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TEP/TEGP: In a $5 Billion Hole; 3Q16 Recap

In a $5 Billion Hole……TEP’s assets are worth around $3B.  Combined, TEP and TEGP have  just over $8B of enterprise value with $2.2B of net debt (including 25% of REX).  This means that the combined TEP and TEGP equity is only worth ~$1B, but it trades at a market cap of ~$6B.  This is Tallgrass’ $5 billion hole, the crux of our short thesis, and what will likely lead to the collapse of TEP and TEGP, down 80% - 90% to fair value (see tables below).  Should our fundamental call on Pony Express be wrong, and that pipeline has no cash flow issues whatsoever in the future, then TEP/TEGP equity is worth ~$3B and has ~50% downside from its current market cap.  Either way, current Tallgrass longs – mesmerized by financial engineering, near-term distributions, and the bizarre notion that Tallgrass is some kind of “platform company” – will be left holding an empty bag.  We’ve seen this movie before (LINN, KMI, ETE, VRX, etc.), the move down is typically sudden and violent, as everyone attempts to exit at the same time through a narrow doorway.  It will be worth the wait.    


On the 3Q16 Results……TEP’s 3Q16 results were as expected.  Pony Express’ volumes were 276 Mb/d, down from 286 Mb/d in 2Q, but management guided to an uptick in October and November, which was a surprise to us.  We don’t expect the volume story for Pony Express to get interesting until (if?!) Dakota Access is in-service, the timing of which remains uncertain.  REX’s 3Q16 adjusted EBITDA was down $(46)MM ((27)%) YoY on account of the UPL bankruptcy and the ECA contract restructuring.  REX’s Zone 3 Capacity Enhancement project is now completely sold out and is expected to be in-service circa Jan 1, 2017, consistent with our expectations and model. 


Aggressive Non-GAAP Accounting……It’s not central to our short thesis, but worth calling out: TEP’s non-GAAP accounting is very aggressive, even relative to its MLP peers.  TEP’s maintenance CapEx on its consolidated assets is only 13% of deprecation.  And maintenance CapEx for REX was $1.6MM in 3Q16, a mere 3% of depreciation.  This is a massive, regulated asset, and TEP wants us to believe that it has an economic useful life of more than 1,000 years!  Further, REX reported $84MM of "DCF" yet distributed $87MM to its partners, and TEP includes its share of REX’s distributions, not the DCF, in its own DCF calculation.  It wasn’t overly material in the quarter, but this is worth keeping an eye on, particularly when TEP owns a larger percentage of REX in 2017+.


Short TEP is Better Risk/Reward than Short TEGP……TEP equity is massively overvalued and the management team is heavily-invested in TEGP – this is the perfect recipe for (a lot of) TEP equity issuance.  As you would expect, this management team is acquisition hungry.  For this reason, we strongly prefer the TEP short over the TEGP short.  TEP is in the 50/50 IDR split and as a result, any large acquisition or investment will likely destroy value for TEP unitholders, but could be very beneficial to TEGP.  Short TEP / long TEGP is too cute for us, but we do agree with that relative positioning.


TEP/TEGP: In a $5 Billion Hole; 3Q16 Recap - tep2



Let us know if you have any questions or comments.


Kevin Kaiser

Managing Director

Cartoon of the Day: 8 Ball

Cartoon of the Day: 8 Ball - Fed cartoon 11.03.2016


“We don’t know what we’re doing.” That’s what one Fed governor recently told investor Jim Rickards at an intimate private dinner.



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Election 2016: Why A Trump Win Could Roil Oil Markets

Election 2016: Why A Trump Win Could Roil Oil Markets - trump image 24

Trump vows to tear up the "Disastrous" Iran Deal and renegotiate it. Re-imposing US sanctions could wipe 1 million b/d from oil markets. 

Hedgeye Guest Contributor: What Happens In Financial Markets After the Election?

by Christopher Whalen, Kroll Bond Rating Agency


Hedgeye Guest Contributor: What Happens In Financial Markets After the Election? - trump clinton wall street


A number of investors have asked Kroll Bond Rating Agency (KBRA) about our view of the market and economic environment after the November 2016 election in the U.S. The short answer is that we expect most of the major trends in terms of the global economy, interest rates, and currencies to be largely unaffected by the outcome of the U.S. poll. Simply stated, what happens within the U.S. political system has less and less impact on the rest of the world.


