CEQP - Crestwood Equity Midstream Partners LP

[Palantir]

I have heard some interest in this name. Here are some numbers and summary I have:

 

•Common units have a 40%+ yield.

•We believe it is sustainable, but management may cut distribution anyways.

•Distribution cut is the cheapest source of equity, and CEQP is not being given credit by the market.

•I'm estimating a distribution cut of $1.00, or 73% resulting in a quarterly distribution of $0.375.

•If this occurs, then common units will still have a very high yield of 12%.

•Savings from reducing distribution will be used to build projects and reduce leverage.

CEQP_160126.pdf

[jawn619]

I have heard some interest in this name. Here is a brief presentation we discussed in our COBF NY meeting.

 

GOOD stuff

[DTEJD1997]

Palantir:

 

Thank you for sharing your detailed write up & research with the board.  That is what makes this board so valuable & useful.

 

One question about CEQP distribution....

 

Obviously the market anticipates a cut coming the near future to the distribution.  The stock has clearly been under selling pressure in anticipation of that.  Do you think that if a distribution cut is announced, that retail investors will further exit their positions putting more selling pressure on CEQP?

 

Additionally, if Quicksilver defaults OR significantly re-negotiates the terms of their contract, that will also put pressure on the price?

 

Thus, the thing to do might be to watch this closely and be prepared to act if it spikes down in response to either event happening?

 

There are certainly some silly prices in the MLP sector and I definitely think there is good money to be made here.

 

[Picasso]

Nice short and sweet summary.  For those that haven't followed CEQP closely it should also be noted that Raging Capital is an activist in the name and has a nice slide deck out there.  In several ways I found the debt of CEQP to be more interesting.  They've deteriorated quite a bit (perhaps hurts the equity thesis) since I first played with the equity; 6% of 2020 now yielding 17% at a price of $63.  In general I've been staying higher in the capital structure until I can get 100% comfortable with the equity risk.  In the case of Crestwood, I became less comfortable with the gathering and rail assets.  Not a buyer of the bonds yet but might be soon.  A lot of moving pieces here...

 

Palantir, any thoughts on First Reserve and how they are getting their asses kicked?  Strong sponsor support is going to be critical here and they might hurt CEQP shareholders if things get really rough. 

[misterkrusty]

how do you think they might hurt shareholders?  (not arguing, just asking)

[Picasso]

Historically the sponsor will redirect cash back to the LP during hard times.  If First Reserve is essentially out of business (the remaining value of their units isn't worth a lot and the dividend cut kills the value of their GP) then they might not be in a position to support the LP.  They need to pull some real financial engineering here to boost the value of the LP units (a sale is tough because they need to find someone who can issue new debt at 6% rates, not possible today; KMI and ETE are getting killed for both small and large transactions) or just bleed as much cash out of the LP as possible.  They've already tried a couple things and it isn't working and now the bonds are plummeting which kind of supports a donut to LP units and a continued high dividend as cash gets pulled out.

 

There isn't a lot of short interest, largely because of the dividend.  If it gets cut (which it most likely will be) then you could see a ton of downside here as shorts come in and sponsor support will be critical.  Recent capital allocation decisions seemed premature and it's shown in the share price reaction after the news.  First Reserve will hurt CEQP in that they won't be in a position to really do anything.  My gut tells me this is a donut, but worth a closer look.  It's something where getting to the finish line gives you multi-bagger returns but you need some aces in your back pocket to know your downside.

 

Then I forgot to mention the maintenance capex issue.  Seems really low for their assets and so there's that as well.  Not related to the sponsor but it makes them more reliant on the capital markets and that's just not happening here. Makes sponsor support that much more important.  Also previous transactions with First Reserve have rubbed shareholders of CMLP/CEQP the wrong way.

[misterkrusty]

I believe CEQP now owns 100% of the GP, so potential for abuse is perhaps lessened.  First Reserve & mgmt just bought $100m of units in the open market, so they certainly seem to believe the story they're pitching.  but of course that doesn't mean they couldn't be wrong.

[Picasso]

That's right, slipped my mind.  I think there were probably a few better ways to close the value gap than the open market purchases.  It struck me as a bit promotional when that's not what the units needed.  Wouldn't surprise me if they basically torched almost all of that $100 million by doing open market unit purchases versus using the cash to pay down debt through new CEQP units @ $20 + a dividend cut.  In these situations you need to take the zero off the table.

 

Oil guys also make me nervous.  There's never a downturn they don't think is about to turn for the positive right around the corner.  So I'm not looking too much into the open market purchases especially when it's only a years worth of distributions from CEQP for First Reserve.  They need to maintain 5.5x leverage ratios and they aren't too far away from breaching that with the potential risks in their portfolio.  Too much optimism from First Reserve can really kill the units if they start this process of reducing leverage too late. 

 

But as you sort of imply, it's now in the sponsors interest to create the most value from CEQP.  So less likely to get screwed through normal means, but more from pressure from First Reserve to pay out more than the business is going to earn on this much smaller unit stub. 

