Description

Atlas Energy, L.P. (ATLS) is the General Partner of Atlas Pipeline Partners, L.P. (APL) and Atlas Resource Partners, L.P. (ARP).  On October 13, 2014, APL announced it was selling itself to Targa Resources Partners LP (NGLS) and simultaneously, Targa Resources Corp (TRGP) was purchasing all related GP interests and shares of APL owned by ATLS.  The remaining stub or “spinco”, as of the close on October 24, 2014, is priced at $7.04 and has an effective yield of 17.7%, which is a HIGHER yield than the underlying LP (ARP’s current yield of 14.3%) which is shocking given that the ATLS stub is the general partner with substantial IDR rights and is expected to enter the “high splits” in the near term.  I believe a more appropriate yield for the stub is 8%-9% which equates to a price target of $13.89-$15.63 into the deal close sometime in Q1 2015 which is an expected return of 122% on the high end in less than five months.

A share of ATLS reflecting the transaction with TRGP consists of the following:

• $9.12 in cash and 0.1809 shares of TRGP which have a combined value of $32.16 and will be distributed on the close of the transaction
• 100% general partner interest and incentive distribution rights (IDR’s) in its E&P subsidiary, ARP, as well as approximately 24.7mm ARP units, which includes 3.75mm Class C Preferred Units in ARP that receive approximately the same dividend as common shares in ARP
• 80% general partner interest and IDR’s as well as an 8% LP interest in ATLS’ E&P Development Subsidiary
• 16% GP interest and 12% LP interest in Lightfoot Capital Partners, which has a 40% LP interest in Arc Logistics Partners LP (ARCX), an independent US based energy logistics service provider
• Net production of approximately 11.5 million cubic feet per day of natural gas production in the Arkoma basin
• Approximately $125-$150mm in new debt

Excluding the cash and TRGP shares with a combined value of $32.16 that will be distributed, the value of the stub is $7.04 given the current price of ATLS of $39.20.  In the release related to the transaction, ATLS indicated that the expected initial annual distributions would be $1.25 per unit indicating a current yield of 17.7%.  However, a full understanding of ARP's distribution is required as most of the $1.25 per unit distribution will come from dividends on the ARP shares the ATLS stub owns and GP and IDR rights held by the stub in ARP.

There are approximately 57mm fully diluted units of ATLS outstanding when multiplied by the current stub value of $7.04 is approximately $401mm in market cap.  Including expected new debt of $125mm, the EV of the new entity is $526mm.  The SOTP value of the assets are as follows:

• 24.7mm shares of ARP (no premium given for preferred shares) = $408mm
• Current GP and IDR payment stream of $16mm annually should be valued around 13x = $208mm (takes no consideration of likely distribution increases at ARP)
• Current cash flows from ATLS’ E&P interest (soon to grow) are approximately $1mm, valued at 13x = $13mm
• $15mm in ARCX shares with no value attributed to GP interest  in Lightfoot Capital Partners
• Assume Arcoma gas assets worth approximately $45,000 a flowing BOE which equals approximately $86mm

Adding these assets yields a SOTP value of approximately $730mm.  Backing out the expected $125mm in pro-forma debt yields a stub equity value of $580mm, or $10.61/share.  I believe that this SOTP value is low because it assumes no growth in any of the GP earnings streams of the stub which is highly unlikely.  In addition, over time, retail investors seeking yield will make this stub a yield oriented play.

I believe that there are three reasons for the disconnect between the value of the stub and the underlying LP:

• Given the bloodshed in the energy sector in October, MLP focused investors and hedge funds in general are concentrated on surviving the year and are not looking for new ideas in the energy space.
• There is an extraordinary amount of capital required to express a position in the stub.  In a market where retail is likely not currently active and energy and MLP focused investors have taken down gross capital exposure, this stub position will suck down a lot of “dry powder”.  For example, to express a 10,000 share investment in the stub with a current value of $70,400, an investor would have to buy 10,000 shares of ATLS worth $392,000 and short 1,809 shares of TRGP worth $230,358.  Therefore, an investor has to put up $622,358 in gross capital to express just a $70,400 bet.
• Given the recent price action in natural gas and oil, investors are likely assuming some distribution cut at ARP in the coming years.

The value of the stub will be realized as the company attends conferences and explains the story into the deal close in Q1 2015.  In addition, I believe there are additional catalysts that could play out:

• ARP could buy back it’s IDR stream from ATLS spin or buy all spinco at a premium.  Now would be the “cheapest” time to do it as ARP is entering the “high splits” of 50/50 for its IDR and such a move would accelerated distribution growth and valuation at ARP.
• ARP is likely to increase confidence that the distribution is not going to be cut but is going to be raised.  On the call announcing the sale to Targa, management was extraordinarily bullish on the prospects for ARP and said, in effect, that the distribution will be going up.  I believe that there are several things potentially in play: the fundraising partnership business is going quite well for the year, ARP is looking at ways to increase acquisition activity without having to tap the capital markets which is always good for an IDR holder and the underlying, or ARP is going to be sold.  Based on the language in the ATLS conference call discussing the Targa acquisition of ATLS and APL, we are likely to get an update on whatever is going to happen before ARP’s November 11, 2014 earnings conference call.

Links to the call can be found here:

http://phx.corporate-ir.net/phoenix.zhtml?p=irol-eventDetails&c=197317&eventID=5171686

ARP currently yields 14.3%.  In a follow-on note or update, I will articulate why I believe that the distribution is secure at ARP.  The appropriate dividend yield for a GP of an upstream MLP should be 8%-9% yielding a price target of $12.50-$15.63.  I will provide comps in an update to this post (VIC community please advise if you would like me to add any or consider particular comps).

The next two weeks are critical as I suspect investors will receive a substantial update with respect to spinco and ARP.  Please read the deal release and listen to the conference call.  At a minimum, it will become clear that the dividend at ARP ($0.1966 per month or $2.36 annually) is well secured and a target of up to $15.63 at spinco is based on sustainable cash flows from the dividend paid monthly at ARP.  It will also become clear that the IDR revenue stream will accelerate in the coming year.

ATLS announcement of Targa deal:

http://phx.corporate-ir.net/phoenix.zhtml?c=197317&p=irol-newsArticle&ID=1976851

Catalyst