Americans like to flatter themselves that events inside our increasingly raucous political economy are somehow more important than developments in other parts of the world. The post-WWII political order imposed by the U.S. provided the illusion of stability and predictability for more than three quarters of a century, but Pax Americana is unraveling, making assumptions about the direction of future events around the globe far less reliable.


At the same time, the political and financial structures that emerged from the two world wars are also breaking down, proof once again that entropy is by far the best model for thinking about complex systems like nations and financial markets.


Hedgeye Guest Contributor: What Happens In Financial Markets After the Election? - whalen 11


If you consider that the period of relative economic and political stability that prevailed after WWII represents the concentration of political and economic power in the hands of the U.S. and other allied nations, today the dispersion of these forces is an illustration of entropy. Another example is regulation. The financial markets were highly regulated by government and controlled by large banks and corporations from the 1930s through the 1970s, when deregulation resulted in a renaissance of non-bank finance and economic expansion that lasted through 2000.


Managing markets and risk was a relatively simple matter when the U.S. economy was largely closed and dominated by the U.S. government and the large banks and corporations that helped the allies prevail in WWII. Today, however, the dispersion of economic and financial power that has occurred due to the impact of globalization and particularly the liberalization of capital flows has added enormous volatility, risk, and unpredictability to the global political economy. Regardless of who occupies the White House, we believe that this tendency towards greater volatility and unpredictability in global markets will remain a central theme in the years ahead. 

The slow motion disintegration of the E.U. illustrates this danger.


Weaker member nations that used the credit standing of the stronger nations to borrow solely to maintain consumption levels are now preparing to exit the union, an eventuality that could create enormous economic disruption and uncertainty. Neither of the presidential candidates from the major political parties seems to be cognizant of this looming hazard.


Regardless of which candidate wins the White House, the U.S. will see continued political paralysis. America will remain distracted by internal political considerations and will thus be unable to exercise effective leadership in Europe or anywhere else at a time when the post-war economic world is literally disintegrating.


One issue that does hang in the balance with the election is regulation. KBRA notes that this year’s G.O.P. platform is, on its face, more pro-growth than the Democrats’. Even so, U.S. markets have responded more favorably to news events that have favored the Democrats, at least at the top of the ticket. That seeming contradiction may reflect the split of probable outcomes between the White House and Congress. A Democratic victor in the presidential race would likely be more constrained enacting new regulation than a Republican president would be in rolling it back.


While the U.S. economy has shown some promising signs in recent months, we believe that the 2010 Dodd-Frank legislation, the Basel III capital rules, and other initiatives have largely canceled out the efforts by the FOMC to stimulate the US economy via low interest rates and open market purchases of debt. Were it not for the salubrious effect of strong foreign capital inflows and the natural tendency of the American people to thrive in the face of adversity, KBRA believes that economic growth rates would be considerably lower than the official statistics currently suggest.

Another risk that has gone largely unnoticed...


... by either presidential candidate is global capital flows, which are proving to be more of a detriment than a benefit in many respects. Even relatively closed economies such as China and Russia cannot avoid the pressures of swings in interest rates, credit spreads, and currencies. The flow of capital leaving China and moving into western markets alone is massive and totals some $400 billion so far this year, according to published estimates.


The recycling of trade surpluses from China and the other Asian exporting nations fueled the U.S. housing boom in the 2000s and led to the financial disaster of 2008. Today, an even larger flow of capital from Asia is fueling the significant uptick in home lending volumes in the U.S., as evidenced by the rapid growth of Ginnie Mae. Once the smallest of the government-sponsored entities, Ginnie Mae now has a larger issuance of securities than Freddie Mac and is headed to $2 trillion in total issuance by this time next year, according to Ginnie Mae President Ted Tozer. The torrential flow of foreign capital coming into the U.S. has distorted asset prices in many markets and has also helped to compressed credit spreads, as shown in Chart 1 below.


Hedgeye Guest Contributor: What Happens In Financial Markets After the Election? - kroll chart 1


The flow of funds out of Asian nations with low or no population growth is an economic boon for the U.S. and promises to keep interest rates low for the foreseeable future. KBRA believes that regardless of which party wins the White House and the Congress next week, and regardless of who sits on the Federal Open Market Committee (FOMC), interest rates are likely to remain low for years to come.


