How Regency’s purchase of Eagle Rock’s assets could increase risk
Regency management comments about Eagle Rock’s assets
Management commented about Eagle Rock:
- “Eagle Rock’s Panhandle assets are in a core liquids-rich area that provides producers’ top-tier single well economics. The area is very active and offers producers in multiple target zones. The stacked pay nature of the area will provide significant drilling opportunities for many years. Eagle Rock’s East Texas system has large footprint that overlies several established and emerging shale plays, including the Woodbine and Tuscaloosa Marine. The infrastructure that is currently in place is well-positioned to capture additional volume as drilling increases in addition to the production that is currently connected to the system. The Panhandle and the East Texas assets are backed by over 3 million gross acres of long term dedications from top tier producers. Eagle Rock has spent over $400 million of capital since 2011 on the assets and we expect these assets to provide additional growth opportunities.”
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Immediately accretive to distributable cash flow
Regency management stated that the acquisition will be immediately accretive to 2014 distributable cash flow per common unit. This means that even with the issuance of more equity to both Eagle Rock and Energy Transfer Equity, Regency expects to generate more distributable cash flow per share of equity pro forma for this transaction. This is a positive for Regency, as it means the ability to potentially grow distributions per unit (cash payouts to unitholders) more than the company would have been able to without the transaction. Management noted that the accretion includes “some synergies but not all.” Synergies may represent benefits such as cost reductions generated by getting rid of overlapping functions with the combined assets or stronger negotiating power.
One potential risk: Eagle Rock’s assets add higher commodity exposure to Regency
Eagle Rock’s midstream assets generate ~40% of their gross margin from fee-based contracts, so the remaining 60% has some commodity exposure. Regency’s gross margin before the Eagle Rock transaction (but pro forma for its acquisition of PVR Partners announced earlier this year) was 78% fee-based and 22% commodity-based. Pro forma for the transaction, Regency’s commodity-based gross margin will increase to ~27%. This means that more of Regency’s margins will be exposed to fluctuations in commodities, particularly natural gas liquids prices (NGLs). A fall in NGL prices could hurt Regency’s earnings and distributable cash flow.
We discuss in detail Regency’s other major acquisition, announced the same day as the Eagle Rock transaction, in the next section of this series.