I have exited my positions in ATLS and TRGP after Leon Cooperman appeared on CNBC to tell the world how much he liked Atlas Energy. I haven’t even watched the video above myself to be honest because I don’t give a fuck what Leon Cooperman thinks, but when the stocks pops as a result I’m happy to sell. When you compare the implied stub price of one week ago (left) with the picture today (right) you see that the market is suddenly valuing the stub a lot higher:
I think the current implied stub price is probably not very far removed from intrinsic value. Unfortunately my gains on this trade are limited because the merger spread between APL and NGLS increased. Making money on a merger arb while the spread increases is not bad though.
No positions anymore
Nice trade, but I think you may be a little hasty. You might want to reexamine the assumptions about merger arb ratios in this deal. If you look at the arb spreads in both the TRGP and NGLS deal, they’ve been not only wide but also extremely volatile – not at all typical of normal merger arbitrage price action. I think the arb spreads have been collateral damage as everything has screamed straight down, driving by extrinsic factors. I don’t think the pricing information from the NGLS spread has high signal/noise.
The NGLS deal is quite an attractive merger arb in its own right – the deal makes plenty of business sense; Targa is clearly committed to going through with it; regulatory clearance has already been attained; and all entities involved are majority-owned by mutual funds who are very likely to vote in favor. I’ll grant that the four-way deal introduces an element of risk, but that’s amply compensated by the fat spread.
That’s nice, but the TGRP deal is much more attractive still. To capitalize the implied NGLS spread and deduct out from ATLS stub means you want no part of that action – I don’t agree, but I can understand wanting to focus on the extreme mispricing in the New Atlas stub. Even so, the ATLS stub is worth a minimum of $5, probably closer to $10. You can in fact short out ATLS’s pro-rata share of ARP to help isolate this – the hedge is a little sloppy, since the ARP will still be embedded in New Atlas after the spin, but it’s still pretty good. I’m not doing this because it’s already a huge balance sheet commitment long/short ATLS/TRGP, and given ATLS pounding the table on $1.10 starting cash distribution rate for 2015, I don’t see a lot of risk on the stub anywhere near these prices… you can always short out ARP after the deal closes (if the stub hasn’t repriced to your satisfaction), once you’ve recycled the merger arb capital.
I enjoy your articles on this situation, but I think you’re leaving a lot of money on the table here. The mispricing is quite extreme.
You certainly could be right that the merger spread in APL/NGLS isn’t a good indication of the risks involved – I don’t know – but I think it does makes sense that the spread has been volatile given the volatile oil market. The more things change compared to the pre-deal situation the higher the probability that something goes wrong. Not only wrt to the votes, but also the required financing.
One thing to realize though is that the value of the stub is very dynamic based on changing oil prices / changing market prices of ARP. The stub is mostly ARP, but leveraged with a decent amount of debt and at the same time ARP has financial and operating leverage to the oil price. I think it is probably worth around $5/share right now, but that’s not a lot higher than the implied market price when you take the merger risk into account.
I entered this trade mainly because of the relative mispricing compared to APL/NGLS. Now that that’s no longer the case – at least a lot less – I think exiting is the right thing to do. But it certainly could be a case of penny wise, pound foolish.
a couple additional thoughts:
One: Targa has all of its financing locked up but ATLS seems not to. One key problem is going to be getting ATLS’s new ~$150MM TL in place. Atlas has already filed two preliminary info statements for the spinoff – in the first one, it estimated 8.5% for its prospective interest rate, and now its estimating 10%. With a backdrop of distress in HY energy credits in general, for a structurally subordinated loan essentially against a geared up underlying entity (ARP) that is in financial distress, this is going to be a challenge. That said I suspect the sheer volume of m&a fees being paid will help a lot of banks get this credit approved. But the interest rate will quite possibly be well north of 10% per annum. Put differently if you are lending to an entity that gets most of its value from equity in a company X, and X has bonds yielding ~13%, how much would you charge to lend on a basis that is deeply subordinated to those 13% bonds?
