Value Investors Club / ATLAS RESOURCE PARTNERS LP 9.25% Snr Unsecured 2021 (049296AE6)

Description

ATLS has been written up several times on VIC, most recently on October 25, 2014 by cwtdal. Given it has

been almost a year and the opportunity has changed with the Targa sale in late 2014 (see the 10/25/2014

writeup for further details) and E&P sell off; it is time to revisit the name. This write-up is structured to go into

the entire ATLS family.

Trade

Primary trade: Buy ARP 9.25% 8/15/21 unsecured bonds at 57, for an YTM of ~22%.

Secondary trade: Buy ARP units at $3.06, distribution yield of 42.5%

Bonds

My favorite trade in the ATLS structure are the 8/15/21 9.25% unsecured bonds in ARP, trading at 57 for an

YTM of 22%, a current yield of 16% with a strong hedge book to protect against the recent plunge in oil prices.

ATLS’ management team is currently reviewing scenarios to reduce leverage and enhance unit value, in any

scenario it’s hard to see where an action does not positively impact the bond holders. ARP has 85% of projected

margin hedged or fee-based through 2018, reducing your basis from 57 to 29 with three years of coupons.

In discussions with management and via company calls, management is actively looking to reduce leverage,

benefiting the more expensive unsecureds if a bond buyback occurs in the event of a strategic transaction. In

event of no deal, you’re clipping 9.25% a year with hedges to last you until 2018+, with potential upside for the

less hedged commodity – natural gas.

ARP’s bonds trade wider than their upstream MLP as a group (excluding LINN’s) of ~15%. ARP’s bonds can

be paired with some of the weaker more levered E&Ps (i.e. CRK’s secured 2021 at 17%, CHK’s 2021s are at

13%, a HY MLP basket at 15% YTM) or a high yield energy index (Citi’s HY energy index trades at 10%

YTM).

Units

My second favorite trade in the structure is the ARP units, trading in the low $3s with a distribution yield in the

low 40%s. While the market is pricing in a distribution cut, hedges allow ARP to maintain its distribution for

the near future. ARP may decide to reduce its distribution and use cash to pay down debt at ARP, but given

negative cash flow at the HoldCo (ATLS), HoldCo debt & the ARP distribution of cash to ATLS required for

development of the growth subsidiary (Atlas Growth Partners - AGP), a complete distribution elimination is

unlikely.

Atlas Energy Group, LLC (ATLS)

Cap Structure of ATLS

At the qtr end, ATLS (stand-alone) had debt of $83MM ($74.5MM + $8.2MM unamortized discount) and cash

to ATLS of $13MM. ATLS consolidates ARP and AGP when it reports its financials.

Management expects to meaningfully reduce the debt at ATLS during H2’15 with the cash flow from its

ownership ventures (mainly ARP, suggesting the distribution from ARP is secure for H2’15).

Removing ARP from ATL’s H1’15 cash flow shows just how much the HoldCo needs ARP and the distribution

ARP gives it.

ATLS is a HoldCo consisting of the below assets:

1) Atlas Resource Partners, L.P. (“ARP”)

ARP is the largest source of value within the ATLS structure.

ATLS owns:

• 100% of the general partner Class A units

• All of the incentive distribution rights (“IDR”)

• ~25.0% limited partner interest (20,962,485 common and 3,749,986 preferred limited partner

units)

Core Business

ARP's assets focus on shallow decline production in the Appalachian Basin, the Fort Worth Basin, the Raton

Basin and the Mid-Continent region, among other areas as well as development locations in the Eagle Ford

Shale in South Texas. ARP has proved reserves of 1.4 trillion cubic feet equivalents, 86% gas, 77% developed,

270 million cubic feet equivalent of net production from 17 states. ARP operates 14,000 wells in 14 states.

ARP's areas of operations have low operating costs, significant infrastructure access and a low decline profile,

currently ~13%.

What has ARP done to manage the commodity downturn?

1. ARP cut its common unit distribution from $2.36/unit to $1.30/unit.

2. ARP entered into a second lien for $250MM.

3. ARP amended its credit facility to give two years of covenant relief:

a. 5.25x for Q2 2015 through Q1 2016;

b. 5.00x for Q2 2016 through Q4 2016;

c. 4.50x for Q1 2017; and,

d. 4.00x for Q2 2017 and thereafter

e. Maximum Senior Secured Leverage covenant of 3.00x through year end 2016

4. ARP started issuing a perpetual preferred.

At Q2’15 ARP had a (covenant) EBITDA leverage ratio of 4.5x vs the max leverage of 5.25x.

