Private Equity Continues to Bet Big on Midstream

Summary //

• Private equity funds have continued to display considerable interest in energy infrastructure, with over $10 billion invested in the midstream space since the beginning of the year.
• Private valuations of midstream assets have been at a premium to public equity market valuations, providing support to the midstream investment thesis and giving public companies the option to monetize their assets at favorable prices.
• Private equity can be a source of capital as a JV partner or asset acquirer, a competitor, or a potential asset seller providing inorganic growth opportunities.

Since we last wrote about private equity (PE) investment in midstream in November 2017, private equity firms have continued to put billions of dollars to work across midstream, spanning shale plays and asset types. So far this year, PE funds have invested over $10 billion in energy infrastructure assets. As Kinder Morgan’s (KMI) CEO quipped at KMI’s Investor Day in January, “Private capital likes our assets better than you all do.” Today we will examine some of the major midstream PE investments so far this year and discuss both the positive and negative impacts those investments have on the industry today and longer term.

Recent PE transactions have spanned geographies and business lines.
When it comes to recent midstream transactions, private equity funds have invested at both the asset level and the company level. For example, Stonepeak Infrastructure Partners and ArcLight Energy Partners have offered to purchase entire midstream companies with their proposed acquisitions of Oryx Midstream and American Midstream (AMID), respectively. Perhaps most notably this year, Blackstone Infrastructure Partners agreed to purchase 100% of Tallgrass Energy’s (TGE) general partner and a 44% interest in TGE for $3.3 billion from Kelso & Co., The Energy & Minerals Group, and TGE management.

While company-level transactions may grab more headlines, many private investments in energy infrastructure this year have come in the form of joint ventures (JV). In March, The Williams Companies (WMB) and the Canada Pension Plan Investment Board (CPPIB) announced a JV in the Marcellus and Utica, with CPPIB investing $1.34 billion for a 35% interest in WMB’s now wholly-owned Ohio Valley Midstream and Utica East Ohio Midstream systems. In February, funds managed by GSO Capital Partners and Blackstone Tactical Opportunities agreed to buy a 45% stake in Targa Resources’ (TRGP) Bakken assets for $1.6 billion. In the table below, we list some of the major PE transactions so far this year.

The “smart money” is betting on midstream.
Private equity firms are often considered some of the most intelligent investors in finance. The investment by private equity across the spectrum of midstream assets, from gathering and processing to water services, as well as across shale plays, from the Permian to Canada, displays a high degree of confidence in the long-term investment thesis for midstream (read more). It’s worth noting that PE firms typically hold assets for at least a few years – a longer-term view than perhaps most investors. For midstream investors that have potentially been frustrated by equity performance in recent years, private equity involvement may add credibility or validation to their midstream investment.

For further validation of the midstream value proposition, investors need only look at recent transaction multiples for PE purchases. For example, last November, Dominion Energy (D) announced that it would sell its 50% interest in Blue Racer Midstream, a Marcellus and Utica midstream provider, to First Reserve for 14-16x 2018 EBITDA. Last summer, SEMG announced the sale of a 49% interest in the Maurepas Pipeline, a crude pipeline system in Louisiana, for 13x EBITDA. This year, CPPIB is estimated to have paid a 14x EBITDA multiple for its stake in the Marcellus and Utica JV with WMB. While many private deals do not disclose financial details, these transactions represent a notable premium to the current valuation of the Alerian Midstream Energy Index (AMNA), a composite of North American energy infrastructure companies. As of April 26, 2019, AMNA was trading at a forward EV/EBITDA multiple of 10.5x based on 2020 EBITDA per Bloomberg. Clearly, there is a disconnect between how public and private markets value midstream assets and the cash flows they generate.

Private equity purchases at such favorable valuations also give midstream companies an opportunity to monetize their assets at attractive prices and use the proceeds to de-lever or fund growth projects. (Keep in mind, midstream companies can often build projects at EBITDA multiples of 4-8x – read more.) PE firms can be an important source of capital as more midstream companies focus on equity self-funding. For example, Plains All American (PAA) targeted $700 million in asset sales in 2018 in order to self-fund equity capital expenditures and enhance its balance sheet. The sale of a portion of PAA’s interest in the BridgeTex Pipeline to the Ontario Municipal Employees Retirement System (OMERS) generated net proceeds of $862 million alone. PAA’s partner in BridgeTex, Magellan Midstream Partners (MMP), initially had no plans to reduce its ownership in the pipeline. However, MMP sold a portion of its BridgeTex stake to OMERS alongside PAA. At the Barclays Energy Power CEO Conference in September 2018, MMP’s President and CEO, Michael Mears, said that “when [management] saw what the valuation was at the bid, in our view, it just represented strong enough value that it made sense for us to take some of that ownership off the table.” While a multiple was not disclosed, the valuation was clearly attractive.

Is private equity a partner or a competitor?
Despite the positives that private money brings to energy infrastructure, the increased competition from private equity-backed companies can be a negative for public midstream operators. PE funds have a lower cost of capital than public companies, which is a competitive advantage from a project return standpoint. Due to a lower cost of capital, PE firms may be able to undercut public midstream companies when competing for business (a lower cost of capital may allow the PE firm to accept lower project returns than a public company). Private equity funds also have a large amount of committed capital with long-term investment horizons, while public companies report quarterly results and must focus more on short-term market sentiment.

Increased competition from private equity could pressure midstream returns (read more). At the company’s investor conference in December 2018, the President and CEO of Enbridge (ENB), Al Monaco, said that the company had to be disciplined with its capital allocation due to new money, particularly from PE funds, compressing returns. However, Monaco also said that the company has not had to significantly reduce its investment in projects and has maintained returns. On the partnership’s 3Q18 earnings call, Energy Transfer (ET) CEO, Kelcy Warren, said that ET was sometimes required to spend money defensively to compete with PE-backed startups, and that this had become more frequent. The potential opportunities across the energy infrastructure space remain robust (read more) providing opportunities for a wide variety of companies. That said, increased PE involvement could be a negative to the extent that it pressures returns for public companies. On the other hand, it could be a positive in terms of forcing greater capital discipline on midstream companies.

What about PE exits from investments?
Eventually, private equity funds will begin to exit these investments to realize returns. A PE fund will typically hold an investment for three to ten years. To exit an investment, a PE firm may sell to another company (private or public) or pursue an initial public offering. Many factors, such as public valuations of midstream assets, equity capital market strength, and the M&A appetite of public and private companies, will play a role in the exit strategy of PE funds.

If there is a strong appetite for M&A among public companies, private equity exits could result in attractive inorganic growth opportunities for larger public companies if the price is right. This year, SemCAMS Midstream’s purchase of Meritage Midstream ULC represented a partial exit for EnCap Energy Infrastructure Fund and TPH Partners, who announced an initial equity backing in Meritage Midstream in 2009. PE’s exit was a growth opportunity for SEMG and KKR’s JV. WMB also purchased privately-held assets this year with its acquisition of Momentum Midstream’s remaining interest in the Utica East Ohio Midstream system in forming its JV with the CPPIB. When this recent wave of midstream PE investments matures, asset purchases like these may become more frequent.

Bottom Line
Private equity’s heavy involvement in midstream has a wide swath of implications for public midstream companies. PE can be a source of capital as a JV partner or asset acquirer, a competitor that potentially pressures returns and forces midstream companies to practice greater capital discipline, or a potential asset seller providing inorganic growth opportunities. For investors, private equity’s long-term commitment to midstream and the multiples at which PE is valuing these assets likely provides added credibility to the midstream investment thesis.