Frac sand producer Hi-Crush Partners (NYSE:HCLP) recently announced that it was bulking up its presence in the Marcellus and Utica shale plays. The MLP is paying $125 million in cash and units to acquire D&I Silica which will in essence double the size of the company. Let's dig a little deeper into this deal and see what it means for Hi-Crush and the proppant industry.
At first glance the deal might seem to be a bit out of place. Hi-Crush, which is a MLP, is an owner and operator of sand reserves used as a fracking proppant. The company owns one sand facility in Wisconsin and a preferred interest in a second facility in the state. The assets it's acquiring don't come with any sand reserves, instead its acquiring a frac sand distributor.
In this transaction Hi-Crush is moving up the value chain in a step toward a more vertically integrated model. As a distributor, D&I Silica adds new customers while deepening Hi-Crush's relationships with its current customers. While most of the sand that D&I procures is already supplied under long-term contracts, the deal does open up possibilities for Hi-Crush to eventually leverage these assets into supply deals for its sand once these existing contracts roll off. Further, the company could leverage these new relationships with other proppant suppliers into an opportunity for future acquisitions.
If there was one major risk to Hi-Crush before this deal was announced it was the company's customer and asset concentration. This is most clearly seen when looking at Hi-Crush against competitor U.S. Silica (NYSE:SLCA). With 15 facilities, 307 million tons of reserves, 250 products and 1,800 customers, there is a certain amount of safety in that diversity that's simply not found at Hi-Crush. The deal to acquire D&I goes a long way in removing some of the risk found in Hi-Crush's concentrated business.
That is really important because the company has already seen the impact of a customer defection after Baker Hughes (NYSE:BHI) terminated its contract. While the two are still locked in a legal dispute, if Hi-Crush loses it could mean its contracts and therefore its distribution might not be as safe as originally thought.
In addition to the much needed diversification this deal provides, it also gives the company a clear path to begin raising its distribution. In fact, Hi-Crush plans to start raising its payout beginning in the fourth quarter of this year. Further, it sees double-digit distribution growth in 2014 and for the foreseeable future.
There is a lot of growth potential at Hi-Crush as it has multiple opportunities to expand in the future. Not only can it purchase additional drop-down interests in its sponsor's Augusta, Wis., facility, but Hi-Crush can look to acquire small competing frac sand providers like those currently contracted by D&I. Additionally, there is an opportunity to expand the D&I model to additional production basins such as the Bakken, Permian, and Eagle Ford.
Foolish bottom line
This appears to be a very solid acquisition for Hi-Crush. It provides much needed diversification both in terms of assets and customers. Further, it gives the company a clear path to grow a distribution that already yields 9.9%. Finally, the deal opens up additional opportunities to acquire D&I's frac sand as well as expands the D&I model outside of the Appalachian basin. Overall, the deal puts the company on solid ground to produce market-crushing future returns.
Motley Fool contributor Matt DiLallo has the following options: Short Jul 2013 $17.5 Puts on HI-CRUSH PARTNERS LP UNIT LTD PARTNER INTS. The Motley Fool owns shares of HI-CRUSH PARTNERS LP UNIT LTD PARTNER INTS and U S SILICA HLDGS INC COM USD0.01. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.