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 (NYSE: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