Description

What is Ferrellgas

Ferrellgas is the second-largest retail propane distributor in the United States with a vast logistics network that services residential, commercial, industrial, agricultural, and wholesale customers. The customer base is predominantly rural in geographies where regulated utility access is limited or non-economic. Propane consumption is a seasonal business since significant demand stems from home heating in winter months. Their domestic tank exchange business under the Blue Rhino brand has ~50% of the domestic United States market share and offers some counter-seasonal demand.

History of Ferrellgas including Post-Bankruptcy Reorganization

The company was founded in Atchison, Kansas in 1939 by A.C. Ferrell, the father of current Executive Chairman James Ferrell. James joined the business in 1965. It expanded organically and via acquisition including the opening of Ferrell North America, a propane and feedstock distribution arm in 1977. Blue Rhino was founded in 1994 around the same time that Ferrellgas Partners, L.P. did an IPO. In 1998, James Ferrell shared the news that Ferrellgas had given ownership in the business to thousands of employees through the establishment of an ESOP (employee stock options plan). In 1999, Ferrellgas acquired Thermogas for $432M. This transaction propelled Ferrellgas to become the largest propane marketer in the United States. In 2004, Ferrellgas merged with Blue Rhino, the largest provider of propane by portable tank exchange in the country. This combined the largest propane marketer with an exchange network with over 29,000 selling locations. Over the 20 year period from 1994 through 2014, Ferrellgas gradually expanded its revenue and EBITDA at a mid-to-high single digits annualized rate with a great deal of consistency as its leading market position and expansive logistics network provided a utility-like service to its diversified customer base.

In June 2015, Ferrellgas agreed to acquire Bridger Logistics for ~ $840M as part of its plans to expand its midstream services business. This transaction destroyed a generation of value creation for James Ferrell and Ferrellgas employees. Founded in 2010, Bridger was named Inc. Magazines “Fastest Growing Energy Company” in 2013. The press release highlighted that “Bridger owns and operates assets across the midstream value chain and can provide end-to-end crude oil logistics, including trucking, terminaling, pipeline, rail, and maritime, from the wellhead to end markets across North America”. To say that this transaction proved to be an utter catastrophe would likely be an understatement. Within one year, Ferrellgas wrote down the Bridger assets by 75% and sold them in 2018 for less than $100M. By 2020, Ferrellgas was seeking a prepackaged bankruptcy restructuring because of debt assumed as a function of the Bridger Logistics purchase.  A company that survived, and generally thrived, for 80 years was in the hands of its creditors due to its inability to repay or refinance the debt due under its $357M senior notes due in 2020.

Summary of Capital Structure Post-Restructuring

Ferrellgas exited prepackaged bankruptcy in April of 2021. Its capital structure can be thought of in 4 parts:

• Unsecured Senior Notes ($650M 5.375% due 2026 as well as $825M 5.875% due 2029)
• Preferred Units (~$700M with redemption price of 12.25% IRR or multiple of invested capital of 1.47x)
• Class B Units: FGPRB should receive either a cash payment or a mix of cash and Class A Units.
  • Cash Payment: $357M accruing at 15.85% (since March 2021) implies ~$543M total to be paid/owed by year end of 2024 with $250M already paid since inception.
  • Cash & A Units: Once $357M is paid to B Units, B Units convert to A Units at increasing rate.
• Class A Units: 4.9M Units with significant insider ownership (Ferrell family and ESOP).

Why is Ferrellgas “Class B” a Compelling Reward-to-Risk Opportunity

• Propane distribution is a better business than the market generally believes with a business profile focused on distribution and logistics and an end customer whose needs reflect more of a seasonal utility.
• Structural challenges in stagnant propane volumes are largely offset by reasonable pricing power, customer captivity, and a highly fragmented market.
• Prior to the bankruptcy, Ferrellgas maintained fairly consistent margins and was often attributed strong, low double digit EBITDA multiples due to its high free cash flow generation. In summary, Ferrellgas is a solid, highly cash generative business with a long history of growth that made one very bad transaction.
• The leverage and complexity of the capital structure have confused investors. This creates an opportunity for us since the Class B Units offer more than commensurate reward for the associated risk. Shares can be acquired at a discount to its redemption value which grows at 15.85% annually on the unpaid balance with an ‘upside kicker’ in the potential of our Class B Units into Class A Units. As the highest cost capital in a complex capital structure where sophisticated investors have material stakes, the employees/Ferrell family are incentivized to pay us off as quickly as possible and each distribution further enhances the sunk cost into expediting this process.
• We estimate the fair value is ~$319 per B Uni, or 70% above the current price, and rising at ~ 16% per year.

