtenay and believe that the company is facing a make or break situation and there is a distinct possibility the company may become worthless. I have been long APL for about a year and, while it is only a small position in my portfolio, I have lost about 90% on this investment. I have spent some time reflecting on my errors and have listed them in the second part of this article. But first, my thoughts on the company today.

APL is not a typical pipeline that collects a toll on the throughput of natural gas in its pipelines. It is, in fact, a natural gas liquids (NGLs) and natural gas (NG) sales company with the same commodity risk as an E&P company. Fifty percent (50%) of its revenue come from NGLs, petroleum products extracted from raw natural gas. NGLs cannot be hedged longer than about 9 mos. This compares to NG, which can be hedged out as long as 4-5 years. Therefore, APL is exposed to the spot price of NGLs, whose prices can vary widely and frequently. Additionally, about 25% of their contracts are under Keepwell agreements where the profit comes from the extraction and sale of NGLs and the company has to make up NG volumes used in the treatment process. These are complex, uncertain and a long way from a fee based toll on volume.

APL is now hurtling head long into a default under its credit agreement and may breech its Debt/EBITDA coverage of 5.25 to 1 in the first or second quarter of 2009. This is why the company is selling 3 of its best assets in a poor market.

Let us take a look at the company’s debt covenants, its EBITDA and the potential asset sales.

• The company is “close” to selling 3 of its assets, the Ozark FERC pipeline, the Appalachian gathering operations (tied to Atlas Energy) and a 50% interest in the new 9 Mile Processing Plant
• Based on 2 institutional sell side analyst estimations, the Ozark pipeline and the Appalachian operations generate about $75-80 of EBITDA. I was unable to see a breakout of the Ozark pipeline but find segment information in the 4Q press release for the Appalachian operations that showed EBITDA of about $32M. This squares with one of the analysts’ estimation, so I am in the ballpark. As the 9 Mile plant is new, I assume it is not producing much EBITDA but worth something.
• At 12/31/08, the company was in compliance with its debt covenants as it produced about $327MM of Adjusted EBITDA with $1,493MM of debt outstanding. Debt equaled about a 4.6 – 4.7x debt, under the 5.25x limit. However the company only complied as a result of a one time special arrangement with its lenders to allow $198MM of losses from the early termination of hedges. Without this, the company would have only generated $129MM of EBITDA and failed its covenant. This loss was the result of the correlation between oil and NGLs breaking down after refineries in the Gulf stopped buying NGLs after being damaged in a hurricane. The company was short oil in a rapidly rising market. To stop the escalating losses, they raised $200MM of new equity and bought out the contracts almost exactly at oil’s peak. While it is impossible to guess commodity markets, this shows how difficult and dangerous it is to manage this business. Management effectively tor up a $200MM bill and through it out the window.
• Assuming the company is able to achieve a sale price of the Ozark and Appalachia assets of 8 to 9x EBITDA, sale proceeds would be about $600MM to $720MM. The 50% interest in the 9 Mile Processing Plant will generate something as well. So if debt can be paid down by $700MM to about $800MM, the company will need to generate $152MM in Adj EBITDA from its remaining assets. I admit to being fuzzy on ’09 projected EBITDA but both analysts believe this is reasonable and possible. But asset sales are never done till they are done, this is a poor market and the company’s EBITDA is highly dependent upon NGL and NG pricing. There is no margin of safety here; if they do not sell assets at these multiples the company faces a bad fate and potentially a $0 share value.
• This is why the company has traded down so low and quickly; it could default and go to $0 (not that much further from here). Also, the company is highly exposed to the spot prices of NGL’s that cannot be hedged past 6 to 9 months. As Mr. Courtenay points out, it could all work out if management’s predictions and hopes come true. If they don’t; no downside protection.

So let’s look at management’s track record. In my humble opinion, these guys are certified value destroyers! The company purchased the Midkiff/Benedum and the Chaney/Dell systems in the mid-continent in July 2007. They wrote down all the $660MM of goodwill associated with that purchase at 12/31/08, 1.5 years later, just to be “super-conservative”. Management purchased these assets from Anadarko for $1.9billion and financed it with the proceeds from an equity offering of $1.1 billion and a debt placement of $830MM (they also put in place a $300MM line of credit) The goodwill represented about 35% of the original purchase price. I wish they had been super-conservative with the acquisition price rather than the goodwill. In my simple mind, this was a very bad acquisition and demonstrates management’s poor capital allocation ability. Let’s not forget the $200MM of equity thrown out the window due to the unlucky breakdown in correlation of NGL prices to crude prices. At this point, I don’t care if management is smart but in a bad business or dumb in a good business; the track record speaks for itself.

