Description

SemGroup Energy Partners LP (SGLP, $6.00 Pink Sheets) is a Public Master Limited Partnership that owns three separate businesses.  First are crude oil storage and terminalling facilities located primarily in Oklahoma (Cushing).  Second is a crude oil gathering and transport business with 1,150 miles of pipeline and over 200 owned and leased trucks.  This business also has an additional non-operational pipeline, which can be sold or possibly turned on in the future.  Third are forty-six (46) asphalt cement storage and terminalling facilities across the United States.  SGLP was spun out of SemGroup (Private Co), once one of the largest crude oil marketing firms in the world.  Private Co went bankrupt in mid-2008 largely due to bad bets made on the price of crude oil.  Since that time, SGLP has completely disentangled itself from its former parent and is now ready to operate as a fully independent entity.  I believe the shares of SGLP represent a compelling opportunity to make strong capital gains and tax-free distributions within the next twelve months as the Company's cash flow and value are rediscovered by equity investors.

RECENT HISTORY

SGLP went public on July 17, 2007 at $22 with an initial minimum payout of $.3125 per share each quarter.  Similar to a cumulative preferred stock, each common unit must receive that minimum distribution or it is held in arrears before the Company can make distributions to its Subordinated Units.  SGLP was spun out of Private Co with an agreement to receive fixed monthly payments from the former parent for its assets.  Subsequent to the IPO, Private Co sold additional assets to SGLP including the Asphalt assets and the Eagle North Pipeline.  At the time of Private Co's bankruptcy on July 22, 2008, nearly 100% of SGLP's revenues were derived from contracts with its former parent.  This event coincided with the change of the General Partner of the partnership from Private Co to Manchester Securities and Alerian Finance who had rights to assume control of this partnership upon the occurrence of certain events at Private Co.  SGLP's stock traded down from a high of almost $28 per share prior to the troubles to a low of $0.87 per share as holders unloaded their common units due to the suspension of the distribution and uncertainty regarding the future prospects of the Company.  As can be expected, SGLP was not able to issue its financial statements during this period of time.  In addition, the Company had to work with its lenders under a series of forbearance agreements also.

As soon as the Private Co went bankrupt, SGLP began to work on moving its crude oil storage, terminalling and transport revenue sources from the former parent to outside third parties.  Private Co continued to pay its monthly obligations for the asphalt terminalling and storage, since liquid asphalt becomes worthless if it isn't kept at extremely hot temperatures.  Finally, in April of 2009, SGLP and Private Co signed an agreement which completely separated the two companies permanently.   Upon this event, the Company was able to get a waiver from its bank group that put it back into compliance.  Its bank facility currently charges SGLP a rate of Libor plus 650 basis points with a Libor floor of three percent (3%) for a 9.5% effective rate plus additional fees.  It also restricts the payment of distributions until leverage reaches a 3.5 times ratio.

SGLP has estimated that 2008 EBITDA was $105 million under its agreements with its former parent.  This was broken down between the asphalt business with $40 million and the crude oil business with $65 million in EBITDA, respectively. 

CRUDE OIL STORAGE, TRANSPORT AND TERMINALLING BUSINESS

SGLP owns approximately 6.7 million barrels of storage capacity in Oklahoma, Texas and Kansas.  Of this storage capacity, 4.8 million barrels are located in Cushing, OK.  Cushing is one of the largest crude oil marketing hubs in the United States and the designated point of delivery specified in all New York Mercantile Exchange crude oil futures contracts.  SGLP also owns 26 acres of additional land within the Cushing Interchange where they can develop more storage.  It is my understanding that rates for storage of crude oil run approximately $0.50 per barrel per month, making this business a $40 million revenue per year business.  As you would imagine, fixed and variable costs of running this business are very low.  I estimate that it currently generates approximately $35 million in annual EBITDA to SGLP.  It operates with long-term contracts and has very stable cash flows.  Currently there is a cotango in oil prices where future prices exceed current prices.  This provides increased demand for storage assets, which will translate into higher storage fees as contracts rollover.

