Midstream executives like to say that it has become too pricey to grow by acquisitions today. Because multiples have risen, they favor organic growth instead. But deals keep happening and the multiples paid for midstream assets keep rising.

Today buyers are apt to pay 10 to 14 times EBITDA (earnings before interest, taxes, depreciation and amortization) for midstream assets, whereas four or five years ago, the average multiple was about four to seven times EBITDA (typically based on either the prior 12 months or the last quarter, annualized).

Despite these prices, midstream buyers still seek to expand their footprint in hot regions where increased gas drilling will require expanded gathering and processing infrastructure.

The key targets are the Barnett shale area, North Louisiana, and the Piceance and Powder River basins, which are very competitive now because gas production is expected to grow in those regions. Too, the gas in these regions is "wet" or high in CO2 and will need processing before it enters the pipeline.

The theory is to do an acquisition now, even if it requires paying a premium, so as to be positioned to grow along with the rising gas production during the next three to five years.

Fueling this action is plenty of money and opportunity. One observer says, "Investment bankers are lobbing in proposals on a daily basis."

In 2003, MLPs raised $3.2 billion in follow-on equity. In 2004, they raised $5.1 billion in IPOs, follow-ons and private financings, according to RBC Capital Markets data. In 2005, they raised $1.3 billion from private deals alone, and another $1.8 billion in follow-ons. Last year, deal flow expanded again, with a total of $5.8 billion

Such powerhouses as GE, Goldman Sachs, Kohlberg Kravis Roberts (KKR) and JP Morgan have raised new infrastructure funds that will invest in midstream assets.



Deal pace

Still, there has been a slowdown from the frantic deal pace seen in 2002 after Enron and its peers imploded. It took until 2005 for the series of ensuing midstream divestitures to help asset-owners whittle down their oversized debt.

"In the past few months, the velocity of transactions has slowed," says Billy Lemmons, senior partner of Flatrock Energy Advisors in San Antonio.

Flatrock assists midstream companies and capital providers-sometimes even gas producers-in midstream asset evaluation, due diligence and management advisory. It advised Dallas-based Crosstex Energy LP on its $480-million acquisition of gathering assets in the Barnett from Chief Oil & Gas last year, a deal that enabled Crosstex to grow substantially.

"Since around second-quarter 2006, a lot of the companies that were acquiring positions now believe they have key assets in place, and may have set up a new MLP, so for them, it is about executing their strategy on and around those assets," Lemmons says.

On the other side of the coin, he says, as the number of midstream MLPs has grown and so many midstream assets now reside in them, the M&A market has been affected. Existing cash-flow streams are highly valued. Many private-equity groups and producers considering the sale of midstream assets look to the MLP path parallel with a traditional sale process.

"It's become difficult for MLPs to shed assets, so it exacerbates the fact that a lot of capital is chasing fewer assets-although there are deals out there.

"We do anticipate a rise in activity during the second and third quarters of 2007, with much industry speculation around some very large packages of assets held by upstream players."

There is much speculation in the market as to what Anadarko Petroleum Corp. will do with the significant gathering assets garnered through its purchase of Western Gas Resources last summer. Then again, some producers who own "gas-farming assets"-that is, resource plays with thousands of wells and locations yet to drill-want to retain the associated midstream assets to maximize the whole.

Morgan Stanley analyst Sean Maher thinks small deals, high price multiples and discipline will introduce the next wave of deal-making. Larger deals will still get done, but they may be fewer and far between. The large public MLPs cannot sustain growth with small bolt-on deals.

Smaller deals remain within reach of more buyers, even if their multiples are rising. Maher cautions that while margins for gas, oil and natural gas liquids (NGLs) have been high enough to support a lot of M&A activity, those prices are normalizing and will yield somewhat less compelling returns.

"This commodity market will spur two types of deals: 'save me' M&A and opportunistic M&A where disciplined buyers with high cash-coverage ratios [for MLPs] are able to pick the bones of sellers," he told attendees at a recent midstream M&A conference in Houston.





New buyers

Just as in the upstream world, private-equity firms and new infrastructure funds are backing start-up midstream companies with the charge to start growing. Soon, they will end up either going public themselves, or selling out to larger midstream buyers.

Maher says some $15 billion in new funds have been raised since 2005 to propel activity. MLPs and financial firms such as private-equity hedge funds account for two-thirds of recent transactions, he adds.

In January, private-equity firm Centre Partners Management LLC and its Dallas affiliate, Centre Southwest Partners LLC, formed a new midstream company, which has already made its first acquisition.

Dallas-based Nexus Gas Partners LLC is the new partnership between Centre and Fritz Brinkman and Mike Davis, two midstream veterans. Brinkman is president. Centre is investing in Nexus through its fourth fund, Centre IV, which has roughly $780 million of committed capital. Nexus acquired a gas-gathering and -dehydration system, the so-called Logansport system, which gathers approximately 100 million cubic feet a day from fields in Shelby and Panola counties in Texas and DeSoto Parish in Louisiana.

"We recognize an attractive investment opportunity in the midstream segment, given the compelling industry back-drop-positive capital deployment of the upstream customers of the segment, and strong recurring-cash-flow attributes of many of the assets in this industry," says Scott Perekslis, Centre Partners senior partner.

Also, NGP Energy Capital Management has formed NGP Midstream & Resources and has raised its first tranche of funds, some $750 million, according to John Raymond, managing director.

It's no surprise to Tony Bohnert, a partner with accounting and consulting firm KMPG in Houston. "All the major buy-out firms have made it clear these assets fit their profile because they generate a steady stream of cash flow," he says.

Then too, publicly traded MLPs are loaded and ready to pull the trigger when a good-that is, easily grown-midstream asset is for sale.

Duncan Energy Partners LP and Targa Resources Partners LP (a Warburg Pincus-backed entity) went public in January and February, respectively. Duke Energy spun out its midstream to form Spectra Energy, which is also newly listed. All will focus on acquisitions as well as organic growth. GE Finance just formed a 50-50 venture with Haddington Ventures LLC to increase its midstream exposure.

These midstreamers, armed with fresh equity, will only increase the price pressure on what few assets may be for sale.

"Public MLPs are under pressure to grow their distributions, but their organic projects are hard to grow by double-digits. A lot of buyers are competing for these assets, so there is a strong level of M&A activity," Bohnert says.

"We're seeing some unbelievable multiples," says Michael Smith, vice president of midstream firm Energy Transfer LP. "I could pay 11 times for an asset and flip it to a private-equity-backed midstream company for 16 times. These private-equity-backed companies are becoming bigger competition to all of us."



Organic growth

Lemmons says the rise of unconventional resource plays in areas with underdeveloped midstream infrastructure (e.g. Barnett shale, Rockies, Woodford shale) have provided attractive investment alternatives to acquisitions (albeit with a different set of risks).

Privately held Clear Creek Energy Services LLC would agree.

"There are an amazing number of projects where companies have drilled a number of good wells, but they may be 10, 20, 30 miles away from the nearest transportation lines. You don't see the big MLPs take on those kinds of projects because they are too small, but for us they are ideal," says Kirk Blackim, vice president of business development in Clear Creek's Houston office.

"Our MO hasn't changed-we want to grow and then sell out to a larger firm, probably an MLP, rather than go public ourselves."

Blackim says the industry will have to build many green-field midstream projects to keep up with the highly drilled resource plays.

The key is to keep gas producers happy by not allowing any of their gas to be shut in, waiting on infrastructure. Midstream companies have to keep a couple of years ahead of their upstream customers.

Comments