Eagle Rock Energy Partners (UNKNOWN:EROC.DL) had been stuck between a rock and a hard place. It tried to be two things and once, but that didn't work out. Now the MLP is shedding its midstream business in a deal that will enable it to focus all of its attention on growing its oil and gas production.
Eagle Rock Energy Partners is contributing its midstream business to Regency Energy Partners (UNKNOWN:RGP.DL) for up to $1.325 billion. In the deal Eagle Rock Energy Partners is picking up $200 million worth of Regency Energy Partners common units as well as a combination of cash and debt being assumed by Regency Energy Partners. The deal value could fall to $1.27 billion if all $550 million in Eagle Rock Energy Partners' bonds are assumed by Regency Energy Partners.
As a result of this deal Eagle Rock Energy Partners will transition into a pure-play upstream MLP like LINN Energy (NASDAQOTH:LINEQ) and Vanguard Natural Resources (NASDAQOTH:VNRSQ). In addition to that, the company will significantly improve its balance sheet as it will repay all of the borrowings under its revolving credit facility as well as have the weight of its midstream bonds lifted by Regency Energy Partners. That will enable the company to push its total net leverage ratio under 1.75 times. For perspective on how good that leverage ratio is, take a look at the following chart comparing it to upstream MLP peers.
We can see that LINN Energy's leverage ratio is nearly double Eagle Rock's as LINN's ratio is just under 4.0 times. What that means is that Eagle Rock Energy Partners has plenty of capital in order to compete against its peers for oil and gas assets as it seeks to grow by acquisition.
The new Eagle Rock
The new Eagle Rock Energy Partners has a solid asset base to build upon. It has proved reserves totaling 350 billion cubic feet equivalent in Texas, the Mid-Continent and the Gulf Coast. It also has a very intriguing position in the SCOOP play of that it now has the capital to drill.
Eagle Rock's SCOOP asset is one for investors to keep an eye on. The company had discussed the possibility of monetizing that asset that asset in the past, but it appears that it will now use it to grow the company. Several U.S. focused oil and gas producers are turning to this emerging Oklahoma oil play in an effort to boost production growth. While it's not a traditional low-decline asset that MLPs like LINN Energy and Vanguard Energy Partners tend to prefer owning, the upside is compelling which is why Eagle Rock wants to develop the asset itself.
What the deal means for investors
This deal accomplished two big goals for Eagle Rock Energy Partners. First, it transitions the company into a pure-play oil and gas producer; second, it completely changes the company's debt profile. This a wholly different company than the one investors owned just last week when it was a diversified midstream and upstream company weighed down by debt.
I really think this is a smart move by Eagle Rock, and investors holding on should do well over the long term. The upstream MLP space has been an excellent area for income-seeking investors over the past few years and I'd expect to see Eagle Rock become a much more stable income producer in the years ahead. While the company did just cut its distribution earlier this year, that cut was easy to spot because of the company's debt and because its midstream business' cash flows were not as secure as others in the space. With those two weights now lifted, Eagle Rock can soar along with its oil and gas production as it has plenty of capital to both buy and build production growth in the years to come.
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Fool contributor Matt DiLallo owns shares of Linn Energy, LLC. The Motley Fool has no position in any of the stocks mentioned. 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.