Description

Investment Summary:

Penntex Midstream Partners (PTXP) presents a highly asymmetric investment with 30%+ upside and an expected catalyst over the next 12 months. Energy Transfer Partners (ETP) now owns 65% of the company and should tender to acquire the remaining shares in order to have unfettered access to PTXP’s cash flows and to reduce complexity within the Energy Transfer complex. In the event ETP does not tender for shares in the near term, you are paid a 7.5% dividend to wait.

Company Description:

Please refer to Yellowhouse’s August 2015 write-up for a more in-depth overview of PTXP’s assets and corporate history. This background is helpful to understand the company, but not central to the current thesis.

Penntex is a Louisiana based MLP, focused on the gathering and processing of natural gas and NGLs in the Terryville Complex. The company was founded by the private equity firm Natural Gas Partners (NGP) and management in January 2014. In the summer of 2015 the company was taken public at $20/share and a 5.5% distribution yield. PTXP’s assets were supported by a newly signed 15 year, fixed fee minimum volume commitment (MVC) by its largest customer, Memorial Resource Development (now Range Resources (RRC)). However, the growth plans at the time of the IPO, including the expected drop-down of Permian assets held by the General Partner (GP), were delayed or did not materialize, resulting in a busted IPO. The limited liquidity of shares due to a sub $200mm free float and a concentrated minority shareholder base further exacerbated the trading performance of shares. This may have also made PTXP shares less appealing to future shareholders which is critical to accessing equity capital in the MLP space.

Timeline/Key Dates:

Less than 3 years after the formation of the company and less than 1.5 years since PTXP went public, Natural Gas Partners decided to cap their upside and take the chance to completely exit their now illiquid investment. On November 2, 2016, NGP sold their 65% stake in PTXP (MLP) and their GP stake (with IDRs) to Energy Transfer Partners (ETP). The consideration for the PTXP shares and GP stake was a combined $640mm and consisted of a mix of cash and ETP shares. The simultaneous sale of the GP and PTXP shares makes it difficult to determine what price ETP paid for the underlying MLP but based on typical value’s for GP’s, it appears PTXP shares continue to trade at meaningful discount to their recent transaction value.

After closing the transaction, ETP immediately fired virtually all of the existing management team at PTXP and installed a majority of its representatives to the PTXP board (ETP now controls 4 of 7 board seats). ETP management also completely control the GP (which has effective control of the MLP). The only remaining PTXP management team members are the General Counsel and the Controller/Chief Accounting Officer (who was subsequently demoted to just VP on 1/23/2017). Based on this, it is clear ETP is already running the entire company as its own.

At the time of the transaction with NGP, ETP also entered into an evaluation agreement with PTXP laying out the terms of any additional tender offers for the remaining 35% of PTXP shares. The remaining independent board members must approve the tender offer price (for either a partial or total tender) before ETP can launch a tender offer. This evaluation agreement expires May 2nd, 2017, after which ETP is no longer required to consult with the independent board members on the attractiveness of their offer for minority shareholders.

I expect ETP to tender at or around the expiration of the evaluation agreement.

Why ETP wants to buy PTXP:

The fixed fee, minimum volume commitment between PTXP and Memorial Resource Development (now Range Resources) was a sweetheart deal between two of NGP’s portfolio companies. This contract also included an area of mutual interest in the Terryville shale play lasting through 2031. Range Resources currently has 220,000 net acres within this area. Other than the prospects that the Terryville might turn into the next Marcellus due to its attractive IRRs and favorable geographic location, the acreage dedication by RRC was probably the main reasons why ETP was interested in buying PTXP. ETP had legacy gathering and processing assets already built in this area of mutual interest that were processing volumes for MRD/RRC. Unfortunately for ETP, these contracts were set to expire at the end of 2017 and MRD/RRC would have to shift all of its volumes to PTXP. This would result in the ETP assets losing their largest customer and beginning to run at a large loss. As a result, acquiring PTXP was one of the only moves for ETP. Now, ETP has the option to sell their existing plants to PTXP or fold them into PTXP if it acquires 100% of the MLP. In a control scenario, PTXP can grow volumes without having to build any new plants (which is much more efficient than if PTXP continues to operate on a stand-alone basis).

Other Reasons why ETP is interested:

• ETP is incentivized to completely buy out PTXP or raise the quarterly distribution. If they don’t raise the distribution then the GP will have little value because it currently receives zero IDR payments. Alternatively if ETP doesn’t raise the distribution and doesn’t buy the entire MLP, then a meaningful amount of cash flow becomes trapped at the MLP.

• PTXP is immaterial in size to ETP. This means ETP management shouldn’t care too much about a large premium and is probably more focused on removing the additional complexity of another publically traded MLP. If they control all of PTXP there may also be some additional synergies they can extract.

• Gives ETP the chance to be the first mover in what could become the most attractive natural gas field since the Marcellus was discovered.

• ETP has a history of tucking in previous MLPs (such as Regency in 2015).

