Last week - on May 6 - two relatively minor players in the natural gas midstream sector announced a merger that should result in a couple of midstream MLP investments with very attractive growth prospects. The Inergy (NRGY) and Crestwood merger has quite a few moving parts, so first I will give an overview and try to clarify what is going to happen. The some investment recommendations.
Note: MLP companies such as Inergy and Inergy Midstream have units and pay distributions. The words stock, shares and dividends may be used here with the understanding that the rules of MLP units apply including the tax consequences of investing in MLP units.
For most of its existence, Inergy L.P. was a retail propane distribution company. The company grew by acquiring local propane sales companies around the country. The company had picked up some natural gas midstream assets and starting in 2011, a decision was made to focus on midstream and exit the propane business.
In late 2011, Inergy spun-off Inergy Midstream L.P. (NRGM) and the propane business was sold to Suburban Propane Partners (SPH) in the late summer of 2012. I covered the resulting prospects of Inergy as a midstream general partner with Inergy Midstream holding the assets in this article: After The Transformation, Which Is Better: Inergy Or Inergy Midstream?
Crestwood came into existence in late 2010. The private Crestwood Holdings was formed by private equity firm First Reserve and Crestwood Management, run by long time energy executive Robert Philips to acquire the GP interests and 60% of the LP units of Quicksilver Gas Service from Quicksilver Resources (KWK). After the purchase, the Gas Service MLP was renamed Crestwood Midstream Partners (CMLP).
In its 2 1/2 years as Crestwood Midstream Partners, the company has aggressively acquired natural gas midstream gathering and processing assets. As a result, Crestwood Midstream owns assets in almost every major shale gas play in the U.S.
Although both Inergy and Crestwood operate in the natural gas midstream sector, the assets each own are quite different with no overlap. Crestwood Midstream generates 95% of EBITDA from natural gas gathering, compression and processing - in the oil field stuff. Inergy gets 51% of EBITDA from natural gas storage and transportation and 43% from crude oil and NGL supply logistics. The Inergy assets primarily sit a little further downstream from the Crestwood Midstream businesses.
According to the merger announcement conference call, the company will be run by current Crestwood Chairman and CEO Robert Phillips. Inergy Chairman and CEO John Sherman will have a place on the boards of the merger follow-on companies. Most of the existing management teams will maintain their current responsibilities.
As a result of the merger there will be a company that generates revenue and earnings from many more parts of the midstream natural gas system between the well head and the end user. The end result will be publicly traded MLP companies with a market cap of $5.3 billion and enterprise value of $7.3 billion. One of the benefits expected out of the merger is that the combined company will receive an investment grade credit rating and the debt to EBITDA ratio can be significantly reduced over the next several years, reducing the risk to investors.
The actual merger of the two entities will be a multi-step and somewhat complicated process. Here is what will happen as I understand the process from the conference call materials:
- On June 14, NRGY will distribute the NRGM units it holds to the current NRGY unit holders with NRGY investors receiving 0.4321 shares of NRGM for each NRGY unit owned.
- Privately held Crestwood Holdings will pay $80 million for the GP interest of NRGY.
- Crestwood Holdings will transfer the GP and IDR rights of Crestwood Midstream Partners to NRGY in exchange for 39.5 NRGY units - post the NRGM distribution.
- Crestwood Holdings has a one-time right to exchange CMLP units for up to 29% of the outstanding NRGY units. This right is expected to be exercised.
- CMLP will be merged into NRGM, with CMLP investors receiving 1.07 NRGM units and $1.03 cash per CMLP unit.
Only that last step, which is expected to finalize at the end of September, requires a vote for unit holder approval. With First Reserve and its 43% stake in CMLP supporting the merger, the vote can be viewed as a done deal.
Once all of the exchanging and merging has been completed, two MLPs will be left standing. Inergy L.P. will be a general partner type MLP, holding the GP and incentive distribution rights of a much larger Inergy Midstream Partners L.P., which will hold most of the cash flow producing assets. Crestwood Holdings and First Reserve will be major unit holders of both L.P. companies and also the Inergy L.P. general partner interest which appear to not have IDRs attached.
When the merger was announced, NRGY popped up by 10%, NRGM dropped by about 7% and CMLP units opened higher by about the same 7% . NRGY stayed pretty flat for the rest of the week and the other two reversed and then recovered some of the initial price changes.
I have been watching Inergy L.P. and Inergy Midstream for a while to see how things would work out as far as growth and distributions. There has not been enough time for anything to happen and I have been happy to sit on the sidelines. I think the same tactic will work out OK with this merger. Wait until a quarter or two after the merger to see what becomes of the distributable cash flow and distribution level for the new, larger Energy Midstream Partners.
Inergy L.P. is a little more interesting, with a further shift the MLP GP type of company status. I would wait until after the NRGM shares are distributed in May and then possibly take a small position in NRGY to participate in the planned multi-year growth pattern the architects of this merger envision.