Eagle Rock Energy Partners (EROC) made headlines Wednesday after announcing it was acquiring CC Energy II, known as Crow Creek. The purchase price of $525 million will increase the size of Eagle Rock greatly, seeing as EROC currently has a market cap of just under $1 billion.
Set to close May 3, 2011, the deal will more than double EROC's production and add significant possibilities to grow through drilling. In addition, the acquisition is expected to propel the distribution sharply higher, from an annual per unit rate of $0.60 right now to $1.00 per unit by the end of 2012. That prospect for that kind of supercharged distribution growth warrants a deeper look at Eagle Rock Energy Partners.
Eagle Rock is an MLP that operates both a midstream and an upstream business, with the midstream business making up 43% of 2010 EBITDA, and the upstream business making up the other 57%. Upon the closure of the Crow Creek transaction, the upstream business will consist of over 600 wells producing about 80 MMcfe/d. Of the 396 Bcfe of proved reserves, 64% is natural gas, 19% is oil, and 17% is NGLs. The midstream business has nearly 5,500 miles of pipeline, and 19 processing plants. The pipelines gather 488 MMcf/d of gas and 7.0 Mbbl/d of equity NGLs/condensate. The assets are focused in Texas, Oklahoma, Louisiana and Arkansas, as well as production in Mississippi and Alabama.
The firm is bouncing back from a transformational 2010, after implementing a recapitalization plan in late 2009. Through ensuing transactions, Eagle Rock sold off its Minerals Business, purchased its GP, and eliminated incentive distribution rights held by Natural Gas Partners (NGP), a private equity firm. It is important to note that NGP owns Crow Creek and holds a large position in EROC. After the Crow Creek transaction closes, NGP's ownership in EROC will increase from its current 24% to 40-45%.
The distribution had been reduced significantly since April 2009, and just was increased from $0.025 a quarter to $0.15 a quarter in January. The firm reported a coverage ratio of 1.4x the $0.15 distribution before the Crow Creek transaction, and management will look to increase the distribution to a $0.75 annual rate by the second quarter this year, which is payable in August. Management further says the transaction should allow EROC to be able to raise the distribution to an annual rate of $1 a year by the end of 2012 while still maintaining a 1.2x coverage. Trading at $11.50, the yield based on a $0.60 distribution is 5.2%
Through this acquisition, Eagle Rock Energy Partners is greatly increasing the distribution growth rate as well as the distribution level. Having streamlined the business in 2010, Eagle Rock's strategy is beginning to pay off for unit holders. Further drilling activity should allow earnings to grow on both sides of the business, and a strong hedging program provides some stability to cash flows.
That being said, Eagle Rock does face substantial commodity exposure, so a decline in the price of oil or further depression in natural gas prices would hurt its longer term prospects. However, with oil prices where they are now, and the distribution projected to ramp up to 66% to $1 annualized over the next eight quarters, Eagle Rock looks like it will continue to move higher. Expect an equity offering to help fund the deal, and use that offering as an entry point.