On Tuesday evening, Tallgrass Energy announced a consortium led by Blackstone Infrastructure Partners had submitted a “non-binding preliminary proposal letter” to take the company private at $19.50 per share. The announcement is a double-edged sword as it relates to our view on TGE. We’ve been negative on the company for nearly 3.5 years – that’s two regimes at Hedgeye Energy and three tickers at Tallgrass.
The crux of our thesis was always predicated on the fundamentals, specifically the highly visible recontracting risks on TGE’s core assets, the Rockies Express Pipeline and the Pony Express Pipeline. Though the recontracting situation was not as dire as our original 2016 work indicated, with Rockies production rebounding in 2018 with crude price reflation, Tallgrass as an enterprise was burdened by cumbersome leverage and expensive equity which prohibited it from diversifying the asset base either organically or through M&A.
When Hedgeye first initiated coverage on Tallgrass it was not without fanfare. Tallgrass CEO David Dehaemers accused then Hedgeye Energy Sector Head Kevin Kaiser of libel and saying “people who act like analysts” misunderstood the company to which Kaiser responded on Twitter…
The work we presented was early. It took time for the market to adopt our view and even longer for this view to be represented in the equity value of the complex. Not until July did the stock begin to crack in earnest. But when it did, it happened quickly, down ~35% from the highs just six weeks earlier. The selloff was ho-hum, occurring on the back of no fundamental news, which was exactly the problem. The first tranche of PXP contracts roll-off in just 2 months and further, TGE’s 2Q19 10-Q filing with the SEC showed little material improvement in future contracted revenue since 2018, an indication that few meaningful new contracts have been signed.
Clearly, Blackstone and co. retain a different view of the company than we do, or than the public markets at the time of the announcement. While we can speculate on the motivations, the simple conclusion is that Blackstone saw more value in the name over its specified duration than what our $10-$16 valuation target suggests. How they intend to capture that value with Bakken and Guernsey differentials at a $2.75 and $2.00 discount to WTI, respectively, a greenfield Rockies crude oil pipeline on the way, an expansion of the Dakota Access Pipeline forthcoming, Opal-Chicago gas differentials of ~$0.30 and a highly volatile natural gas market is a mystery to us. TGE leadership did well to bail out its LP unitholders, while also leaving a nice golden parachute for themselves.
The proposed transaction price values TGE at $10.5B, 13.5x our run-rate 2020 estimates once the brunt of recontracting pressure hits and ~11x consensus estimates. Assuming a similar 35%/65% debt to equity split to finance the 2nd half of the buyout, Blackstone and its partners will need to layer on another ~$1B in debt to finance the transaction, taking gross leverage over $7.0B or ~7.0x 2Q19 annualized EBITDA.