Midstream Companies Merge to Maximize Valuations

What if I told you that you a merger could create higher valuations and increased earnings? Well that's the motive behind Devon Energy's (NYSE: DVN  ) merger with Crosstex Energy Inc (NYSE: ENLC  ) , which is the general partner, and Crosstex Energy L.P. (NYSE: ENLK  ) , the MLP.

Devon is going to combine most of its midstream assets with Crosstex in a way that will give it ~70% ownership of the general partner and ~53% ownership of the MLP. Crosstex Energy Inc shareholders will receive one share of the new general partner (still to be named) and a one-time payment of $2. Crosstex Energy L.P. unitholders will end up with a 40% stake in the new MLP.

The argument for the merger
There are a few reasons why this could be a good idea. Devon thinks that by having its midstream assets publicly traded, investors will give those assets a higher valuation.

Crosstex shareholders/unitholders have already been richly rewarded, with Crosstex's general partner surging 60% while the MLP shot up 30%. Going forward shareholders/unitholders will be rewarded by synergies, more scale, and a bigger yield. The new MLP is expected to have a yield of 6.7%, which is much higher than Crosstex Energy L.P.'s 5.4% payout, even after the surge.

The larger the midstream company the more pipelines and other infrastructure projects it can bring online. This allows it to be competitive against much bigger midstream companies like Enterprise Products Partners, which has a $60 billion market cap.

Devon has forecasted the combined midstream company making (pre-synergy) $700 million in EBITDA in 2014, $500 million of which will go to the MLP. Compare that to the $475 million Devon expects to make in 2013 from its midstream assets. That extra cash flow can be used to build out more infrastructure and connect Devon's shale plays to refiners.

This gets even better when you add in the estimated $45 million saved from synergies that will come into effect in 2014. That means the new midstream company will be making 6.4% more in EBIDTA, with the potential for more synergy savings in the future.

Another midstream operator that is the combination of two companies is DCP Midstream Partners (NYSE: DCP  ) . DCP Midstream was created by the merger of Duke Energy's and ConocoPhillips' gas gathering and processing assets. Now DCP Midstream is a 50/50 joint venture between Phillips 66 and Spectra Energy and owns a 22.9% stake in DCP Energy Partners. 

Strong stock performance
Devon's valuation argument for the merger is strongly supported by DCP Midstream Partners. Back in 2008 when DCP Midstream Partners first began being publicly traded it has outperformed the S&P 500 by almost 300%. Now this may not happen for the new midstream company, but there is a chance Devon will create far more value with its stake in the new company versus keeping it in house.

DCP Midstream Partners has been increasing its valuation by investing its cash flow growth into further growth projects. Looking ahead, from 2012 to 2015 DCP is guiding for growth across the board.

In 2012 DCP Midstream Partners had 5.9 trillion British thermal units of processing capacity a day, with guidance to grow that to 7 trillion by 2015. NGL production will increase by 100,000 bpd in that same time period, but the real growth is coming from NGL pipelines.

DCP Midstream Partners is planning on increasing the length of its pipeline infrastructure by 214% to 3,000 miles by 2015. A catalyst about to come up is the completion of the 150,000 bpd NGL pipeline, Front Range, which could be increased by 80,000 bpd if needed. Front Range will be completed in the fourth quarter and will start adding to DCP Midstream Partners' cash flow.

DCP Midstream Partners has been able to deliver market-beating performance because it invests in major projects that are very accretive to its cash flow. The additional scale DCP Midstream Partners was able to get through the merger allowed it to complete more projects that were bigger in size and push up cash flow further than if it was a singular entity.  

Final thoughts
Devon and Crosstex's midstream merger will push up their combined EBIDTA and allow for more projects to be brought online with the larger cash flow. If Devon can also get a higher valuation for its midstream assets then that's just a cherry on top.

DCP Midstream Partners has ambitious growth prospects that will allow to it keep doing what it has been doing: investing back in the business.

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