SGLP owns two operational and one completed but un-operational pipelines.  The two operational pipelines, the Mid-Continent system and the Longview systems, which consist of 1,150 miles of pipelines that gather crude oil for its third-party customers and transport it to refiners, to common carrier pipelines for ultimate delivery to refiners or to terminalling and storage facilities owned by SGLP and others.  The Mid-Continent system is located in OK and the TX panhandle and has a combined length of approximately 820 miles.  The Longview system is located in East TX and has 330 miles of tariff-regulated crude oil gathering pipeline.  The non-operational pipeline was purchased for $45 million from the former parent in May 2008 as Private Co began to suffer from cash flow problems.  This pipeline was originally 130 miles long and a planned 10 mile $3.5 million expansion was completed to enable it to connect to Cushing, OK.  In addition to its pipelines SGLP gathers crude oil from remote wellhead locations generally not connected to pipeline and gathering and transportation systems using 200 owned or leased trucks in KS, OK, TX, NM and CO.  I estimate that this business currently generates approximately $30 million in annual revenues and $20 million in EBITDA.  This business is dependent on the flow of oil being pumped out of the ground and is therefore somewhat sensitive to the price of oil. 

ASPHALT STORAGE AND TERMINALLING

On February 20, 2008, SGLP purchased the former Parent's domestic owned liquid asphalt cement terminalling and storage assets for $378.8 million.  It consists of 46 terminals in 23 states with an aggregate storage capacity of 6.6 million barrels.  The asphalt business is highly seasonal.  As asphalt is produced it is stored at high temperatures to keep it from hardening.  Once it leaves the storage facility, it can only be transported a limited distance before it begins to lose its liquid state.  Therefore the asphalt business is highly regionalized and has its peak throughput seasons during the warmer months in the northern states.  Most markets for asphalt have between one and three storage facilities, which leads to stable long-term pricing for the industry.  Under SGLP's old agreement with Private Co, the Company generated approximately $40 million per year in EBITDA.  My 2009 estimate is for $20 million in EBITDA as the Company signs new agreements for its 46 facilities (45 signed to date) and finishes its relationship with Private Co by October 31, 2009.  These 45 contracts primarily run through December 2011.  For 2010 and beyond I believe that SGLP will be able to generate EBITDA of $35 million (90% of former cash flow) from this business.  This number could rise substantially if the stimulus for United States road construction is spent by the Obama administration.

SGLP CLAIMS AGAINST PRIVATE CO

SGLP has $55 million in unsecured claims against it former parent.  These claims were part of the settlement agreement announced on March 23, 2009.  Private Co has announced that two of its three main creditor groups have tentatively agreed to support a plan to reorganize the bankrupt crude oil marketer.  It is hard to estimate how much SGLP's claim is worth.  However, there are analyst reports that value it at between 40% and 50%.  Private Co is due to reorganize as a public company during the third quarter.  This could result in $20 to $27 million in cash that can be used to repay bank debt.

SGLP EBITDA ESTIMATE FOR 2009, 2010 AND BEYOND

SGLP has issued financials for only the first nine months of 2008 as they play catch up due to their former parent's bankruptcy.  In numerous conversations with SGLP's investor relations, the Company has stated that it believes that it was generating EBITDA at an approximate $105 million per year rate prior to Private Co's problems.  For 2009, I am assuming that this number drops to $70 million due to the quickness with which SGLP needed to contract with new partners for use of its assets.  For 2010, I assume that EBITDA recovers to $80 million into perpetuity.  These assumptions are based on the my view that SGLP will get stronger utilization of its assets in 2010 without the distraction and uncertainty caused by Private Co's problems.  It also assumes that corporate general and administrative expenses run at $5 million in 2009 and $10 million per year thereafter.  This EBITDA estimate excludes the legal and accounting cost of dealing with the issue of Private Co's bankruptcy, since these are one-time expenses.  This should bring SGLP's debt to a level at the end of 2010, where SGLP should be able to refinance its debt and begin to start paying the required distributions.  See the table below:

