Chesapeake: When 100x Cash Flow is a Fire Sale

Chesapeake (CHK) sold out of its interests in Chesapeake Midstream Partners (CHKM) this week, in case you didn’t hear (see press release, Forbes blog, FuelFix for more info).  It happened a bit earlier than was probably originally planned, to its partner Global Infrastructure Partners (GIP) for $2.0 billion.  GIP also purchased other midstream assets in a separate transaction for another $2.0 billion.  I’m going to focus on the first transaction here, the direct purchase of G.P. and L.P. interests.

(this probably won’t be the logo for long)

Below is the back of the envelope calculation of stripping out the L.P. units purchased to get an implied GP value and comparing that to the current cash the GP receives on an annualized basis.  Purchase price implies 103x current annualized GP cash flow.

The GP interest of CHKM currently receives $6.5 million in annualized distributions.  As shown above, the implied value of the GP interest (after stripping out the L.P. units owned by CHK) is $664.9 million.  I get there by taking the value of the 33.7 million CHK-owned common units at par ($845.0 million) and the 34.5 million subordinated units at a 5% discount ($822.6 million), which leaves $332.4 million for 50% of the GP interest (and IDRs), or $664.9 million implied value for 100%.

So, it seems like CHK made a great trade getting rid of an asset for 103x cash flows, but that’s fairly short sighted.  If CHKM executes its original plan (although probably under a different name, and it won’t be Global Partners) for the next 2-3 years, the CHKM GP stake purchased this month will be a great trade for the buyer.

For example, let’s say CHKM issues $1.0 billion in new equity issued at CHKM in next 2 years at an average of $26 per unit, and distributions grow 15% annually for the next 24 months, CHKM will have 38.5 million new units outstanding and will be paying an annualized L.P. unit distribution of $2.14 per unit.  Those expectations are well within the announced guidance and expectations of management.

Cash flow to the GP interest at that point will be running at an annualized rate of $52.8 million, which would make the today implied GP purchase price of $664.9 would represent a 12.6x cash flow multiple.  At that point, GIP could take the holding company public with a 25x implied multiple on the GP cash flow (more in line with comps), or $1.3 billion.  That would be $600+ million in valuation uplift in 24 months, not to mention all the cash distributions received in the interim.  The alternative exit for GIP would be to sell the GP interest down into CHKM or sell to some GP aggregator like ETE is trying to become.

That cash flow growth is why you don’t see general partner holding companies going public until their cash flows have ramped up to the 50% IDR tier (Hiland Holdings being the exception to date), and you rarely see the GP interest sold privately until the MLP reaches that top IDR tier, unless the GP owner is under some kind of duress.  It is also an illustration of the value CHK is leaving on the table with this deal despite getting a huge GP multiple today.

It’s all about execution at this point.  CHKM has a great balance sheet on any metric, ample opportunities to grow cash distributions, even with CHK question marks.  If CHKM is able to grow with third party acquisitions and execute drop downs, should work out fine for all parties, and CHK will have left quite a bit of money on the table.

 

Disclosure: No positions in CHK or CHKM.  The information in this article is not meant to be financial advice, I am not your financial advisor and I am posting my comments for informational purposes only.

Category MLP Market Post,Stock Analysis