[Palantir]

GOOD stuff

 

Thanks dude

 

Obviously the market anticipates a cut coming the near future to the distribution.  The stock has clearly been under selling pressure in anticipation of that.  Do you think that if a distribution cut is announced, that retail investors will further exit their positions putting more selling pressure on CEQP?

 

Additionally, if Quicksilver defaults OR significantly re-negotiates the terms of their contract, that will also put pressure on the price?

 

Thus, the thing to do might be to watch this closely and be prepared to act if it spikes down in response to either event happening?

 

This is a really important question. One thing to keep in mind is that even the "institutional" investor base for these companies is really a retail proxy - CEFs run by large investment houses who have all been force selling due to leverage constraints. For older MLPs everybody can't necessarily sell because they may have a really low cost basis, but that might not be an issue here. I personally don't think there will be tons of retail selling, partly because even a 75% cut will still put them at a pretty high yield, and there is the offsetting result of rising prices from interest from other investor types, that and a lot of retail guys will want to wait for a turnaround, which is reasonable. But you never know, if these guys just suspend the distribution, then it could become an orphan...

 

 

As for Quicksilver defaulting, yeah, I think a total default would weaken the upside case significantly, however, I valued it with a QS default, and still expect significant upside. Raging Capital is confident that Quicksilver won't default, but I'm trying to understand why, and I am not sure about that yet. Another concern could be credit risk from other counterparties like Sabine, Chesapeake and Trinity, which I don't know too much about. Thankfully the S&T business has much better counterparties (utilities).

 

Palantir, any thoughts on First Reserve and how they are getting their asses kicked?  Strong sponsor support is going to be critical here and they might hurt CEQP shareholders if things get really rough.

 

I think this would have been a much greater problem in years past when the LP/GP structure was extant, but since then, with the merger and IDR relinquishment, First Reserve has only a non-economic GP stake, so essentially I don't think there is a conflict of interest where they can issue LP equity to drive IDR payments etc. Overall, I think FR is in the same boat as common holders. I think the best sponsor support is a dist cut, there is just so much money that can be then used to buffer up leverage especially if anybody defaults. They won't need to tap into any external financing, and it will IMO add a lot of upside by just shrinking the debt piece of valuation.

[SharperDingaan]

Good analysis; but put the numbers away and think.

 

This thing is trading at 7.8x, when most can build (in normal times) at 6-7x. In abnormal times, MLP’s will build by buying out of bankruptcy sales at maybe 60c in the $; assume an average 1/3 off, & the multiple is 4-4.67 (.67 x 6-7). A multiple of 4.33 implies a pending price drop of 44%

 

They have very high debt, and are reliant on 1 customer. Problem is that if they lose this customer to bankruptcy; there are not enough other customers to make up the volume, and the odds on the banker ever getting repaid become extremely dim. The banker will want the entire dividend cut, & 100% of the funds immediately diverted to debt repayment. Cut the dividend by a lot more than expected, and the price drop will overshoot. A 15% overshot will reduce the multiple to around 3.7 and drop the price by 52%.

 

This firm has a strategic gathering facility with minimal ongoing CAPEX. Very attractive to a banker as it means they can seize the firm by calling in the debt, & simply sit on it. The wall of money waiting on the sidelines cannot move any production without dealing with them, & thereby raising the price. Bankers are not stupid.

 

Long term, CEQP may well survive, but short term CEQP may well look very different. Most would be shorting them & not establishing a long position until after the forthcoming dividend position is known, and neighbouring producers have reported Q4 results.

 

SD

 

[wjsco]

Oh, by the way - check out Quicksilver Resources 8-k from 9/22/15, go to page 15 of the powerpoint. It says right there -

"Crestwood rate concessions offset by Quicksilver development plan"

 

So, they're not going to default, they're going to restructure...and Crestwood will make rate concessions in return for additional development.

 

And then, page 48 of that same presentation (CEQP 9/22 8-k), which Raging Capital also used in their presentation, Quicksilver itself writes on the left hand side of the slide that it hasn't rejected those key contracts, and is looking to cut expenses while providing opportunity to midstream guys, like CEQP. So Quicksilver itself wants to restructure with CEQP. We can speculate as to why, but it doesn't matter.

 

Edit: Looks like an asset purchase agreement came out, too (for Quicksilver)...the filing says something about assigned vs. excluded contracts, and then says to look at exhibit D or H (or something) for a list of contracts, but there is no exhibit D :/

 

[Palantir]

 

They have very high debt, and are reliant on 1 customer. Problem is that if they lose this customer to bankruptcy; there are not enough other customers to make up the volume, and the odds on the banker ever getting repaid become extremely dim. The banker will want the entire dividend cut, & 100% of the funds immediately diverted to debt repayment. Cut the dividend by a lot more than expected, and the price drop will overshoot. A 15% overshot will reduce the multiple to around 3.7 and drop the price by 52%.

Which 1 customer are they reliant on? Quicksilver? They are not "reliant" on them.  They may lose QS to bankruptcy but it is not certain. Even if it were to happen, so what? There are other operations going on here. In the event that there is a default, a suspended distribution would great for equity holders, as it would quickly bring leverage back under control, which should be of prime importance to management.

 

[SharperDingaan]

We simply commented on the analysis. Good, but application needed more thinking through.