Ferrellgas Propane Distribution is a Better Business Than Many Believe

Propane is a by-product of natural gas processing and petroleum refining that is commonly used as a fuel in domestic and industrial applications and in low-emissions public transportation. It was discovered in 1857 by a French chemist and became commercially available in the U.S. by 1911. Distributing propane is a logistics and service business where customer demand tends to be seasonal whether for heating in the winter or grilling in the summer. The following images are from a Ferrellgas 2021 presentation. They highlight some of the characteristics of the propane distribution business (above) as well as some of the products and uses (below).

Headwinds from Lack of Demand Growth

Propane is a tiny component of total energy consumption (see arrow in blue in chart below). As a leading natural gas producer in the world, the United States has a significant excess of propane. In 2022, ~ 66% of propane produced in the United States was exported.

The chart below highlights the incremental decline in demand expected across all uses of propane in the United States. This reflects the expectation that slightly warmer weather will reduce the demand for home heating (the primary component along with cooking) for residential use. While weather patterns are uncertain and regional,

U.S. heating degree days have declined (on average) by .11% annually since 1998.

Positive Business Attribute #1: Margins generally pass through (minimal commodity or production risk)

Positive Business Attribute #2: Diverse Customer Base

Positive Business Attribute #3: Logistics Network Scales Technology Deployment & Enhances M&A

• Note: All charts on this page from March 2021 Ferrellgas Presentation

Valuation #1: Class B Unitholders Receive a Cash Payment with No Conversion

The Class B Units offer a compelling reward and, based on the fairly consistent underlying Ferrellgas business, solid downside protection.  In order for the employees (via the ESOP – employee stock ownership plan) or the Ferrell family to have a return on their Class A Units, our Class B Units need to receive ample returns. Since the Class B Units are so expensive to hold (nearly a 16% annualized cost of capital), other Stakeholders (including ESOP and Ferrell family) are incentivized to pay Class B Units off as quickly as business and capital market fundamentals permit.

As highlighted above, one ‘negative’ feature of the Class B Units is that before March 2026, these other stakeholders have a choice as to how to pay off the Class B Units (assuming they have the resources to do it).

My initial assumption was that our Class B Units would receive $357M of principal basis and then convert the Class B Units to Class A Units (discussed on following pages). After further analysis, it appears the insiders might prefer payment of the $357M principal plus accrued interest option. Since the Class B Units accrue interest at a 15.85% annualized rate on the outstanding $357M principal balance (plus accrued interest) until this balance (and interest) are fully paid off, the hurdle is difficult to overcome. Despite strong cash flow over the past few years and payments of $250M (or $192/Unit) over the past 3 years, the estimated capital distribution required to fully pay off the Class B Units for Cash has only experienced a minor ~25% decline despite already distributing $192 per unit (see chart below on left).  In summary, the company would owe another ~$265M today (or ~$204/Unit) to retire Class B Units for cash. This figure increases to $293M (or $225/Unit) and $339M ($261/Unit) at the end of 2024 and 2025, respectively. The expected returns (based on our recent $153/unit acquisition) implied range from ~33% (if redeemed immediately) to ~71% (if redeemed at the end of 2025).

Schedule of Amounts Owed and Paid Under Class B Call Schedule

Valuation #2: Class B Unitholders Receive a Combination of Cash ($357M) and Convert to A Units

The alternative option for Ferrellgas to exit the costly terms of our Class B Units is for them to pay $357M in cash ($275/Unit) and then convert Class B Units into Class A Units. As illustrated in the chart below, the Class B Unitss convert at an increasing rate over time. Therefore, the longer that it takes Ferrellgas to pay the

$357M amount to Class B Unitholders, the greater percentage of Ferrellgas ownership Class B Unitholders will have upon conversion. Specifically, if Class B Unitholders were to receive the $357M amount between now and 3/30/2025, Class B Unitholders would receive 4 Units of Class A for every 1 Unit of Class B that they own. Based on 1.3M Class B Units and 4.9M Calls A Units outstanding, this would give Class B Units a 52% ownership interest in the combined entity. If the conversion were to occur post 3/30/2025, Class B Unitholders would receive 5 Class A Units for every Class B Unit and their share of the combined entity would rise to 57% from 52% today. In summary, every year that passes, Class B Unitholders get an increasing percentage of the company upon conversion. Depending on your view of the fair value of the company, this interest can be very high with incremental value accruing to our Class B Units every year.

