PennTex Midstream (PTXP) – Acquisition Target – 50% upside

Current Price – $15

Expected Buyout – $23

Upside – 50%

Expiration Date – TBD (expected in H1 2017)

 

Penntex Midstream is likely to be fully acquired by ETP, which already owns 65% of the company. This is similar to OCI/OCIP transaction that was posted on the site earlier as well as a number of other consolidations in the MLP space (TRP/CPPL, TLLP/QEPM) whereby general partner which owns majority of MLP buys out the remaining limited partner units.

If this thesis does not materialize, PTXP sports 8% dividend yield which is 1.5x covered by the contracted minimum payments. This dividend is very safe, not dependent on commodity price fluctuations and will support share price in case no transaction happens. So downside seems to be well protected and market is not pricing in the potential acquisition at all.

 

Background

PennTex is a natural gas gathering and processing MLP (two gas processing plants and related pipelines) with locked-in 15-year take-or-pay fee based contracts. When the company was established in 2015 (IPO at $18 share) it’s main and (almost only) customer was Memorial Resource Development (MRD), a low-cost gas E&P in the Terryville complex. Both MRD and PTXT were owned and managed by the same PE group Natural Gas Partners, which also acted as a general partner of PTXP and owned majority of the limited partner equity. Minimum volume commitment contracts (if the certain volume of gas and liquids is not delivered for processing, the customer still needs to pay up as if the whole minimum volume was transported and processed) ensured guaranteed revenue levels for the next 15 years and removed any commodity price exposure. Actually PTXP has performed almost as per IPO prospectus (see page 62 for the financial projections). In the last quarter company generated $17.2m of distributable cashflows – equivalent to $0.43/share vs $0.295/share in dividends. Going forward the same financial performance is expected with a potential upside when minimum volume thresholds are exceeded. Thus dividends are very well covered and fully supported by minimum volume commitment for at least till 2026.

See further details on company’s presentation and IPO prospectus.

 

Why PTXP is likely to be acquired?

A number of developments happened during 2016 positioning PTXP as likely acquisition target.

- MRD (main and only customer of PTXP) was acquired by Range Resources in May 2016. This transaction justified the viability and prospects of Terryville Complex, where PTXP has exclusive rights for gathering and processing gas and liquids.

- In Oct 2016 Natural Gas Partners sold their GP and LP stakes in PTXP to Energy Transfer Partners (ETP). Following this transaction ETP owns 65% of limited partner interest and 100% of general partner interests of PTXP. Shares of PTXP jumped to $18/share upon the announcement, but have since retracted to the current levels of $15/share.

- With this purchase ETP also entered into an evaluation agreement, pursuant to which it will evaluate the potential purchase of all or a portion of the remaining common units in PTXP, but will be under no obligation to do so. This clearly shows that consideration to purchase the remaining units is on the table.

- This roll-in of PTXP units was also confirmed during the ETP Q3 conference call:

John Edwards – Credit Suisse Securities

Yeah. Good morning, everybody. Thanks for taking my question. Just if we could just kind of circle back to PTXP just a bit, just sort of kind of the longer-term plans there. I mean, is it ultimately to roll it up into ETP or help me think about that?

Matthew S. Ramsey – Energy Transfer Partners LP

Yeah. John, that would be – there’s no immediate plans to do that, but that seems to be kind of where our head is. We’re not trying to add additional MLPs around here that we manage, but rather that for us to access these assets that are so incredibly complementary to us, they existed in another publicly-traded MLP and we respect that structure. Presently, they’re an independent MLP that has an independent board and in a way they are a competitor. I don’t see that structure being appealing to us long term.

- In Nov 2016 Sunoko Logistics Partners (SXL) and Energy Transfer Partners agreed to combine operations. Both entities are controlled by Energy Transfer Equity so the move is pure internal consolidation to reduce complexity and costs. Full roll-in of PTXP would fit this reduced complexity framework as well. However, there might be a delay in PTXP roll-in until merger of ETP and SXL is completed (was expected by Q1 2017).

 

How much is ETP likely to pay for the remaining PTXP units? 

EPT paid $640m for 26.3m of LP units, all of GP units and all incentive distribution rights (IDRs). So the purchase amounts needs to be split somehow into the three buckets.

IDRs currently do not pay anything and would start paying only after distributions to common unit holders exceed 0.3163 per quarter per share (vs current $0.295). In this case IDR holder would get 15% of incremental distributions, which further increase to 25% and eventually to 50% when distributions for common unit holders reach $0.4125/share. Thus distributions need to increase substantially for IDRs to become valuable and any increase in distributions would obviously be also very accretive to common unit holders and push up the share price. Additionally, in the press release Energy Transfer Equity (parent of ETP) agreed to IDR waiver in the amount of $33m annually in perpetuity – so if I am reading this correctly then distributions to unit holders need to double before anything gets paid out beyond this IDR waiver. So these IDRs (at least with the current asset base) are worth close to zero.