Liquidity

At Q2’15 ARP had $200MM available under its RC. ARP’s next redetermination is November 1, 2015. On the

latest earnings call, management mentioned they could have gotten an extra $60MM from the $750MM. Given

the amount of drilling during H2’15 as well as the $60MM cushion passed, the $200MM available under the

RC and ARP’s positive free cash flow, servicing the debt is not a concern.

Hedging

At 8/6/15 ARP’s hedge book was worth $327MM and was comprised of fixed-price swap and costless collar

positions through 2019.

Gas hedges - for H2’15 and the full years 2016, 2017, and 2018, ARP is hedged 72%, 67%, 62% and 51%,

respectively, for its natural gas production at an average price of $4.17/mcf, based on second quarter 2015

average production.

Oil hedges – for H2’15 and the full years 2016, 2017, and 2018, ARP is hedged 100%, 85%, 62% and 59%,

respectively, for oil at an average price of approximately $78/bbl based on second quarter 2015 average

production.

In aggregate, Atlas Resource Partners has approximately 85% projected margin hedged or fee-based through

2018.

Drilling Partnerships

ARP is a leading sponsor and manager of tax-advantaged investment partnerships, in which ARP co-invests, to

finance a portion of its natural gas, crude oil and natural gas liquids production activities.

ARP raises retail capital from individuals who are looking for tax benefits where ARP allocates to those

investors, the intangible drilling costs and they apply those tax benefits, against their ordinary income. The

partnerships generates fee-based cash flow as well as providing upfront drilling fees as ARP drills new wells in

new partnerships, and that enhances rates of return.

ARP sells partnerships in all 50 states with 50,000 active investors and 90% of investors’ investment is tax

deductible against that ordinary income.

Example – “So if you're in the 40%, or, excuse me, 50% marginal tax bracket and you make a $100,000

investment, on April 15, you receive a check back from the government of $45,000, and you have remaining

invested in the partnership $55,000 of which you'll get a cash flow stream from the wells that we drill over the

next several years that not only pays you back on the $55,000, but ultimately on the $100,000 investment and

beyond.” 6/2/15 ARP BoAML conference.

The distribution channel is AIG; ING; Lincoln Financial; MassMutual; Linsco Private Ledger, LPL;

independent broker dealers.

ARP’s upfront fees (called well construction fees) are cost plus 15%. ARP receives a reimbursement of our

G&A for every well drilled as well as a 30 plus years well service fee, and ARP receives carried interest and

acreage credit for contributing the locations. Investors end up contributing 75% of capital, receive the tax

deduction and a percentage of the production from the wells drilled.

The majority of capital comes in Q4 and capital is deployed throughout the year, but to get investors the tax

benefit required the wells must be spud by March 30th.

In 2014 ARP generated $22.6MM of margin, listed as well construction and completion in its segments, which

consist of cost plus 15% on the drilling. ARP’s administrative and oversight fees for the programs (driven by

new funds raised every year) generated $12.5MM of EBITDA in 2014. ARP also has ongoing fees from the

program, this is an annuity stream for the life of the well: administrative fees of $3MM in 2014, well service

fees of $15MM. In total for 2014, $53.1MM of EBITDA, out of total adjusted EBITDA of $285MM for 2014.

While the partnership is economically advantageous for ARP, and ARP has done a very good job raising capital

for it ($0.7bn form outside investors over the past 5 years), it is confusing for the sell side and complicates

modeling out ARP. The fund raising is lumpy and geared to the back half of the year, pro-forma for a

normalized partnership margin the Q2’15 distribution would have been 1.0x. ARP is budgeting $150MM raised

in 2015 and recognize $27MM in investment partnership margin in H2’15.

How confusing is the drilling partnership to the sell side? On the Q4’14 John H. Abbott of BoAML asked how

ARP would meet its partnerships’ “guarantee a rate of return of about 10% to 12% for five years to eight years.”

He was told there is “no guarantee of anything.”

Cap Structure

Financial Review and Projections

Based on the above projections, you create the bonds at 4.0x for the next few years. Leverage is based on

adjusted EBITDA, not Covenant EBITDA, leverage last qtr using covenant EBITDA was 4.5x compared to

adjusted EBITDA leverage calculated above of just over 5.0x. Management is focused on a transaction to

reduce leverage to 3.5x on a covenant EBITDA basis.