SGLP will continue to trade at a discount to the average multiples of its peers until it can reinitiate its $1.25 annual distribution.  Based on the chart above, I believe that this distribution will be restarted in the later half of 2010 based on debt pay-down from free cash flow.  There are two scenarios where this distribution re-initiation occurs at a quicker pace. First, it is possible that SGLP could make assets sales of non-core assets like its $48.5 million cost non-operational pipeline to start this process at an earlier date.  Second, SGLP is actively looking for a new marketing partner who could increase the volume of crude oil products transported and stored through its facilities, thus increasing cash flow to levels well above my estimates.  It is also likely that SGLP will be able to renegotiate its bank deal once cash flows have stabilized to a rate better than it current 9.5% plus fees.  That might allow SGLP to repay bank debt faster and to reinitiate its distribution earlier than the second half of 2010.

VALUATION

There are a number of public master limited partnerships that are similar in asset composition to SGLP.  These comparables are Nustar (NS), Plains All American Pipeline (PAA) and Enbridge Energy Partners (EEP).  NS transports and stores crude oil and refined products, including asphalt.  PAA and EEP transport and store crude oil.  The chart below details that these type of companies trade for between 10 and 11 time trailing twelve months EBITDA, distribution yields of between 7.5% and 9.6% and have leverage of 4.0 to 4.5 times.

Using the average EBITDA multiple and applying it to projected 2009 and 2010 EBITDA and Net Debt yields a value of between $14.94 and $21.43 per share as shown below.

At these values there is no legal money ($22.00 offering price plus $1.25 arrearage minimum valuation) left to payout the 12.57 million Subordinated Units or the General Partner.  Under this scenario, I would imagine that in a total sale of the business there would be a negotiation between the General Partner and the Common Unit holders to pay something to them to facilitate a transaction.

Using the average distribution yield of 8.4% and assuming that SGLP can start paying its minimum $1.25 per share distribution in the second half of 2010, yields a value of $14.88 per common unit.  This supports the valuation provided by the 2009 EBITDA multiple and I believe that if SGLP can pay a distribution it will attempt to use as much of its free cash flow as possible to catch up to the arrearage on the distribution.  Currently, this arrearage sits at $1.25 per common unit.  For the Subordinated Units to begin participating in the cash flows of SGLP, the Company would have to catch up on all of its arrears and pay 4 straight quarters of $0.3125 distributions.  Until then the Common Units will receive 98% and the General Partner 2% of the cash flow, respectively.

EXPECTED SCENARIOS / TIMING

• 1. Utilize free cash flow and assets sales (un-operational pipeline and Private Co securities) to pay down and refinance bank debt so that SGLP can reinitiate its $1.25 annual distribution. I believe a mid 2010 date is the most likely occurrence for this situation. Happening at current moment.
• 2. Partner with third party crude oil marketing firms to improve the yield on SGLP's assets and improve cash flow to restart distributions. Happening at the current moment.
• 3. Sell the whole Company once cash flow has been maximized. Only probable if General Partners can reap a financial reward.
• 4. Relist SGLP back on NASDAQ once company makes filings current. SGLP still owes its 2008 10-K and March 2009 10-Q. This should occur over next six months.

RISKS

• 1. Crude oil prices crater and production of crude declines markedly in the United States affecting its transport and storage.
• 2. SGLP is unable to increase cash flows across its assets due to unforeseen economic circumstances.
• 3. Current SGLP management gets distracted by legal issues from senior employees who worked for the Private Co
• 4. Future Legal settlement with former Common Unit holders could drain SGLP company resources.
• 5. SGLP continues to delay SEC filings and therefore the Common Units remain trading on the Pink Sheets.

Catalyst

1.  Reinitiation of the disribution

2.  Assets sales and recovery on Semgroup LP bankruptcy claims

3.  New marketing partners for SGLP operating assets

4.  Sale of Company