Management said on its last call that it wants to get more fee income and re-write some of its contacts, thereby admitting the inherent problems with the business. However, they are selling two of their businesses that actually generate fee income. So even if the asset sales go through, what is left for the shareholders is a terrible business. NGL prices cannot be hedged past 9 months and they subject to demand interruptions caused by severe weather in the Gulf. Since July 1 this company has lost approximately 90% of it value and like a good buckaroo, I rode it right down.

Since Mr. Courtenay mentioned the Coopermans, I thought it might be helpful to review what Wayne Cooperman said about Atlas America in March 2007 in Value Investor Insight. He recommended Atlas America pointing out that the company’s structure was “a bit complicated but that is one of the reasons we like it.” He also pointed out that the individual “publicly traded units now have their own currencies that they can use to do their own deal, which should benefit the entire system.” Referring to the combined Atlas Management Team, “This is a case where we know management very well and have confidence in their ability to create value. That is why we own approximately 10% of the shares outstanding.”

It turns out that Mr. Cooperman was mostly right. The business is a bit complicated, but in retrospect, I will side with Mr. Buffett and say that complexity is a vice, not a virtue. He was right, the individual units did have their own currency along with the need to spend it. And spend it they did. I have touched on the some of management’s results above. Lastly, perhaps the Coopermans knew management too well or at least misplaced their faith. Management has an undisputed record of destroying over $1.5 BILLION of value in about 6 months. I see almost no hope of recovering any of it.

In conclusion, my lessons learned:

• I took my eye off the ball, as it was a small position. I should have put in a stop loss at 15-20% down. Almost every position that I have been in that went down 20% went down a lot more.
• I did not do my homework. I relied on “smart guys, the Coopermans and Seth Klarman.
• I did not understand how the company made its money. I did not understand how subject they were to NGL prices that could not be hedged long term. I did not understand the complexity involved with hedging the company.
• I did not understand their sales contracts and how complex and vulnerable they were to commodity price swings.
• I did not appreciate the conflicts of interest between all the companies. Note that in January the company gave the general partner more preferred stock with a high yield. Leon Cooperman was not pleased with that one. Again, the business it too complicated.
• The company was too highly leveraged. When the credit markets ceased, I should have sold figuring the company was vulnerable.

Bottom line – I am out of here. I believe there are safer places to go with what is left of my money and there is little upside here with this terrible management team.

Disclosure: Author (currently) holds a long position in APL, AHD, ATN

Comments

[greeytop:]

I, too ,hold a small position in APL.It is merely one more very bad recommendation from the Stansberry organization.

Mar 16 11:19 AM

[antiquary:]

Thanks for turning me off a company I'd been considering. The truth of the matter is that for some companies, obfuscation is their main goal. It's their main shield against regulation and perceptive investors.

Mar 16 11:42 AM

[jpau:]

Skip, will you be holding ATN? What is your perception there? I cannot tell if they are being punished for APL's sins, or if it has to do with them not being fully hedged next year.

Mar 16 12:16 PM

[Wawizzle:]

I'm glad that I came to Seeking Alpha today. I was about to click my purchase button but your article has pulled some wool from under my eyes. Much thanks!

Mar 16 01:07 PM

[jimmy46:]

You didn't mention the parent company: ATLS

How do they benefit or suffer from this?

Are they walled off from the losses at
APL, AHD, ATN ?

One thing is for sure, the Cohens are paying themselves richly for stupidity.

Mar 16 01:40 PM

[divi-divi:]

Someone's been buying up shares of APL and AHD in this rally, certainly not indicative of an MLP going to zero!

Mar 16 01:50 PM

[John Polomny:]

I will play devils advocate. Your analysis is excellent however I am wondering with the amount of rigs being laid down, over a 50% drop in the last year and avaeraging around 45 per week, if natural gas may be putting in a bottom. The last time the rig count fell this much the gas price responded with an 86% increase over the next year. I am not suggesting that will happen again. What I am suggesting is if the price of gas and liquids were to have a serious move higher over the next year would it be enough to bail out management? What price for gas or liquids would be required in order to give them breathing room?