General Partner fees are 0.33m per month or $4m annually. Valuing this revenue stream at 10x (which is a very generous multiple), I get $40m value of general partner stake.

This leaves $600m for the acquisition of common units, resulting in $22.8/share.

I doubt PTXP shareholders will agree to an amount significantly below this figure forcing ETP to increase the price to acceptable level (as happened with TRP acquisition of CPPL)

 

Risks

There is possibility that the deal is not consummated and PTXP remains an independent company. In that case I do not mind continuing to collect the 8% safe dividend stream and wait for any further developments. ETP paid $23/share for PTXP (based on my estimates), so buying it for $15/shares seems like a pretty good deal. If the company remains independent there are couple of additional risks. The first one relates to minimum volume contracts – I am not a legal expert so not sure how enforceable these are in case the paying party for one reason or another decides not to comply. However, my impression is that during the recent energy slump majority of similar take-or-pay contracts in the market were honored despite severe stress for financials. Another risk relates to maintenance capex – currently maintenance capex is low as PTXP facilities and pipes are brand new, however generally MLPs tend to understate maintenance capex requirements and capital expenditures might increase in the upcoming years limiting the cash available for distributions. These concerns are only important if PTXP is not fully acquired and only for those willing to keep the shares for the long term.

Also worth noting that despite no exposure to commodity prices due to MVC contracts, the shares of PTXP can still get volatile with changes in energy prices – e.g. in Feb 2016 PTXP traded at $10/share despite performing in line with projections.

I might have also underestimated the value that is being attributed to GP interest or IDRs – ETP might find various arguments on why a smaller portion of the acquisition price needs to be attributed to common units and in turn argue that remaining units also deserve lower price. Still do not believe this would be taken out at anything below IPO price of $18/share (still 20% upside) as company is performing almost in line with IPO prospectus.

33 COMMENTS

  1. Makarid

    Hi dt,

    as i read in the evaluation agreement document, ETP bought PTXP 65% for 640 mil,but only 320 mil was in cash.The other 320 mil was in common units representing limited partner interests in ETP (“ETP Common Units”).Does this changes the total price per share payed? Thanks a lot!

    1. dt

      I do not think it makes any difference. ETP is $20bn market cap company so if Natural Gas Partners wanted to liquidate their $320m ETP stake, there would not be any problems. So I consider it to be pretty close to cash equivalent. There might be some lock-up restrictions on selling, but again I do not think that pushes it far from cash equivalency.

  2. Nick Meilinger

    In this deal taxation may be an issue for non-US citizens. Ownership of LP units triggers need to hand-in a US form, if I am not mistaken? Anyone with experience on this?

    Thanks!
    Nick

    1. dt

      Nick, I think one would buy and sell PTXP units as any other listed shares. I am not aware on any specific requirements related to MLP units. In my understanding these are equivalent to ordinary shares when it comes to trading.

        1. dt

          I think this talks about standard withholding tax on dividends for foreign investors, no different than for any other US company.

          1. Wang Liaoliao

            There IS a difference dt. As a foreign investor, from my knowledge, distributions from a MLP is treated differently from ordinary stock dividends. The IRS will withhold 30% or more from your distribution and you can only get them back after filling for all sorts of tax claims, which can be very frustrating. So for foreign investors, they may want to hire some tax firm do it for them, or sell the shares before dividend and buy back later (hopefully at a lower price after the dividend). If not, close to 40% of distribution income will be gone.

    1. FM

      Do you think there’s an arbitrage opportunity in OKS now? If the purchase price is 22.4% above closing price on Jan 27, then it will be $54.1, and price now is $52.62.

      1. dt

        Yes, there is an arbitrage opportunity, but it is tiny.
        OKE will acquire OKS by exchanging 0.985 OKE shares for each share of OKS.
        OKE closed at $54.4 and 0.985 of it is worth $53.5, which is 1.7% above yesterday closing price of OKS ($52.62), so spread is really tight.

  3. Scott Rodgers

    Thanks for the good idea. Very interesting.

    Regarding the GP stake, you mention a $4m annual fee. It seems to me this is a reimbursement fee for expenses and shouldn’t be capitalized (ie the GP doesn’t “make money” off this fee).

    “(ii) direct expenses incurred by our general partner on our behalf (including costs incurred as a result of becoming a publicly traded partnership), which we estimate will be $4.0 million for the twelve months ending June 30, 2016 based on an evaluation of other similar public partnerships in our industry.”

    Is this the same fee you were referring to, or is there an incremental fee that you are capitalizing?

    It seems that the GP interest is a non-economic general partner interest.

    “Our partnership agreement provides that our general partner will own a non-economic general partner interest in us, which does not entitle it to receive cash distributions.”

