Atlas Pipeline Holdings: Accelerated Growth in the Pipeline

Atlas Pipeline Holdings (AHD) is an unusual company. The company does not directly own any hard assets or have any operations of any significance. Instead, the company holds ownership interests in Atlas Pipeline Partners (APL). Atlas Pipeline Partners is one of the largest natural gas transporters and processors in the United States. Atlas Pipeline Holdings owns 100% of the general partner of Atlas Pipeline Partners and 5.4 million limited partner units of Atlas Pipeline Partners. 

The company’s ownership of Atlas Pipeline Partners' general partner entitles Atlas Pipeline Holdings to incentive distributions, via its ownership of incentive distribution rights (IDRs), which allow Atlas Pipeline Holdings to collect a flexible percent of distributions from Atlas Pipeline Partners depending on the rate that Atlas Pipeline Partners increases its distribution to unit holders. 

Atlas Pipeline Holdings currently is entitled to 50% of all total distributions above $0.60 per quarter per Atlas Pipeline Partners' unit. If Atlas Pipeline Partners wants to pay out an additional $10 million to the company's unit holders, it would also have to pay $10 million to Atlas Pipeline Holdings. What this means is that Atlas Pipeline Holdings' distribution increases are levered to distribution increases at Atlas Pipeline Partners, with the leverage being substantial over the long haul.

Because of Atlas Pipeline Holdings' ownership of Atlas Pipeline Partners' incentive distribution rights, along with its holdings of 5.4 million Atlas Pipeline Partners units, a $0.10 per unit increase in Atlas Pipeline Partners' distribution would provide enough additional cash flow to Atlas Pipeline Holdings for Atlas Pipeline Holdings to increase its distribution per unit by $0.16. This occurs as a result of Atlas Pipeline Holdings' lower unit count compared to Atlas Pipeline Partners and Atlas Pipeline Holdings' ownership of Atlas Pipeline Partners' units.  Since Atlas Pipeline Partners' current distribution is so much higher than Atlas Pipeline Holdings', this provides Atlas Pipeline Holdings with a growth rate substantially higher than that of Atlas Pipeline Partners.

Several days ago, Atlas Pipeline Partners announced a significant increase in its distribution guidance due to a restructuring of Atlas Pipeline Partners' hedge book. Atlas Pipeline Partners had previously suggested that it would distribute $1.95 during the second half of 2008 with a coverage ratio of 1.2. Now Atlas Pipeline Partners is guiding for $2.10 for the second half of 2008, allowing the coverage ratio to increase to 1.3.

The following table shows where Atlas Pipeline Partners' and Atlas Pipeline Holdings’ distributions should be for the second half of 2008:

 

	Current Distribution	Annual Rate Based on Second Half Guidance	Growth Over Current Distribution
Atlas Pipeline Partners	3.76	4.20	11.7%
Atlas Pipeline Holdings	1.72	2.42	40.7%

The above table does not take into account the growth in Atlas Pipeline Partner’s coverage ratio. Atlas Pipeline Partners cannot increase its distribution without paying equal amounts of cash to Atlas Pipeline Holdings. Any excess distributable cash flow at Atlas Pipeline Partners that is not being distributed should be considered to be half owned by Atlas Pipeline Holdings. If Atlas Pipeline Partners ran with a 1.0 coverage ratio, Atlas Pipeline Partners and Atlas Pipeline Holdings would have the distributions shown in the following table. The numbers are per unit.

	Based on Current DCF	Based on Annual DCF Based on Second Half 2008 Guidance
Atlas Pipeline Partners	4.14	4.83
Atlas Pipeline Holdings	2.32	3.43

Tuesday’s news that Atlas Pipeline Partners is issuing 5 million additional units to finance the hedge book restructuring should be viewed as a great thing for Atlas Pipeline Holdings. These additional units will increase the cash flow to Atlas Pipeline Holdings via their incentive distribution rights and they will further increase Atlas Pipeline Holdings' leverage to Atlas Pipeline Partners going forward. These 5 million additional units should increase Atlas Pipeline Holdings' cash flow and distribution by a further 10% once the issuance is completed.

As if this was not exciting enough, Atlas Pipeline Partners is the pipeline operator with the largest exposure to the Marcellus shale, something I am very bullish on. Atlas Pipeline Partners can probably sustain at least a 5% annual growth rate for years, with substantial upside possible, depending on how fast the Marcellus is developed. I expect to see Atlas Pipeline Partners sustain a growth rate of at least 7% for several years, which is still well below Atlas Pipeline Partners' past growth rate.

Additional upside at Atlas Pipeline Partners and Atlas Pipeline Holdings may be seen in the future through further commodity price appreciation and/or additional acquisitions at Atlas Pipeline Partners. Because of the recent commodity price appreciation and modification to Atlas Pipeline Partners' hedge book, Atlas Pipeline Holdings' DCF has likely increased by nearly 50%. As growth at Atlas Pipeline Partners continues, I expect growth in Atlas Pipeline Holdings' DCF to continue to be close to 20% annually without any additional benefit from commodity prices or acquisitions at Atlas Pipeline Partners.

The bottom line is that Atlas Pipeline Partners' most recent announcement should be viewed in extremely positive light. Atlas Pipeline Holdings and its parent company Atlas America (ATLS), which I have talked about here, should both benefit immensely. The Atlas companies are without a doubt some of the best-run companies in their industry and I believe that this week’s news only reaffirms my bullishness for each of them.    

For Further Review:

Atlas Pipeline Partners Press Release

Disclosure: Long ATLS

Comments

[Paul A.]

The secondary offering of 5 million common units is a device to get the public to pay off the $250 million APL expects to lose on their derivatives. This sort of three-card monte is typical of all the pipeline MLPs. ADH of course wins no matter what, so your recommendation is sound.

Personally, I can not see why anyone would purchase any of the new stock issue. Let APL and ADH find the money someplace else. I'm eager to see if this issuance works. If it does, more for current holders. If it doesn't, the general partner still makes out okay and everyone else loses.

[badbernanke]

As I understand the APL's releases, they will raise about $250 million from the offerings and the GP's contribution and then close a hedging position which will apparently increase cash flow from operations by about $250 million over the next 18 months. Even with increased distributions on new units and old units, APL should have additional positive cash flow of over $200 million over the next 18 months - the $250 million in new cash flow minus about $50 million in additional distributions.

It looks to me that what APL is really doing is getting an additional $200 million to use to build out its infrastructure in the Marcellus Shale play in Appalachia. A smart move since it has a contract to provide gas transmission to its affiliate, ATN, and ATN is growing its Appalachia production at double digit rates with its Marcellus drilling. RRC just announced a $175 million contract with Mark West to build pipelines for RRC's Marcellus properties .

The negative press from the hedging payoff is really due to the public's misunderstanding of hedging in oil and gas and goofy GAAP accounting which recognizes liabilities for hedges but does not match those liabilities with the increased cash flow which results from rising oil and gas prices. People hear "derivative losses" and panic, not understanding the whole financing mechanism in an environment where the hedge obligation is backed up by product and cash revenues that increases in value along with the hedge -- often in equal measure, but not recognized by GAAP.