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Devon Energy Cancels MLP Spinoff, Opts for Merger Instead

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Crosstex Energy LP (NYSE: ENLK  ) and Crosstex Energy Inc (NYSE: ENLC  ) were up big yesterday on plans to merge with Devon Energy's (NYSE: DVN  ) midstream assets to create two new publicly traded entities, one general partner, and one master limited partnership. Today we're taking a closer look at yesterday's big announcement.

The New Company
For now, this new collaboration does not have a name, referred to simply as the "New Company" in Devon's press release.

To get things started, Devon Energy will contribute $4.8 billion in midstream assets to Devon Holdings, which will then contribute a 50% limited partner interest to both the New Company General Partner and the New Company MLP . Those 50% stakes will then merge with what already exists within the Crosstex Energy family, which had a combined market value of about $2.8 billion before shares soared on the announcement .

Barry Davis, the current CEO of Crosstex, will lead the new operation, which will be headquartered in Dallas. John Richels, current CEO of Devon Energy, will be the Chairman of the Board.

Mergers like this can be complicated at first blush, given the various layers and stakes involved with GPs and MLPs. Let's look at the final product and work backwards for clarity's sake.

Here's a visual of how ownership of the two new entities breaks down:

Source: Devon Energy

Current shareholders of Crosstex Inc will receive one unit in the new general partner for every unit of XTXI they own, plus $2.00 per share in cash. That will represent a 30% stake in the New Company GP. Devon Energy, via 115 million units, will control the other 70% of the GP.

Similarly, unitholders of Crosstex Energy LP will make up 40% of the New Company MLP. Devon Energy will control 53% of it via 120 million units. The New Company General Partner will hold the remaining 7% limited partner stake of the New Company MLP.

What This Means for Devon Energy
Devon's planned midstream MLP, Devon Midstream Partners, is no longer in the works; this merger is happening in place of that. Devon's CEO John Richels was quoted in Reuters explaining, "We were well advanced on doing our own stand-alone MLP. This combination certainly gives us a bigger company. It has a much more diverse asset base, and we believe diversification enhances long-term shareholder value."

The deal is expected to be immediately accretive to Devon because it assigns a market valuation to the company's midstream assets. On top of that, Devon's stake in the general partner will set it up to profit handsomely from incentive distribution rights, a lucrative revenue stream in the world of master limited partnerships.

What This Means for Crosstex Energy
Crosstex Energy LP and Crosstex Energy, will both cease to exist, folding into the New Company and taking on new ticker symbols. The deal is supposed to be immediately accretive to Crosstex shareholders as well, given the bump in distributable cash flow that comes with the new assets, not to mention the share appreciation that happened as soon as this deal was announced.

On top of that, the new entity has an enhanced asset footprint that can continue to expand, driven by Devon's upstream exploration projects. The New Company has operations in the Marcellus and Utica shales, as well as multiple plays in Texas, Louisiana, and Oklahoma, while Devon continues to develop its production assets in Colorado and Canada .

Making the Grade
Once again, the importance of an investment grade credit rating surfaces in an MLP deal. Crosstex Energy LP currently sports a non-investment grade rating from Standard & Poor's of B+, but Richels and company expect the new entity to open up shop with a credit profile worthy of an investment grade rating, which would mean better access to capital, as well as a lower cost of capital, than many of its MLP peers.

If everything goes according to plan, the ratings agencies could very well make that dream come true. Management forecasts a debt-to-EBITDA ratio of 2.5 times, which is lower than the industry average . Standard & Poor's likes to see the ratio close to 4.0 times debt-to-EBITDA before it even considers rating an MLP something other than junk, which bodes well for the New Company.

The new entity will have several other factors going for it in its quest for a great rating, including 95% fee-based revenue and a diverse geographic footprint. Management must still execute on its vision, but the blueprint looks solid so far.

Richels is just the latest in a long line of CEOs to be vocal about the quest for an investment grade rating, with prior mentions coming from Bob Phillips of Crestwood Midstream Partners and Michael Bradley of Regency Energy Partners at the announcement of their respective deals.

Bottom Line
There is a lot to like about this deal, particularly the details that make an investment grade credit rating possible: low debt-to-EBITDA ratio, high percentage of fee-based cash flow, and a diversified asset footprint. Investors will want to wait for the official SEC filing before making an investment decision of course, but it certainly appears to be an intriguing opportunity at first glance.

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  • Report this Comment On October 22, 2013, at 12:59 PM, bunngolf wrote:

    Thanks for your take on the merger. It appears the market likes it. Devon's quarterly conference call should be interesting.

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