Indeed, even if the FOMC does raise benchmark interest rates this year and next, we anticipate that the yield curve and spread relationships will continue to be effected by strong capital inflows. But these same inflows of offshore funds may create severe bouts of short-run volatility in both debt and equity markets.

Regardless of who wins the White House next week...


We believe that, absent strong capital inflows from abroad, some degree of regulatory reform is needed to get the U.S. economy back on track in terms of sustainable, long-term economic growth. But regardless of which party prevails next week, we believe that there is a strong likelihood that most major trends in terms of the financial markets and the economy more generally will be unchanged.


Hedgeye Guest Contributor: What Happens In Financial Markets After the Election? - kbra disc



This is a Hedgeye Guest Contributor research note written by Christopher Whalen of Kroll Bond Rating Agency. Whalen is a Senior Managing Director in the Financial Institutions Ratings Group. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington. This piece does not necessarily reflect the opinion of Hedgeye.

Central Bank Blowup? Buy Gold

Takeaway: As central bankers rush to devalue their currencies, investors should buy gold.

Central Bank Blowup? Buy Gold - explosion


Central bankers around the globe have cut interest rates almost 700 times since Lehman Brothers’ collapse. That’s not a typo.


Here’s the “Central Banker Playbook”:


Cut interest rates → Devalue the currency → Stocks up!


It’s a monetary mirage. The Fed, ECB and BOJ have $12.4 trillion on their collective balance sheets. Again, not a typo. The global money supply is currently $100 trillion. Meanwhile, total gold mined globally is just $7 trillion.


We suggest you buy some.


Gold is free from central bank tinkering and the principal beneficiary of any blowup in the central planning #BeliefSystem. Investors agree. Gold is up 22% year-to-date. As economic growth slows throughout the world, we expect central bankers to double down on their failed policies (think helicopter money).

We’d buy more gold


CHART OF THE DAY | Jobs Report: Tune Out Wall Street (Here's What Actually Matters)

CHART OF THE DAY | Jobs Report: Tune Out Wall Street (Here's What Actually Matters) - ears plugged


Investors are eagerly awaiting the October update on the Jobs Market to be released this Friday. But don’t expect blockbuster results.


As we’ve discussed before, the monthly jobs added number on tomorrow’s non-farm payroll report is very volatile and subject to massive revisions in the months following. The confidence interval on the initial release is plus or minus 115,000. This means if the number reported is 200,000 new jobs the subsequent revisions could swing wildly between 85,000 or 315,000.


So tune that out.


What actually matters is the year-over-year rate of change in jobs growth. This measure is much more predictive. By that measure, jobs growth peaked at 2.3% in February and has declined to 1.7% in the September report. Note: Once jobs growth peaks, it converges to zero 100% of the time as we head into economic recession. That's why jobs growth is called a #LateCycle indicator.


Where do we go from here?


More jobs growth declines, says Hedgeye U.S. Macro analyst Christian Drake in today’s Early Look. As you can see in the Chart of the Day below, jobs growth faces some tough “comps” in the fourth quarter. Basically, that means when you’re measuring year-over-year changes, you have to “compare” against last year’s number. A tough comp will make the year-over-year change worse.


On that score, here are the relevant numbers:


  1. NFP: 4Q15 = 282K vs 3Q15 = 192K
  2. Hourly Earnings Growth: 4Q15 = 2.53% vs. 3Q15 = 2.3%
  3. Aggregate Income Growth (private): 4Q15 = 5.55% vs. 3Q15 = 5.4%


With growth in jobs, hourly earnings, and aggregate income all slowing, this obviously isn't a good setup for future consumption growth, Drake points says. “Wage growth needs to accelerate at the same rate payroll growth decelerates just to keep aggregate income growth flat (and, by extension and all else equal, consumption growth flat as well),” he writes.


So while Old Wall and its media fret over tomorrow's headline jobs market number, we'll continue to measure and map the slowdown in the rate of change. That's what actually matters.


CHART OF THE DAY | Jobs Report: Tune Out Wall Street (Here's What Actually Matters) - Employment Comps CoD

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