Kelcy L. Warren is the CEO of the General Partner of Energy Transfer Partners L.P. (NYSE:ETP) and Chairman of the Board of Energy Transfer Equity L.P. (NYSE:ETE), the entity that owns the general partner of Regency Energy Partners LP (NYSE:RGP). The string of major acquisitions and divestitures he led over the past ~30 months is listed below (the list excludes transactions within the Energy Transfer family such as asset drop-downs and other transfer of assets between related parties):
- In March 2011, ETP entered the natural gas liquids ("NGL") business through the $1.35 billion acquisition of LDH Energy and the formation of the Lone Star joint venture with RGP;
- In June 2011, Southern Union Co. agreed to be bought by ETE for $7.9 billion, topping a bid from rival Williams Cos (NYSE:WMB);
- In November, 2011 ETP sold its propane business to AmeriGas Partners, L.P. (NYSE:APU) for $1.46 billion;
- In April 2012, ETP announced it was acquiring Sunoco for $5.3 billion; and
- In December 2012, ETE and ETP sold certain Southern Union assets to Laclede Group for $1.035 billion.
The acquisitions total ~$14 billion, but interviewed on September 24, 2013, Mr. Warren made it clear more is to come: "You're going to see the resumption of some kind of M&A strategy that we deliberately shelved for quite a period now." The resumption came fairly swiftly - RGP announced on October 10, 2013, that it was acquiring PVR Partners, L.P. (NYSE:PVR) for $5.6 billion.
From a strategic, longer-term, perspective the benefits cited by management of this acquisition seem to make sense. These include:
- Increased scale: pro forma, RGP will be one of the 15 largest master limited partnerships, as measured by enterprise value (RGP's will exceed $15 billion);
- Potential reduction in cost of capital: the rating agencies typically require, among other things, free cash flow of ~$500 million to qualify for investment grade; this acquisition could help RGP move closer to its goal of receiving an investment grade rating;
- Basin diversification: RGP obtains presence in two prolific shale formations (the Marcellus and Utica shales in the Appalachian Basin, and the Granite Wash in the Mid-Continent (Texas inland region and Oklahoma);
- Acquisition of fee-based EBITDA: a majority of PVR's gross margin is generated by fixed-fee contracts. Marcellus, which is expected to comprise ~55% of PVR's EBITDA in 2013, is all fee-based. Also, PVR has coal leasing operations that generate steady free cash flow.
- Acquisition of growth projects: PVR has ~$1 billion of organic growth projects aimed at expanding its strategic position in the Appalachian Basin; these are supported by long-term agreements that have been announced with completion dates from 2014 to 2019.
In the near term, however, it seems to me this transaction makes it likely that RGP's coverage ratios (which, as noted in a prior article, have not been exhibiting strength) will face additional pressure. It also makes it highly unlikely that distributions will grow. The reason for that is the high price paid for this acquisition. Competition for pipeline assets is intense and the ~25% premium over PVR's October 9 closing price translates to in excess of 20x PVR's latest 12 months ("LTM") EBITDA of $275 million. Even if we assume 25% growth in the next 12 months, the multiple paid on a forward basis is ~16x, still very high. This is equivalent to a ~6% yield and compares very unfavorably with mid-teen yields that MLPs can typically generate via organic growth projects.
Table 1 below presents a back-of-the-envelope analysis that quantifies the near-term cash flow impact of the acquisition:
Of course, RGP will also incur substantial transaction fees (e.g., for lawyers and investment bankers) and other "one-time" expenses associated with the process of integrating the operations, so the cash shortfall is likely to be significantly greater in the first year following the acquisition.
RGP has ~210 million units outstanding and will have ~355 million units outstanding once the acquisition is consummated, so a ~$47 million drop in cash represents relatively modest dilution relative to the pro forma combined LTM EBITDA of $825 million. However, the prospects for distribution increases greatly depend on the ability to achieve the planned growth in PVR's EBITDA and to realize the planned synergies.
From ETE's perspective, the initial impact of the transaction will be modestly accretive as it stands to gain ~$20 million per annum in incremental distributions to be divided among ~281 million units outstanding. But ETE will benefit greatly if the forecasted results are achieved and is slated to receive an additional "kicker" once distributions grow beyond $0.525 per quarter. Currently, RGP's quarterly distributions of $0.47 is within the $0.4375 - $0.525 band that entitles ETE to receive Incentive Distribution Rights ("IDR") amounting to 23% of total distributions made. However, on quarterly distributions in excess of $0.525 ETE's share of distributions increases to 48%.
Following the acquisition, RGP's public unitholders will own ~42%, ETE and ETP will own ~20%, and PVR unitholders will own ~38%. Pro forma leverage will increase to a fairly high ~4.5x (vs. the current level of 4.2x an internal target of 4x).
In summary, I see RGP still generating low DCF coverage ratios, exhibiting relatively high leverage, and providing low likelihood of near-term distribution growth in light of its expensive acquisitions. Adding to my discomfort is the structural complexity surrounding ETE, ETP and RGP (for example, see page 3 of RGP's 2012 10-K report). In my opinion, the PVR acquisition also diminishes the potential for RGP to be acquired by ETP. So I remain on the sidelines and would not buy RGP despite the enticing 7.14% yield.