Mar 16 01:55 PM

[jimmy46:]

I did not appreciate the conflicts of interest between all the companies. """""

Could you go into some more detail here?
thanks

Mar 16 02:55 PM

[davidbdc:]

APL has issues, but there is a lot more upside than downside here.

If they can get a partner for some of their developments then the "pie gets bigger". Will they have lost some of the potential of the Marcellus? Yes, but can they exploit more with a partner than on their own? Yes. So 60% of a big development can be more than 100% of a small development.

And would it be better if they didn't have to sell some of the other assets? yes, but thats life. I would wait until the asset sales are announced and the impact on distributions in the future. What you left out is that after this month they have no major debt due until 2013 I believe....so thats a lot of breathing room. Even if the distribution was cut 33% it would still yield 25% at this level. The risk/reward here is pretty good IMO.

Mar 16 06:52 PM

[divi-divi:]

"Bottom line – I am out of here. I believe there are safer places to go with what is left of my money and there is little upside here with this terrible management team."

You failed to mention that APL has recently hired a
new CEO, Eugene Dubay to replace Cohen, so your comments about management's past mistakes is a mute point, but if you don't like the business model it doesn't matter who the CEO is.

Mar 16 07:35 PM

[Steve Ward:]

Kinder Morgan is similar to Atlas, a lot of incestuous relationships. Management uses these relationships to seek over-compensation and control.

Mar 17 11:24 AM

[Skip Olinger:]

AUTHOR RESPONDS:
Thank you all for your comments and questions. I will attempt to answer all questions in this reply.

As to some people bidding up the stock, I don't know anything about short term movements, reading sheep entrails or tea leaves. The company could sell its assets as planned and avoid defaulting on its bank debt and the stock will trade up, probably by a lot. However, if they don't and do default there won't be much left for the shareholders after the lenders get through. I will leave that type of investment to Bill Ackman or Marty Whiman. I try not to invest in companies that have a downside of $0. That leads to "gamblers ruin".

As to conflicts of interest and new management at APL, yes Mr Dubay is the new CEO of AHD and APL; however, if you look at the companies you will see that Ed Cohn and his son Jonathan still hold the positions of Chairman and Vice Chairman at APL and Mr. Ed is still CEO at ATN and ATLS. To me, it seems that the Cohns might still have some influence around there. I would also comment that a business model and management are interlinked. You might have a great business model but will not do well if management cannot execute. Furthermore, management in all 4 companies is virtually the same. There are numerous inter-company agreements including the sales contract between ATN and APL, the incentive distribution rights between APL and AHD, and the new preferred stock issued from APL to AHD. Are they really arms length, probably, but who knows.

As to compensation, let's say we don't have to worry about where the Cohn's next meal is coming from. There are about 20 pages in APL's 10K dedicated to explaining management's compensation programs. I did not have the time nor stomach to go into all 4 company's comp plans but it looked like shareholders took some dilution to their ownership percent over the years. From management's perspective, why work with one company when you can have 4 to get paid by?

Regarding rising NG and NGL prices, it sure can't hurt. If they went back to $80/bbl and $8/mcf I would think the company would be profitable. But remember, the company needs NGL prices to follow oil and gas prices and there needs to be a market for them. I make absolutely no prediction on the short term movement of energy prices or the weather. But, it is the next few months that really matter.

As to finding a jv partner, you might be confusing ATN with APL. ATN raises investor program money to fund well development costs. APL lays pipe to connect to new wells and then processes the gas and moves it to big long distance pipelines. Yes APL, along will all other domestic E&P companies, are capital constrained due to debt environment. However, the big issue here is not when their line expires but whether they go into default in the next few months. If they do default, the lenders will call the line immediately and may force liquidation of the company to repay the loans. You as a shareholder are at the bottom of the heap.

Atlas America is the parent company of all the other entities. Their income is a function of the distributions they receive from the down stream companies like APL. Yes they are affected by the fortunes of the other companies.

Atlas Energy Resources is probably the best of the lot. The downside is that their investor programs may get hurt by the new tax laws eliminating the upfront expensing of Indirect Development Costs. They are hedged for about 60-70% of production for this year and part of next (please confirm that on your own) but they are no Linn Energy that has it production hedged out 3 years.

My conclusion is that this company has a very bad record of capital allocation and has destroyed a lot of value for shareholders. They are very close to defaulting on their debt and that would bring down the whole company. I personally don't want to invest in a company that has a chance of going to $0 (not matter what the tea leaves or market might currently be implying). There have to be better investments than this company if you want yield and some upside from rising energy prices over the next 3 years. If you are comfortable with the odds that they will finalize 3 asset sales in a few months at prices sufficient to pay down enough debt to avoid default, put your money on the table. Best of luck.

