Atlas Energy (ATLS) is a diversified energy play offering investors growth in both exploration and production (primarily focused on natural gas assets) through its Atlas Resource Partners (ARP) subsidiary and pipelines with exposure to ethanol prices through its Atlas Pipeline subsidiary (APL). ATLS is set up as an MLP [similar to Kinder Morgan (KMI) and Energy Transfer Partners (ETE)] but to think of it as a stodgy, boring dividend play is solely done at one's risk. Edward Cohen, who has a long history of deal making is running the show here, and based on what he did at Resource America (REXI), which is more of a financial company than a resource company, one can expect some solid and savvy deal-making going forward.
Back in March the company announced a somewhat complicated partnership structure, which allows it to transfer the financial and operating risk to its subsidiaries while participating in the upside if they are successful. Per the recent Morgan Stanley report, analysts believe that, "While ARP presents a solid growth profile, the imposition of ATLS's general partnership interest will serve to diminish the economics received by ARP."
As a general partner, ATLS receives cash flows from its 2 partnership interests above, with APL currently flowing the most cash, as pipeline companies usually do, and ARP providing the growth as it takes on more acquisitions in the natural gas space. Significantly, besides the dividends received and partnership units held by ATLS, management has set up a carried interest platform that gives ATLS shareholders a LEVERED CALL OPTION to participate in the growth of both companies and allows for the fastest growing cash flow in the MLP universe. Through these "Incentive Distribution Rights," the higher the dividend paid by the subsidiary, the larger % that ATLS receives -- you can think of it like a call option, with the delta increasing dramatically as the stock rises above its strike price. As an example, ATLS receives 13% of any distribution over 42 cents and 23% of any distribution over 52 cents and 48% of any distribution over 60 cents, the latter of which is expected by the end of 2013. This will allow for hyper dividend growth at Atlas, with estimates of over $3 per share in distributions by the end of next year, which would yield over 10% based on today's stock price
As further proof to the confidence that analysts have expressed in the ATLS management team, APL was recently added to 3 of the Alerian MLP indices, which has caused the stock to run from $29 to $33 in the past few days. While APL was likely added because it is a pure pipeline play, it is likely that ATLS, which is far more liquid, will soon be added to Alerian's indices, which could cause a similar 10% move in the stock if it happens
A chart of ATLS only tells half the story when looking at the volatility the stock has experienced. The new structure was announced back in March and the stock immediately ran from $26 to $36 as management signaled that the projected dividend yield would almost double from 5% to 10% under the next structure. After reaching a high of $40 upon announcing their second deal, market confusion has pushed the stock back down below $30 - where investors should have support from great yield protection and upside growth
ATLS should be valued by the sum of its parts and given current prices, the holdings of each subsidiary are worth roughly 50% each of ATLS share price. To create the value of what ATLS should be worth when looking at its subsidiaries, I have attached 2 charts showing ATLS versus its subsidiaries. The ratio has fallen dramatically in the past few weeks as fears arose over an increase in the revolving credit line at its APL pipeline subsidiary. Market investors have confused this increase with fears that ATLS is getting ready to lever up and make a big acquisition, which would be completely out of character for this management team, since it uses its subsidiaries to lever up and simply receives the benefit of their growth.
Based on Morgan Stanley's recent price targets, ATLS presents almost 70% upside from these prices while ARP presents a much more modest 12% upside and APL presents almost 40% upside. If one were to do a simple arbitrage and sell 500 shares of ARP and 500 shares of APL while buying 1000 shares of ATLS, a decent return could be made. However, given the structure of the assets and the current risk/reward, I would advocate shorting ARP versus buying ATLS.
Shorting ARP gives you an opportunity to sell a levered cyclical near its high, with over 30% downside compared to other natural gas stocks. With a projected dividend yield of only 5% versus over 10% for its more established MLPs like BreitBurn Energy Partners (BBEP) and Vanguard Natural Resources (VNR) and a P/E ratio of 17x versus 7x and 10x for BBEP and VNR, ARP is overly expensive in this market environment.
In sum, ATLS is a way for shareholders to invest in the same vehicle that management is using to receive dividends in the stable pipeline business of APL while participating in the upside of whatever strategic deals it will make in its ARP subsidiary. By setting up Incentive Distribution Rights, shareholders in ATLS are rewarded as the cash flow from each subsidiary rises. Since the value of each subsidiary will ultimately be determined by the growth and value of its cash flows, buying ATLS at prices similar to where the market valued it when its projected yield was half of what it is today seems like a steal. Equally important, with a dividend yield that is only half that of its peers and a PE ratio that is over twice that of its peers, it is clear that ARP is overvalued and has Downside RISK back to $20.
Let the shareholders in ARP take the risk for you while you hold the cheap call option in ATLS that lets you participate in the upside if it all works out. Management put its money where its mouth is, so should you