We do not have a position, and it is very unlikely we will take one.

 

A reality of public markets is that analysis is toilet paper. Needed, but it is for one-time use - and disposable; don't marry it.

One ply broad strokes, or three ply plush - the end result is the same.

 

SD

 

 

 

 

[shhughes1116]

 

They have very high debt, and are reliant on 1 customer. Problem is that if they lose this customer to bankruptcy; there are not enough other customers to make up the volume, and the odds on the banker ever getting repaid become extremely dim. The banker will want the entire dividend cut, & 100% of the funds immediately diverted to debt repayment. Cut the dividend by a lot more than expected, and the price drop will overshoot. A 15% overshot will reduce the multiple to around 3.7 and drop the price by 52%.

Which 1 customer are they reliant on? Quicksilver? They are not "reliant" on them.  They may lose QS to bankruptcy but it is not certain. Even if it were to happen, so what? There are other operations going on here. In the event that there is a default, a suspended distribution would great for equity holders, as it would quickly bring leverage back under control, which should be of prime importance to management.

 

First, in O&G bankruptcies, assuming the pipeline volume is actually being used by the O&G outfit undergoing restructuring, contracts with pipeline operators are usually not terminated in bankruptcy court (someone with a better handle on the bankruptcy process can probably do a better job explaining this, with the appropriate legal jargon).  So if Quicksilver is restructured, it is likely that they would continue to produce and make use of the pipeline volume commitment.  It is more likely that there would be a renegotiation of the commitment (i.e. reduced rates in exchange for higher acreage dedication and/or agreement to operate an additional rig in the dedicated area and/or extension of the commitment period).  The recent Chesapeake-WPZ renegotiation provides an excellent example of this process, although this occurred outside of a restructuring process.

 

Second, the idea that a bankrupt producer's volumes will simply be replaced by another producer, in most hydrocarbon basins, is naive.  If Quicksilver is not making use of the minimum volumes agreed to with Crestwood, than generally that should tell you something about the economics of that basin (or the specific formation within that basin).  Remember also that most basins are served by multiple gathering systems, multiple header lines, multiple fractionation assets, and multiple intrastate/interstate lines.  Other producers likely already have arrangements for minimum volumes on other lines, so they can't simply switch their volumes to another operator.  Replacing Quicksilver volumes would require additional rigs and/or additional O&G operators to start producing in the basin.     

 

Anyways, I am not sure I understand the fascination with this entity.  Sure, they have a relatively high distribution, but most of their assets aren't worth getting excited about.   

 

   

[constala]

A very thought-provoking view of the MLP sphere....with its perverse incentives (IDR, leverage, equity raising) and technical risks ahead (should dividends levels be cut)  by Harris Kupperman. In two parts.

 

http://adventuresincapitalism.com/post/2016/02/14/A-Crisis-In-Ponzi-Land-(MLP-Style).aspx

 

[awindenberger]

A very thought-provoking view of the MLP sphere....with its perverse incentives (IDR, leverage, equity raising) and technical risks ahead (should dividends levels be cut)  by Harris Kupperman. In two parts.

 

http://adventuresincapitalism.com/post/2016/02/14/A-Crisis-In-Ponzi-Land-(MLP-Style).aspx

 

Thanks, very interesting article. Ponzi finance is terrible for the layman investor, but it does serve up some very interesting opportunities at the bottom of the cycle.

[MYDemaray]

http://www.reuters.com/article/us-usa-oil-lawsuits-idUSKCN0VV0DK

[shhughes1116]

"A judge on New York's influential bankruptcy court said on Feb. 2 she was inclined to allow Houston-based Sabine to end its pipeline contract, which guaranteed it would ship a minimum volume of gas through a system built by a Cheniere Energy (LNG.A) subsidiary until 2024. Sabine's lawyers argued they could save $35 million by ending the Cheniere contract, and then save millions more by building an entirely new system."

 

I'll preface this comment by saying that I am not a lawyer, or judge, so others on this board may be more knowledgeable on this topic than I.  If that is the case, I hope they will weigh in with their expertise. 

 

I thought this quote was particularly interesting in light of precedent already established in the 2nd Circuit Court regarding executory contracts for pipelines.  During Calpine's bankruptcy, they attempted to end their contracts with pipeline providers.  The district court ruled that FERC had sole jurisdiction for this, and thus the contract could not be ended via bankrupcty court.  Calpine appealed this to the 2nd Circuit Court, and the 2nd Circuit Court affirmed the District Court's opinion on the matter.  Of particular interest here is that Calpine was not using the space on the pipeline.  (I believe Sabine is using the space on the pipeline, although they don't like the rates.)

 

One should also note that with this ruling, there is a difference of opinion between the 2nd Circuit (Calpine ruling) and the 5th Circuit (Mirant bankruptcy ruling).  The 2nd Circuit Court affirmed the district court's ruling on Calpine, even in light of the 5th Circuit Court's earlier ruling on Mirant (allowing Mirant to end executory contracts for power purchase agreements regulated by FERC). 

 

2nd Circuit Court covers NY, CT, and VT.  5th Circuit Court covers TX, LA, and MS.