Quest Resources Expands in the Marcellus Shale Play

In my previous article on Quest Resources (QRCP), which can be found here, I talked about the significant growth that is possible from the acquisition of developed properties by Quest Energy Partners (QELP), a subsidiary of Quest Resources. 

This week, Quest Resources and Quest Energy Partners jointly announced a sizable acquisition that will both increases the size of Quest Energy Partners and increases the amount of Marcellus acreage held by Quest Resources.  This represents exactly the type of value creating acquisition that Quest Resource’s unique MLP (Master Limited Partnership) structure provides.  The acquisition is fairly large, with the Quest companies paying $140 million dollars for 78,000 acres of land with 67,000 of those acres lying in the Marcellus Shale.   

Yesterday’s acquisition appears to significantly increase the value of Quest Resources, as it manages to grow Quest Energy Partners while at the same time provide Quest Resources with additional Marcellus acreage, which according to Wachovia can easily be worth as much as $6,000 an acre.   It is difficult to speculate on exactly the amount of value created today until Quest can provide numbers on how much Quest Energy Partners will be paying for the developed properties and how Quest Resources will finance the remaining acreage.  The deal does however appear to clearly be accretive to the value of Quest Resources. 

Previously I had surmised that management’s near blunder with the proposed Pinnacle Gas Resources (PINN) acquisition justified a discount to fair value at Quest Resources from $21 down to the high teens.  Following this announcement, it appears that management is on the right track and fully aware of the value that can be created with the company’s MLP structure.  Even before accounting for the additional value created today, I think that Quest Resources no longer needs to have its value discounted due to its management. 

The most important thing that gives me confidence in management is that this entire transaction is being made by Quest Resources with Quest Resources then selling the developed properties to Quest Energy Partners.  By having Quest Resources first purchase the developed properties before selling them to Quest Energy Partners it provides the additional benefit of increasing Quest Resource’s cost basis in its Quest Energy Partners stake.  Quest Resource’s cost basis in Quest Energy Partners is important because it provides tax savings as it is depreciated every quarter when Quest Energy Partners distributes cash to Quest Resources and the company’s other shareholders.

This type of transaction should be regularly repeatable potentially creating incredible value for Quest Resource’s general partnership interest in Quest Energy Partners. Furthermore, as more accretive acquisitions are made at Quest Energy Partners it not only increases Quest Resource’s incentive cash flow via Quest Energy Partner’s general partner but it also increases Quest Energy Partner’s distribution per unit providing Quest Resources with rapidly increasing amounts of cash flow to fund high return drilling projects in the Marcellus Shale play.  Quest Resources can then sell the developed Marcellus properties to Quest Energy Partners for cash to fund new projects while at the same time increasing Quest Resource’s cash flow from Quest Energy Partners by increasing the company’s distribution per unit and the general partnerships take from its incentive distribution rights.

Quest Resource’s small size makes the impact of even a small property acquisition significant (and the most recent one was quite large).  With only 2% of the United States oil and gas reserves in MLPs the company should, in theory, only be limited by the time it takes to integrate an acquisition.  As long as Quest Energy Partners is able to grow its distribution rate, Quest Resources should have no problem using Quest Energy Partners' stock as cheap currency for future growth.  Especially, because the more acquisitions that Quest Energy Partners makes the faster its distribution rate rises and the more attractive of an investment Quest Energy Partners becomes.

Essentially, Quest Resources is like a legal pyramid scheme whereby Quest Energy Partners can create incredible amounts of value for Quest Resources by making a long string of accretive acquisitions.  Quest Resources benefits because of the incentive distribution rights [IDRs] that it holds that generates cash flows from Quest Energy Partners' expansion.  This creates a form of free leverage for Quest Resources that will allow for incredible value creation.  Quest Resources and Quest Energy Partners are still in the early stages of an incredible growth process that will likely last for many years to come.   

For Further Review: Quest Resource's Press Release

Disclosure: Long