    So perhaps the whole economic value paid by ETP was for the LP interest and IDRs.

    And, I think from ETP’s perspective, there is no incremental value of the IDR’s in a buyout scenario because the IDR value only comes from a shift in payouts between LP and IDR holder. If the LP holder and the IDRs holders are 1 and the same, there is no incremental value to holding the IDRs. (With ETP already holding 65% of the LP interest, this is already largely the case).

    So perhaps most of the value paid by ETP was for the aggregate assets (with no regard to the splits), which is effectively the LP interests.

    Regarding taxation, I believe investors in MLPs will receive a K-1 form for taxes, and thus may receive different treatment than if this was common equity. Not sure of all the ramifications for foreign investors.

    1. dt

      Hi Scott, somehow missed your comment, so only responding now.
      - GP interest – you are correct that it does not carry any economic interest besides compensation for management of the company. If I recall correctly, they get paid c $4m a year + reimbursement of expenses (I capitalize only the management fee). So clearly GP interest has some value and I believe using 10 x annual management fee is the highest possible valuation.
      - I agree with your thinking that there is no value in IDRs in full buyout scenario (GP interest does not have any value in that case either) – as then one simply looks at the assets of the company instead of the ways the capital and distributions are structured. But at the moment 35% of LP interest does not belong to ETP. Therefore, in assessing the value of LP units ETP could argue that certain portion of $640m was paid for GP interest and IDRs in order to lower the cash-out price for the remaining LP units. Basically I am trying to guess the ways in which ETP could screw minority shareholders, but there seems to be very limited scope for that.

  4. daniel zucker

    With the poor earning report for PTXP, will dividends be maintained at 8%? Is it advisable to still purchase at current price? Thank You.

    1. dt

      Daniel, what do you mean by ‘poor earnings report’?
      Dividends are still covered 1.5x, so no issues there at all.

      1. daniel zucker

        PTXP .18 loss in 4th quarter and revenue 18.3m vs. 24 m. last year. D. Zucker

        1. dt

          The line items you need to pay attention to is distributable cashflow and dividend coverage ratio.
          Accounting entries of revenues and net profit do not represent the true economic reality of the company:
          - Part of the revenue that is related to minimum volume commitment is recorded as deferred revenue and therefore does not appear in P&L, but only in cashflow statement.
          - Net profit also included non-cash charge related to buyout by ETP and vesting of equity awards.

          Hope this makes the situation clearer.

  5. over2u

    On 26 of April special meeting of ETP holders is scheduled and given the very tiny arbitrage between SXL and ETP of less than 1% the likelyhood of the transaction is high. So, I guess the timeline of PTXP transaction is getting more visible. DT, what is you take on PTXP situation? Thx

    1. dt

      Still think full acquisition is likely. Shareholders can expect some commentary with regards to this in Q1 conference call. Would not say the timeline is more visible, rather that some kind of announcement one way or another is likely to occur during the upcoming months.

      So far sitting tight and enjoying 15% return to date.

      1. over2u

        As I understood there will be no call for Q1, as well as there were no comments on potential M&A in quaterly report.

        1. dt

          There was some chatter on the ETP conf call:

          “Jeremy Tonet

          Okay, great. Thanks. And then one last one, just as far as great strategy towards simplification within the family, just wondering is there anything left out there as far as PennTex and SUN as far as strategic moves that still needs to be done there or further simplification that we should be thinking about?

          Kelcy Warren

          This is Kelcy, I would say, we are exploring a lot of things. We are back looking at as I have said before, we believe that the correct mix of M&A with organic growth is the only way to run – successfully run these partnerships. So we are exploring that, but PennTex is doing very well and we are coexisting very well. SUN, as we stated before, we have really like the new, the effort of the assets sales close, we really like the new SUN a lot and we think it’s going to be positioned well for growth. We see that as coexisting quite well with the – as an existing MLP in the refined products business primarily terminaling, pipelining and what other opportunities may be derived from that. So and then of course, we are – and as I have said before, we are looking at other assets that would be complementary and we are not having much success right now, but we are churning a lot.”

          This is a much softer language compared to the one I quoted in the write-up. But really not sure if it is indicative of management’s position towards full PTXP acquisition. Sounds like simple non-committing answer without revealing much info.

  6. slow

    Hi DT

    ETP tender PTXP for $20.
    Do you think higher price is possible

    Thanks

  7. dt

    All worked out as expected, just the buyout price is slightly lower than my calculations, but still a nice 32% return in 4 months.

    Re bump in the offer, I would not count on it as so far ETP is not even seeking approval of the independent members of PTXP BoD. Special committee to evaluate the offer could still be formed, but even in that case $20/share looks quite fair.

  8. work 22

    Great call dt! I had bought a decent amount, so thank you!

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