No Attention Span Summary: A new entrant into the MLP universe producing sand used in well fracture stimulation ("fracking"), that is a very interesting investment if the unit price is closer to $17 or less (vs. current $20 mid-point of IPO price range).
Hi-Crush Partners, L.P. (HCLP)
HCLP is currently on the road looking to price its IPO on the evening of August 15, 2012. The Company is looking to sell 11.25 million common units at a mid-point price of $20 per unit raising approximately $225 million of gross proceeds. I am going to assume readers are familiar with Master Limited Partnerships ("MLPs") and energy related concepts in general and focus more on key Pros and Cons for HCLP and how it compares to the current MLP universe. Additionally this article uses some unique terms and ratios that are explained in an earlier article, A Ranking Protocol for the MLP Space.
HCLP's Business
We are a pure play, low-cost, domestic producer of premium monocrystalline sand, a specialized mineral that is used as a "proppant" to enhance the recovery rates of hydrocarbons from oil and natural gas wells. Our reserves consist of "Northern White" sand, a resource existing predominately in Wisconsin and limited portions of the upper Midwest region of the United States, which is highly valued as a preferred proppant because it exceeds all American Petroleum Institute ("API") specifications. We own, operate and develop sand reserves and related excavation and processing facilities and will seek to acquire or develop additional facilities. Our 561-acre facility with integrated rail infrastructure, located near Wyeville, Wisconsin, enables us to process and cost-effectively deliver approximately 1,600,000 tons of frac sand per year.
This is the first time that a sand producer has attempted to use the publicly traded MLP structure, so it is a little outside the MLP sandbox (couldn't help myself), so comparing the valuation of HCLP to other MLPs is going to take a bit of artistic license. HCLP has a typical full Incentive Distribution Right structure (max IDR tier of 50% to the GP) with Subordinated Units held by the General Partner ("GP")/Sponsor.
Pros
Strong Industry Fundamentals: The well fracking business is absolutely booming so demand for their higher quality Northern White sand is very strong and growing. Even if the total number of wells drilled decreases the ever increasing complexity and number of stages used when fracking wells will lead to growing demand for their product.
Competitive Advantage with Low Cost Operations: HCLP's current Wyeville Facility (the only facility that will initially be in the MLP) is 561 acres with 48.4 million tons of easily recoverable shallow "Northern White" sand reserves situated with on-site rail facilities. Northern White sand is highly valued as a fracking proppant due to its specifications. Rail transportation is a competitive advantage versus competing locations that require a large amount of higher cost truck transportation.
Long Term Fixed Price Contracts with Strong Counterparties: Weighted average contract life of 4.6 years with staggered expirations to major investment grade oilfield service companies. Current contracted pricing is also below current spot market which should provide pricing and cash flow upside as contracts get renewed.
Strong Private Equity Sponsor with Experienced and Incentivized Management Team: Avista Capital Partners has an experienced energy team that has led over $2.7 billion in equity investments in energy companies. HCLP's management team owns 39% of the GP/Sponsor entity and will benefit more from the growth of HCLP unit distributions as opposed to their relatively low salaries.
Strong Balance Sheet Post IPO: HCLP will have no outstanding debt after the IPO and $100 million of Revolver availability, which gives some comfort that HCLP will not receive any IPO proceeds itself.
Reasonable Projected Distribution Coverage Ratio and High Estimated Distribution Growth Rate: In the S-1 the Company projects a Distribution Coverage Ratio of 1.2x over the next twelve months. Additionally in the roadshow presentation management mentions that they expect to grow distributions at a "double digit rate" going forwards.
Drop Down Growth Opportunities: GP has a significant near term drop down growth opportunity from its ownership of the Augusta Facility, with similar strengths as the current Wyecliff Facility and 46.2 million tons of sand reserves. Given the uniqueness of the Wyecliff and Augusta Facilities additional similar assets may be difficult to develop/acquire.
Cons
New Asset Type MLP makes Valuation Tricky: HCLP's asset type is different and new to the MLP structure making exact peer valuation comparison impossible so it is difficult to gauge how Institutions will react to this opportunity.
Low Estimated Tax Deferral on Distributions: The S-1 currently estimates that only 40% of the estimated distribution through December 31, 2014 will be tax deferred (so at the bottom of the MLP universe). Additionally it includes this language:
Thereafter, the ratio of allocable taxable income to cash distributions to you could substantially increase.
This language is rare for MLPs and my preference when comparing MLPs is to look at the projected yield after estimated taxes. The tax deferral benefits make the extra effort involved with dealing with K-1 filings worthwhile. If HCLP's already low tax deferral is also somewhat uncertain after two years then I would prefer a discount / additional margin of safety for that risk. Also the risk to HCLP's qualifying income for sand production also appears higher than more traditional MLP asset classes. The S-1 of course has the typical litany of Risk Factors to cover any possible future IRS tax issues.
Comparison Chart
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(1) Most data taken from HCLP's roadshow presentation slide 20 with some modifications based on my data sourced from various Company financial filings.
(2) HCLP data taken from S-1 and metrics calculated using estimated next twelve months data, mid-point IPO unit price of $20 and assuming an aggressive 3 year distribution growth rate of 10% per annum. Comparative data shown based on market closing prices as of August 14, 2012.
Sensitivity Tables
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Conclusion
HCLP has many strengths behind its unique story; however, HCLP's uniqueness may also lead Institutions to want better/lower pricing at IPO (similar to what happened for the recent Northern Tier Energy, L.P. IPO (NTI)). Given the higher risk with unproven public MLPs and HCLP's low estimated tax deferral I would prefer to buy units if the price is closer to $17 or below, just based on competing MLP based investment choices, especially when looking at the 3 Year Forward Yield After Tax ("3YR FYAT") / Valuation Coverage Ratio ("VCR") Sensitivity Table. However, I may have varying open limit orders when HCLP begins trading and will be watching closely to try and gauge market reception. If the IPO pricing comes out on Wednesday night and it is at $20 or better then the Institutions are in more of a buying mood than I am, or maybe the junior teams are left running the show while the senior people are at the beach lounging on the...
Sources
HCLP Roadshow <<The HCLP roadshow presentation will be removed on the night of August 15th, but the website is great to bookmark for future IPOs.
Disclosure: I am long NTI.
Additional disclosure: I may initiate a position in HCLP over the next 72 hours.