Projections above are based on the forward curve, taking into account the most recent hedges with minor

reductions on the cost basis. The company can meet all interest payments and even scraps by with roughly 1.0x

distribution coverage, using maintenance capex, using total capex provides a more difficult picture for the

distribution. The coverage is below management’s stated desire to have coverage in the 1.2x to 1.4x. ARP

stated it “expects to establish a distribution coverage ratio of 1.2x – 1.4x for the full year 2015 at the current

distribution level, assuming current forward strip prices for oil and natural gas. “(2/23/15 press release).

2) Atlas Growth Partners, L.P. (“AGP”)

ATLS owns:

• 80.0% general partner interest

• 1.2% limited partner interest in Atlas Growth Partners, L.P. (“AGP”).

While ignored by the sell side, AGP is a Delaware limited partnership that currently conducts natural gas and

oil operations in the mid-continent region of the United States.

On June 30, 2015, AGP concluded a private placement offering, during which it issued $233.0MM of its

common limited partner units. Of the $233.0MM of gross funds raised, ATLS purchased $5.0 million common

limited partner units.

AGP has over $500MM in development opportunities in the Eagle Ford with potential to originate or acquire

additional MLPs (Q1’15 conference call). AGP’s inventory comes from the Q3’13 $115MM acquisition of

6,271 acres in the Eagle Ford containing 8 locations already drilled and an additional 53 undeveloped locations.

At the time ARP spent $225MM for 22 producing wells and 19 undeveloped locations containing estimated net

reserves of approximately 12 million barrels of oil equivalent.

3) Lightfoot Capital Partners, L.P.

ATLS owns:

• 15.9% general partner interest 12.0% limited partner interest in Lightfoot Capital Partners, L.P. and

Lightfoot Capital Partners GP, LLC, its general partner, which incubate new MLPs and invest in

existing MLPs.

Lightfoot Capital Partners in turn owns a 40% interest in Arc Logistics (NYSE: ARCX), a growing publicly

traded terminalling, storage, and transloading company. Lightfoot Capital was built to incubate new MLPs and

invest in existing MLPs. Other holders of Lightfoot Capital include Blackrock, COR Energy, Triangle Peak,

Magnetar Capital and GE Energy Financial Services.

The distribution from Lightfoot is small, for H1’15 ATLS received $0.8MM in net cash distributions and

$0.7MM in H1’14.

4) GP of future LPs

Management had wanted to set up ATLS as an MLP incubator, to grow future MLPs. The company is currently

looking at starting a midstream MLP and rumored to be in talks with GSO. It’s uncertain how this will be

structured, given the company is looking to use this transaction to de-lever ARP, the bonds may benefit from

some sort of shuffling the deck chairs.

Is ATLS interesting?

Without giving value to the GP at ARP, LRCX and AGP (hard to do given ATLS is not receiving IDRs today),

I have a very hard time finding a valuation case for ATLS. The biggest source of value is the ARP LP shares

and ARP preferred securities ATLS owns (a combined value of $112MM along with cash of $12MM to give a

value of $124MM, which just covers debt and cash at qtr end). The remaining value is a combination of

Lightfoot, but that gives you ~$17MM, vs a market cap of $78MM (a combo of the market value of the LRCX

stake and a value attributed to their Gulf LNG), or a value for Lightfoot at ~$0.65 cents per ATLS unit, creating

the various ATLS GP investments in ARP/LRCX and AGP at $2.35/ATLS unit or $61MM. The question is,

what is the cash from GP at ARCX, AGP and more importantly ARP worth given the IDRs are paying zero

today? You’re paying $2.35/share to buy an option on future GP value and IDR growth.

An ATLS holder would prefer an IDR reset at ARP, potentially in combination with a cancellation of LP

interest that ATLs holds and a transaction. More potential outcomes are listed below.

Potential Outcomes

ATLS is currently reviewing strategic options, the company has been very public the last several months about

its strategic focus in this environment: reducing leverage and strengthening the core of the business, while at the

same time maximizing the most out of its existing assets. Management has repeatedly said they are working

hard behind the scenes in moving this forward and expect to make an announcement shortly.

On the Q2’15 conference call, management said: “we are taking steps to further reduce debt outstanding. We're

well along in our effort to obtain additional funding with which we will further reduce debt. We will structure

any additional funding so that this additional capital enhances common unit holder value.”

