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.
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)
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.