Two: I really don’t see how this could be a good deal for both NGLSs and APL. I think at best this is a good deal for ATLS, TRGP and one more entity. The reason is, if you run any plausible distributable cashflow projection through APL’s existing IDRs and then through the Targa IDRs (post unit conversion), you see that Targa’s pro forma GP is taking a huge slice of what was cash flow to APL unitholders (and the small IDR givebacks associated with the deal don’t really change this nor does the cash payment of $1.26 / APL unit). So as a first cut, you say the deal transfers wealth away from Atlas Pipeline LP to the GP, so its a bad deal for Atlas Pipeline LP. You might then counter that APL unitholders will do well because they’ll benefit from an existing growth pipeline at Targa. But if that is true then you’re really talking about transferring value from NGLSs to APL to offset wealth being transferred from APL to the GP, in which case NGLS unitholders are worse off. The deal is baked around few synergies, and any diversification benefit is small to APL [NGLS] unitholders– they could after all just buy NGLSs [APL] units in the open market to diversify. The only way I can conceive that the deal improves the lot of NGLSs and APL unitholders is the argument that APL is so badly mismanaged that APL in and of itself improves dramatically from having Targa’s senior management post transaction and that this management benefit outweighs the massive transfer of wealth away from LP unitholders to the GP via Targa’s much lower IDR thresholds (on a unit equivalent basis). But I don’t really believe that is true (or that there are huge hidden synergies in here).
Thanks for the comment, agree with it all I think 🙂
What’s IMO also a relevant data point is that short interest on ARP is relative high and that the borrow fee is around 10%. When people are willing to pay that kind of money to short a stock it might be that the true value is below the current market value. Since the sub will be a leveraged bet on ARP that could be problematic if the shorts are right.
Good comments D. Agree with all about post-spin ATLS/ARP; it’s pretty gamy – but it’s very cheap. The same dynamic you note of TRGP about the GP carry works for ATLS too; as long as the wheels don’t fall off ARP, the plan is to do drop-downs and jack themselves well into the high splits. ATLS will get bridge financing I imagine.
The point about the zero-sum game between APL and NGLS is a good one, but it ignores the stock prices. If APL was trading at $0.01/sh and NGLS was trading at $100/sh, you better believe APL shareholders would vote for just about any deal NGLS proposed.
These things are schemes to raise lots of capital at cheap cost, ultimately driven by cheap cost of equity which gives access to debt too. You want to be big and acquire littler guys. This may be especially intensified if persistent low oil prices curtail fracking… you want to be big and well-funded, serving the geographies with the lowest cost to produce, and be able to use your stock as currency to acquire assets from people hurting worse than you.
I would suggest that its actually a negative sum game between APL and NGLS because the Targa IDRs siphon off more cash to the pro forma GP from APL’s assets, than would be done from under APL’s existing IDRs. (If you’d like an analogy, I’d say its more like playing Poker at a casino than with a group of friends. Poker with friends is a zero-sum game, whereas poker at a casino is a negative sum game because the house [GP] takes a rake off all games played. Or we could talk about playing poker at a casino with a low rake and being forced to move to a casino with a much higher rake…)
You have a point that APL unitholders are likely to vote for something purely on market prices alone, if market prices are way out of whack. That doesn’t necessarily mean its intelligent behavior, though. (I still think back to all of the unaffiliated investors that approved KMI’s LBO back in 2007.)
More to the point, though, if you held say 1% of NGLS, and 1% of APL, this deal makes you worse off because pro forma for the deal, you are ‘donating’ much more of your distributions to your GP. There really is no way around this conclusion other than invoking hidden synergies or big time mismanagement at APL.
Being big certainly helps get you better access to capital markets, and size in and of itself does improve your credit profile. (Again, I’d assert that while the size benefit is real but not enough to outweigh the increase GP rake for APL unitholders.)
Over time I’ve become increasingly skeptical of the arguments about cheap MLP equity capital for companies with IDR splits beyond the 75:25 threshold. The cost of equity for companies that are deep in the 50:50 splits (like KMP used to be) ends up basically being double whatever the company would have been on its own. Getting a 20% – 50% uplift in valuation because of tax benefit and possibly naive investors is helpful for MLPs, but doubling that implied cost of equity tends to overwhelm any valuation benefit. Basically no companies are as deep into their splits as Kinder was, so the straightforward adjustments isn’t quite as extreme…. (There is an additional convexity adjustment that LPs should do though I’m not convinced that they actually do it. Failure to do such an adjustment really is a direct, zero-sum, transfer of wealth to the GP so it should wash out for the firm as a whole though.)
Anyone have ARP est. distribution in 2015 & 2016 running futures curve on nat and crude and factoring in hedges?
I would stay long based on two factors;
1) The GPs involved (TRGP and ATLS) have a strong incentive to get this deal done, which means it almost certaintly will get done. It also will likely get done within a couple months or so (high annualized returns).
2) Even though ARP’s dividend will drop eventually when cash flows dry up from lower commodity prices, Atlas Energy has a strong incentive to prop them up in the next couple years to extract as much from IDRs as possible. If AEG continues it’s $1.25 distribution, you get paid back very quickly for the stub with valuation upside as well.