• The CFO of ETP expressed interest in simplifying their structure on their Q3 call and was highly complimentary of PTXP’s assets:

Valuation:

PTXP currently trades at an 11% distributable cash flow yield and is building cash on the balance sheet due to its conservative ~1.5x distribution coverage.

To derive a value for PTXP shares requires backing out the implied value ETP paid for the Penntex GP stake. If the distribution payout was increased to a sustainable $0.43 per quarter (a 1.1x distribution coverage ratio) the GP would receive ~$2.7mm from its incentive distribution rights. This would put the IDRs at the 25% take-rate split. Applying a 35x multiple to this IDR payment implies a $95mm value for the GP and a residual $545mm for NGP’s 64.6% stake in PTXP. This equates to a $20.73 price for PTXP shares. If ETP were to tender for the remaining shares at this same price and adding the dividends shareholders will receive by the end of May, shareholders would make a 33.5% return in less than 3 months. Even if a tender takes over a year from now you still stand to make a 39% return while you collect distributions.

Even though PTXP has no price risk, virtually all of its revenues are guaranteed until 2031, exposure to a growing basin and very low leverage, it still trades at a meaningful discount to its peers. These factors should provide ample downside support in the event ETP does not make a bid in the near term.

Although this is not my base case and I expect a low probability of this happening, ETP could decides to use PTXP as a growth vehicle given it’s lower cost of equity capital. In this scenario there would be meaningfully more upside to shares over a 2-3 year period than what I expect in the buyout scenario.

Risks:

• ETP and Sunoco Logistics (SXL) are currently merging. If this merger is blocked or drags on it may also delay a tuck-in of PTXP.

• In the event of a buyout, PTXP shareholders may receive shares of ETP (or SXL if the merger has closed) as consideration instead of cash.

• Kelcy Warren is a shrewd investor and PTXP shareholders have few rights given the LP structure. Warren will try to limit the amount of value leakage to minority unitholders. ETP only paid a 13% premium to Regency shareholders when ETP folded in the company in an all-stock deal in January 2015.

• ETP forces PTXP to buy its legacy Terryville assets for an unattractive valuation – transferring value from the minority shareholders to ETP without requiring a vote. This scenario is unlikely as a “drop-down” or asset transfer from a related party would have to be approved by the independent board members or a conflicts committee.

• Illiquid shares (~$1.2mm ADTV over the last 30 days)

• Well economics in the Terryville are not as strong as initially expected – as this acreage continues to be delineated this appears to be less and less of a risk.

• Range Resources is drilling at volumes at less than their MVC with PTXP – some cash payments PTXP receives today are deferred revenue under the terms of their contract and will have to be earned at some point in the future. These payments are included in the calculation of distributable cash flow.

• Customer concentration/counterparty risk (Range Resources makes up the vast majority of the PTXP’s revenues)

• Limited Call Right / squeeze out scenario – If ETP is able to acquire 80% of the common units in PTXP it can then squeeze out the remaining limited partners at a price equal to the greater of:  1) the current market price or 2) the highest cash price they paid for any shares over the previous 90 days. ETP only owns 64.5% of PTXP units (once it is able to convert its subordinated units) so it would have to tender at least once prior to this scenario playing out which would give shareholders an opportunity to exit. PTXP is probably too illiquid and the shareholder base too concentrated for ETP to reach this 80% threshold without having to alert shareholders in advance (or file a revised 13-D with the SEC). No shareholder vote or fairness opinion would be required in this scenario.

   

Further Reading:

Range Resources has indicated that they should earn 71% IRRs based on current strip pricing in the Terryville. This is meaningfully higher than 59% type well IRR they earn in the best part of their Dry Marcellus acreage and 25% IRR in the Wet Marcellus. This economic return differential should incentivize RRC to drill more aggressively in the Terryville. Range is rapidly delineating the remaining parts of their acreage position and has indicated they may further increase their drilling inventory based on these tests.

http://ir.rangeresources.com/phoenix.zhtml?c=101196&p=irol-newsArticle&ID=2240278

The Terryville acreage has multi-stack potential that can further improve well economics if the same pads can be used multiple times (there are even more pay-zones than the three shale layers in certain parts of RRC’s acreage in SW Pennsylvania).

Another NGL portfolio company, WildHorse Resource Development (WRD), IPO’ed in December 2016. The company has a significant acreage position in the Terryville that overlaps with PTXP’s assets. The company outlined in its S-1 a target of $62mm of capex in their Terryville acreage in 2017. They hope to drill 12 wells and have 9 producing by the end of 2017. This should provide further growth opportunities for PTXP while shareholders wait for a buyout.

WRD S-1:  https://www.sec.gov/Archives/edgar/data/1681714/000119312516790166/d200402ds1a.htm

Disclaimer: The information contained herein reflects the views of the author as of the date of publication. These views are subject to change without notice at any time subsequent to the date of issue. The author has an economic interest in the price movement of the securities discussed in this presentation, but the author’s economic interest is subject to change without notice. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition, there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trademarks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over their use. This presentation is confidential and may not be reproduced without prior written permission from the author.

Catalyst

• Buy out by ETP

• Continued growth in distributable earnings as dedicated volumes continues to ramp up