Entered the ATLS/TRGP merger arb/stub trade

After my post on the Atlas Energy merger arb/spin off a lot has changed in just a few days because the carnage in the MLP land has continued unabated. This also has had big effect on the implied new Atlas Energy Group stub price that has tumbled from $4.21/share to $0.42/share. This is however a bit of a deceptive figure since it does not account for the merger risk inherent in buying the stub. We can estimate the merger risk by looking at the NPL/NGLS deal that is codependent on the ATLS/TRGP deal, and the deal spread has grown together with the carnage in the sector. If we adjust for the merger risk we get the following price:

Implied price Atlas Energy Group

The estimate of the merger risk is of course just that, an estimate, because while both deals have the same probability of completion the downside risk might not be identical when the deal fails. I don’t think this difference is material though, although the ATLS deal might have a bit more risk since a larger percentage of the price is paid in cash. But we also get paid a whole lot more than the 7.13% of the APL/NGLS deal. If we only look at the value of the ARP LP units that the new Atlas Energy Group owns we already get a value of $2.26/share:

ARP LP units value minus debt

In addition to this we also get:

  • 100% of the GP and IDR units of ARP (probably worth at least $0.50/share in current environment and a potentially extremely valuable option on a oil price recovery).
  • A 12% LP stake in Lightfood that owns 40% of ARCX (worth $0.29/share).
  • A 15.9% GP interest in Lightfood (no idea how valuable).
  • A 80% GP interest in the E&P development subsidiary and a 2.5% LP interest.
  • 11.5MMcfd of gas production in the Arkoma basis (valued by management at $1.15/share, and gas prices have remained basically unchanged)

I honestly don’t know exactly how to value all these various interests, but when you get a bunch of potentially valuable assets basically for free I think this almost has to be a good bet with a positive expectation. So I have initiated a small position yesterday. Anything else than a small position is probably not wise/doable though since you need to tie up a lot of capital, and you get a lot of deal risk as well. You could theoretically hedge the deal risk to some extent by shorting APL and buying NGLS, but that would require even more capital.

Disclosure

Long ATLS, Short TRGP. No (direct) position in ARP, ARCX, APL or NGLS.

11 thoughts on “Entered the ATLS/TRGP merger arb/stub trade

  1. D

    What are your thoughts on buying ARP units directly (currently with a ~24% yield) or ARP’s notes (the 7.75% notes due 2021 have a yield of ~14% right now). Obviously these are a bit less eye popping than the ATLS stub valuation, but then again it’s very hard to effect the stub and only the stub without taking on ancillary risks, whereas buying ARP units or debt is a very straightforward trade. The notes are rated B- / Caa1 in part because they are behind the company’s 1st lien credit facility. Obviously the equity units claims are jr to the notes…

    My sense is that ARP could credibly improve the ‘safety’ of its distributions and interest payments if it were to layer on significantly more nat gas hedges for 2017 and 2018, and to provide capital markets a bit more disclosure on the Partnership fee stream (and related items like how subordination of production revenue to investor partners within Drilling Partnerships, actually works — and associated commodity price sensitivity implications). I am not sure whether management is interested in doing either of these things though. Of course, there are other tools out there as well.

    One nit: there seems to be a bust in the Value column in arp_minus_debt1.png

    Reply
    1. Alpha Vulture Post author

      Yes, copy/paste error in the value column, thanks for noticing. The per share numbers are correct (or at least were correct when I wrote this – lots of movement in all parts here).

      I have looked – or at least tried looking – into ARP. Not so sure that these units or the notes are a great deal, but it’s complicated to figure out expected cash flows. Cash flows will decrease significantly once hedges roll off and a lot of the (potential) value of ARP also goes to the GP and the preferred equity (also owned by new Atlas Energy, although it will automatically convert in 2016). I haven’t looked at the debt covenants in detail, but a potential risk I see is that the covenants aren’t restrictive enough and that the company can distribute a lot of cash flows to the GP and LPs. What’s left in 2021?

      Reply
  2. D

    I would suggest that you if you’re looking for a position in ATLS and you’re not comfortable with buying ARP at current prices, you may want to re-think your position in ATLS, either by closing it or shorting ATLS’s underlying position in ARP (though that has challenges of its own), or …

    as for the notes:
    The company’s reserve life index is in the neighborhood of 15 years, so even in an unlikely steady-state, there would be considerable reserves left for the notes in 2021. The prospect of ARP potentially paying out a ton of cash flow before 2021 is a bit troubling but endemic in the MLP world. Typically you’d expect the reserve base to continue to grow, and ARP to issue more debt, beyond 2021, as it does more acquisitions — and this loop itself is credit positive for those notes, allowing further acquisitions… But, the whole acquisition cycle gets gummed up when ARP’s debt and equity yield so much that it really can’t access capital markets.

    Atlas is a very interesting situation, but one that in practice is loaded up with quite a few different, subtle, risks.

    Reply
    1. Jacob

      Very well stated. I am thinking about the situation similarly, but perhaps overthinking it a bit. In my mind the biggest risk is that the transaction doesn’t close. Are you comfortable being left with legacy ATLS/ARP and a short position in TRGP (which might even go up) in that state of the world?

      Reply
      1. Alpha Vulture Post author

        Comfortable is a big word: if the deal is cancelled I expect to lose money, but you are getting paid a decent amount of money right now to take that risk (although it is hard to quantify exactly since it depends on the value of the spin-off).

        Reply
      2. BDUBS11

        Been long ATLS, short the TRGP to create Newco at my perception of attractive levels. I think toughest question is what happens to both stocks if the deal busts. Based on general TRGP analysts sentiment toward deal(very positive), significant accretion , and management recent statements I think the risk of a break is small. If the deal broke today, my best guess is ATLS trades to $27 and TRGP trades to $94. If this were right i make $5 X .1809($.90) on the TRGP short and lose $2.40 on each share of ATLS i’m long. Would welcome any other views on this “dealbreak”, which I realize has a large component of guesswork ??

        Reply
        1. Alpha Vulture Post author

          My simplistic idea: the current spread between APL/NGLS is pretty big. So the market seems to think that either the probability of the deal being completed is very low or that the downside is very high (or a combination of both). If the market agrees with you that the probability that the deal will be completed is high it certainly won’t agree with you w.r.t. your downside estimates.

          Reply
  3. Peter

    Trying to understand today’s press release stating 70-80 cents of annual distribution. Is that per current ATLS share or is that for each share of the New Atlas, which would mean only 35-40 cents of annual distribution per current ATLS share. Their most recent filings showed $1.10 per current ATLS share, or $2.20 for the New Atlas. I wish the press release was more explicit in its explanation.

    Reply

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