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This Coal and Gas Play Should Consider a Breakup

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CONSOL Energy (NYSE: CNX  ) drills for natural gas and mines for coal. Management believes that the value of the company is being masked by the weakness of the coal market. Here are some options that might get considered for the "optimal corporate structure."

Breaking up
Since CONSOL operates in two very different industries, the simple answer is to break in two. That's exactly what Inergy (NYSE: CEQP  ) did when it decided to make the shift from a propane business to a midstream oil and gas company.

Propane is a slowly shrinking industry that's going through a consolidation phase. With more growth opportunities in the midstream space, management chose to change gears. That's roughly similar to CONSOL's situation, though the reports of coal's death are greatly exaggerated.

Inergy spun off Inergy Midstream (UNKNOWN: NRGM.DL  ) to hold its midstream properties and sold its propane business to Suburban Propane. Those transactions turned Inergy into the general partner of Inergy Midstream.

The transition to this state was complicated, however after a year or so of confusion, those who have held throughout own shares in all three companies. And Inergy appears to be shifting back to growth mode, recently completing the acquisition of Crestwood Midstream Partners . It is in the process of integrating the operations of the two limited partnerships it now controls.

While this means that 2013 will be another transition year, 2014 should start to see the fruits of all this labor. And, perhaps more importantly, bring the opportunity for a return to distribution growth. Inergy Midstream, meanwhile, never missed a beat, increasing its distribution in each of the last five quarters.

Suburban Propane, on the other hand, nearly doubled revenues and increased net income to about $2.45 a unit in the first nine months of its fiscal year, up from around $1.80 last year. And it increased its distribution in January. While this year should be a good one for Suburban, next year should allow a return to the acquisition trail since the Inergy propane integration process will be wrapping up.

Speaking of limited partnerships
CONSOL is a regular corporation, so a breakup should be less complicated than that. However, there's no reason why CONSOL couldn't spin off its coal business into a limited partnership and remain the general partner. That's a time honored business plan in the energy space. A recent example is Phillips 66 (NYSE: PSX  ) spinning off Phillips 66 Partners to hold its midstream assets.

The transaction allowed Phillips 66 to raise cash from the sale of the new units, effectively giving value to something that may have been hidden within its larger oil and gas business. And, even better, it allows Phillips, as the owner of the general partner, to retain control of and continue to receive income from the partnership.

That sounds like having and eating your cake, and it positions Phillips to speed up the growth of its core business. Perhaps the best part is that Phillips can repeat the process by selling additional assets to the new partnership to raise cash and fuel the LP's growth. That should please investors in both entities.

Alliance Resource Partners, Rhino Resource Partners, and Natural Resource Partners are all examples of coal limited partnerships that exist today, so CONSOL spinning off a coal LP wouldn't be unusual. If you liked the Phillips 66 transaction, keep an eye on CONSOL's coal business.

Cutting off the pieces
Another option is to break parts of the company off piece meal. For example, CONSOL owns the Baltimore Terminal. CONSOL's coal represented about 60% of the terminal's 2012 volume, so a spinoff of this asset, perhaps as an LP, would be relatively easy since its customer base is already diversified to some degree. And if it went the LP route, it would still retain control of the asset and benefit from its cash flows.

As a comparison, consider Canada's Westshore Terminals (NASDAQOTH: WTSHF  ) . The company owns a coal storage and loading terminal at Roberts Bank, British Columbia. Despite coal's downtrodden state, Westshore is doing quite well. That may sound surprising, but foreign demand is increasing and should continue to do so.

The company expects to ship between 28 and 30 million tonnes of coal this year compared to around 26 million last year. Management believes it can support around $1.30 in annual distributions at this level of throughput. That could make CONSOL's Baltimore terminal an interesting proposition for income focused investors.

The problem is that growth for a company with just one terminal is likely to be hard to come by. In other words, Westshore shareholders shouldn't expect much more than a $1.30 a share a year in distributions. Thus, a sale of CONSOL's terminal might be the easier course of action.

However, the company also owns a parts business and other shipping assets, so it has more to sell than just a port. While such divestitures might not unlock the hidden value of the company, they would help to streamline it and raise cash that could be returned to shareholders or put toward growth.

Waiting on the word
CONSOL promises that it will have more to say at its next quarterly earnings meeting. That should make for an interesting discussion. Although it is shifting to maintenance spending in coal today, that doesn't mean it wants out of the business completely. A coal LP spinoff, then, might be the ideal solution. However, it clearly isn't the only one. If you like special situations, CONSOL's decisions on unlocking value should be closely monitored.

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