Despite the underlying consistency of the business, Ferrellgas’ equity value has a vast range because of the significant levels of debt and preferred equity that is senior in priority to the A&B Units. Therefore, modest changes in multiples applied offers vastly different fair value outcomes. For starters, we look at distributable cash flow to Unitholders over the trailing 12-months (TTM). We estimate that Ferrellgas is generating ~$100M+ (actually $105M TTM) in distributable free cash flow. This represents a ~40% pre-tax free cash flow yield to equity based on the combined A and B Unit market caps of $260M. This is ~4x the pre-tax free cash flow yield to equity of a typical regulated utility and assumes the full obligation of the preferred interest obligation (not just ~$64M over TTM) as well as ~2x the maintenance capital expenditure assumed by Ferrellgas management in their annual report.

The Historic Valuation of Ferrellgas and Suburban Propane

Ferrellgas and peer Suburban Propane’s Enterprise Value to EBITDA and Enterprise Value to Revenue multiples over various time periods provides a sense that a normalized EBITDA multiple might be 9x-12x and normalized Revenue multiple might be 1.3x-1.8x. The post-Bridger period for Ferrellgas is excluded to reduce the likelihood of incorporating questionable data. This valuation range is not inconsistent with large scale M&A in the propane industry which has taken place at 9-11x EBITDA. In 2019, UGI acquired Amerigas minorities at 10x EBITDA in a $2.5B deal. In 2018, Superior Plus acquired NGL propane distribution operations for 10.5x EBITDA in a

~$1B deal. In 2012, Suburban Propane acquired Inergy propane distribution operations for 9x EBITDA in a ~$2B deal. In the following page, we illustrate our Base Case which assumes 1.6x EV/Revenue, 9x EV/EBITDA, and 13x EV/EBIT multiples.

Furthermore, this list of distribution companies from comparable Superior Plus’s 2021 Investor Day presentation highlights that Ferrellgas margins (EBITDA 16.7% and EBIT 11.7%) are actually higher than a basket of companies that are generally perceived to be better businesses than propane distribution and, in this regard, trade at higher valuation multiples. While we don’t believe that Ferrellgas deserves to be considered on par with many of these other companies, it supports the underlying valuations suggested above (and below).

Summary of Fair Value under a Conversion Approach

After applying a range of valuations that fit within the parameters described above, we arrived at an estimated fair value for our Class B Units of $319 per Unit assuming conversion before March 30, 2025. Nevertheless, the range is quite wide between Bearish and Bullish assumptions. The methodology and assumptions to our Base Case across three different time periods is set forth in the chart below. The $319 Base Case in an A Unit conversion exceeds today’s cash redemption amount ($204 per Unit).

• Bull Case assumes 20% increase in fair value via higher multiples or stronger financial performance
• Bear Case assumes 20% decline in fair value via lower multiples or reduced financial performance

The chart below illustrates the Base Case valuation waterfall based on Revenue, EBITDA, and EBIT for scenarios where Class B Units receive a 52%, 57%, and 62% stake, respectively with all other assumptions remaining consistent (and not accretion to value from cash flow generated within these periods of time). As noted above, there is a ~$40/Unit increase in value for every passing year as Class B interests ratchet higher and cash accrues to Ferrellgas (assume $50M/year compared to $100M+ of trailing annual distributable cash flow.

• Bull Case assumes 20% increase in fair value via higher multiples or stronger financial performance
• Bear Case assumes 20% decline in fair value via lower multiples or reduced financial performance

The chart below illustrates the Base Case valuation waterfall based on Revenue, EBITDA, and EBIT for scenarios where Class B Units receive a 52%, 57%, and 62% stake, respectively with all other assumptions remaining consistent (and not accretion to value from cash flow generated within these periods of time). As noted above, there is a ~$40/Unit increase in value for every passing year as Class B interests ratchet higher and cash accrues to Ferrellgas (assume $50M/year compared to $100M+ of trailing annual distributable cash flow.

BASE CASE FOR CLASS A AND CLASS B OF FERRELLGAS

Catalyst

Class B Units are paid off