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.
Let us know if you have any questions or comments.