Is the Biggest MLP Deal in 18 Months Any Good?

Last Thursday, Regency Energy Partners (NYSE: RGP  ) announced it would acquire PVR Partners (NYSE: PVR  ) for $5.6 billion, including debt. This is the biggest midstream merger since Energy Transfer Partners acquired Sunoco last year. The deal could mean great things for Regency, so today we're taking a closer look.

The Deal
First and foremost, PVR Partners has key natural gas gathering assets in the Marcellus Shale thanks to its $1 billion acquisition of Chief Gathering in 2012. This buy-in gave PVR six gathering systems spread over 300,000 acres, and it will give Regency a strong foothold in the Marcellus, the booming northeastern shale play where production numbers continue to climb despite depressed natural gas prices.

On top of that, Regency Energy Partners will assume PVR assets in Texas and Oklahoma, which include gathering systems and six processing facilities with a combined capacity of 460 million cubic feet per day.

And, of course, Regency will pick up PVR Partners' coal assets. While a coal business might seem like an absurdly terrible idea right now, PVR does not operate its mines, and therefore does not take a hit when coal prices fall. Instead, PVR leases its mines to producers, generating revenue from royalties and long-term contracts, not unlike the model Kinder Morgan hopes to implement with its terminals business.

The acquisition is a unit-for-unit transaction, with an additional $40 million one-time cash payment going out to PVR Partners shareholders, which ultimately means every one unit of PVR will be exchanged for 1.02 units of Regency Energy Partners.

The deal also includes $1.8 billion of PVR Partners' debt. Given that Regency has a long-term debt load of just under $3 billion right now, that may sound like a bitter pill for investors to swallow. But management estimates Regency's leverage ratio will remain around 4.5 times debt to capital, which is not significantly higher than what it's been in the past, or what the partnership will target in the near future, which is 4.0 times debt to capital.

Why PVR?
Regency is looking to attain an investment grade credit rating, and one way to do that is to pick up assets that generate cash via reliable, fee-based contracts. Over the past three years, PVR Partners has been working to convert the vast majority of its revenue to fee-based agreements. It has been able to swing its percentage of fee-based revenue from 30% to 80% in just three years. This is a solid foundation for an acquisition, and the steady income should prove instrumental to Regency's quest for a Baa3 or BBB- credit rating from the agencies. It currently sports Ba3 and BB ratings, respectively.

Aside from that math, PVR's assets increase Regency's geographical diversification in a big way. The bulk of the partnership's current footprint is based in Texas and Louisiana. PVR's assets give Regency exposure to the Marcellus and Utica shales in the Appalachian Basin, and the Granite Wash play in Oklahoma, as well as additional assets in the booming Texas shale plays, the Eagle Ford and the Permian.

Though Regency will gain diversity from an earnings perspective by picking up PVR's coal royalty business, after the acquisition more than 50% of its earnings will be derived from gathering and processing services:

Source: Regency Energy Partners

At this point it's important to remember that volume is the big driver of earnings when it comes to gathering and processing. Gatherers and processers are not as exposed to commodity risk as producers are, in the sense that when natural gas prices rise and fall, revenue will remain flat at a G&P as long as volume does. That said, if producers pull back on drilling when prices fall, G&Ps will feel it in the form of lower volumes.

Bottom Line
Regency Energy Partners has a long history of making acquisitions, and this is one of the most significant ones in recent years, because of the geographic upside with the addition of the Marcellus and Utica assets. While this acquisition is expected to be dilutive initially, if it gets the partnership that all-important investment grade credit rating it will certainly benefit shareholders in the long run.

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