The question is what can ATLS / ARP management do? How does this affect a potential investment in the

ATLS / ARP complex?

Cut the ARP distribution

Given that ARP is ATLS’ primary source of cash flow, a complete suspension is unlikely. However, a reduction

would be positive for the bonds, obviously negative for ARP units and thus ATLS units, though with ARP

trading at a 43% dividend yield, a fair amount of this is priced in. A distribution cut is complicated by ATLS’s

desire to reduce debt at the HoldCo level via the cash flow generated from ARP.

“At June 30, ATLS had a debt balance on its term loan of $74.5 million, net of an $8.2 million unamortized

discount with a cash position of approximately $12 million. This represents a debt reduction of approximately

$33 million between periods, which is principally due to the net proceeds from the sale of the Arkoma assets to

ARP during the quarter. We expect to continue to meaningfully reduce the debt at ATLS through the remainder

of 2015 with the cash flow generated from its ownership ventures.” Q2’15 Earnings Call

A transaction for cash that moves E&P properties out of either ATLS or AGP into a drilling venture.

The cash would be used to tender for bonds at a premium in the market, or to buy them back directly. This

would be positive for the bonds. If the move were accompanied with a distribution cut it would be obviously

negative for ATLS / ARP.

Merge AGP into ATLS, drop down assets into ARP

“In my opinion, ARP's market acceptance and ATLS's unit price have suffered from a perceived lack of assets

that can be "dropped downed" from its general partner, a practice that has buoyed the market acceptance and

unit price of MLP subsidiaries of major energy companies. As you would expect, we are working

imaginatively, we hope, to eliminate this shortcoming.” Q3’14 earnings call.

ARP’s management has long thought that ARP suffered from not having assets that could be dropped down into

ARP. By creating AGP, management put together an asset growth platform where AGP would develop the asset

(in part funded by funds from the partnership program), once the wells are brought online and deemed to fit

with ARP’s “shallow decline production” profile, assets could be dropped from AGP to ARP in exchange for

unit distribution. ATLS previously held gas assets that it dropped down to ARP earlier this year. AGP could

even merge with another MLP, in combination with some sort of tie up with ATLS, giving more assets to be

dropped down into ARP.

Exchange unsecured bonds for second lien bonds at a premium to the market price.

Collapse the structure.

An IDR reset at ARP.

ATLS owns 25% of the LP at ARP and all of the IDRs, because the unit distribution is too low ATLS is

currently not receiving any IDR distribution. ATLS can reset the IDRs in exchange for selling back their LP

stake. This could be constructed in way to enhance the credit quality and distributions coverage of ARP,

resulting in a rise of ARP’s unit value.

ATLS “values above all incentive distribution rights, those IDRs.” Q1’15 conference call

Midstream expansion.

In the Q1’15 conference call management hinted they would be open to restarting a midstream business,

management sold ATLS’ midstream business to Targa late last year and is restricted from starting a completive

business only in Texas and Oklahoma within 16 months.

Grow EBITDA to reduce lvg VS Issue more equity to pay down debt

“We think we have a good stable cash flow, good stable business, and we are very focused on driving the debt

side into a better position because we believe for the equity holders that will mean a lower yield and thus a

higher unit price as we drive debt lower.” 6/2/15 BoAML Conference

It’s hard to say exactly what ARP is going to do, but it seems the bonds are the main beneficiary.

Other - Leon and his 13D

Omega / Leon Cooperman currently owns ~20% of ATLS, he also has a ~7% stake in ARP. On the Q2’15

earnings call he urged management to consider a distribution in 2016. Cooperman has a historic relationship w/

management and his urging for a distribution at ATLS is positive for ARP units.

ATLS in early 2015 guided to a $0.70 annual dividend, the company indicated it has delayed the decision to

initiate a dividend until 2016. In Q2’15 Atlas Energy Group generated distributable cash flow of

approximately $5MM or $0.19/ unit for the period compared with $5.4 million for the first quarter of 2015.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

See above writeup, several upcoming potential catallysts, especially for the bonds.

show sort by

			2015	2016
Price:	57.00	EPS	1.44	1.35
Shares Out. (in M):	95	P/E	2.13	2.27
Market Cap (in $M):	292	P/FCF	2.45	2.09
Net Debt (in $M):	1,492	EBIT	290	291
TEV (in $M):	1,984	TEV/EBIT	20.55	17.70