For the record, I am out of all Atlas positions.

On Mar 17 11:24 AM User 213076 wrote:

> Kinder Morgan is similar to Atlas, a lot of incestuous relationships.
> Management uses these relationships to seek over-compensation and
> control.

Mar 17 01:29 PM

[Jack Walker:]

Skip,

This is a thoughtful and well-prepared article. We may well be near the bottom of natural gas prices but the complexity of this company and all of the financial engineering materially increases the risk and certainly increases the time necessary trying to understand the risk.

Jack

Mar 17 03:09 PM

[secmaven:]

Today's 17% haircut in the price of APL suggests that other owners are thinking like the author. If the company really had any future wouldn't the big boys who bought in at 40 and higher to fund its operations be dollar averaging their stock right now with big buys?

Mar 17 08:39 PM

[turbo47:]

Skip,
Thanks very much for your thoughtful analysis. I wish both of us had "been out of here" a lot sooner. My problem was I heard what I wanted to hear. ..had a nice chat with Ed Begley when the stock was at 7...as I recall a Citicorp analyst had blown the whistle about possible debt covenant problems in '09, so I called the company and heard what I wanted to hear. Nobody misled me, but me.
Sorry for both of us. Thanks again fror your take.
Turbo

Mar 17 09:40 PM

[Skip Olinger:]

Thanks for the compliment. The only problem is that the company may be running out of time and unable to wait for the market to improve.


On Mar 17 03:09 PM Jack Walker wrote:

> Skip,
>
> This is a thoughtful and well-prepared article. We may well be near
> the bottom of natural gas prices but the complexity of this company
> and all of the financial engineering materially increases the risk
> and certainly increases the time necessary trying to understand the
> risk.
>
> Jack
>
>

Mar 18 02:05 PM

[Skip Olinger:]

I spoke to Ed as well, nice guy. Funny, he didn't mention the possibility of default to me either. Their 4Q call was interesting in the fact that they announced quite happily that they were close to selling 3 assets but did not mention anything about their covenants. It wasn't until the Q&A that the subject came up. I have been in Ed's shoes and you want to present the information in the best possible light but you don't want to omit key facts either. I threw in the towel. I know Baupost significantly reduced their position. The Coopermans followed this one all the way down as well. We are not alone. The lessons are understand how a company makes it money and where the risks are, be ruthless about getting out if the stock goes down, set a bail out point ahead of time and just because a smart guy invests still do your own homework. Oh, one other, complexity is not your friend. Thanks for the comment


On Mar 17 09:40 PM turbo47 wrote:

> Skip,
> Thanks very much for your thoughtful analysis. I wish both of us
> had "been out of here" a lot sooner. My problem was I heard what
> I wanted to hear. ..had a nice chat with Ed Begley when the stock
> was at 7...as I recall a Citicorp analyst had blown the whistle about
> possible debt covenant problems in '09, so I called the company
> and heard what I wanted to hear. Nobody misled me, but me.
> Sorry for both of us. Thanks again fror your take.
> Turbo

Mar 18 02:21 PM

[RWRocksOn:]

where did you find the break out of the NGL's from revenue. I see that gas and natural gas derivatives are grouped under one line on the 10-K.

Raising capital by equity issuance when the stock was trading in the 40's was a good move by management for pre-existing stockholders. The goodwill in the Anadarko purchase had to do with the high price of gas and NGL's.
at the time. Management has no choice to write it off with commodity prices dropping - to do otherwise is fraud. Note that when prices go up, goodwill will NOT go up - GW can only go down.

The time to sell APL was long ago, when the price of oil was so high consumers were cutting back. The upside is much greater than the downside. If APL makes their debt covenants and the price of oil goes up even a bit more (can anyone say weak dollar) this can easily be a ten bagger within 1-2 years.

Also remember that APL paid out a substantial distribution for many years before slamming their management as a destroyer of capital. I agree they overlevered themselves.

Mar 22 09:19 PM

[PeteK:]

Wawizzle;
You'll be sorry that you didn't "Click the button."
You can't trust just one article and believe it.
There are 2 other articles that really saying the opposite.
Trust yourself, not what people write.

Apr 18 11:13 PM