EQT Corp.'s announced plans to separate its midstream and upstream businesses came as no surprise to analysts who cover the Appalachian gas producer. But the details of the move left some scratching their heads, given that some driller-sponsored pipeline master limited partnerships continue to benefit from their symbiotic relationships with their parent oil and gas producers.
The Appalachian gas giant on Feb. 21 said the benefits of the old model for a combined EQT were "diminished," especially after its $6.7 billion acquisition of Rice Energy Inc. and its midstream arm in 2017.
"I agree 100% that in the high-growth era and as the assets were being tested through new drilling and gathering systems ... we gained a lot of efficiencies and create lot of value through integration," President and CEO Steven Schlotterbeck said during a Feb. 21 conference call. "But where we stand today, especially after the acquisition of Rice ... we can contract for midstream services in a more thoughtful and more proactive way than we could in the past. ... And on the midstream side, the system now especially once combined with [Rice Midstream] has a very, I think, enviable position across that core of the Southwest Marcellus."
During the call, executives detailed plans to create a new standalone publicly traded corporation for its pipeline assets through dropping down its midstream assets to EQT Midstream Partners LP, merging EQT Midstream and Rice Midstream Partners LP and selling Rice Midstream's incentive distribution rights to EQT GP Holdings LP.
MUFG Securities Americas Inc.'s Barrett Blaschke questioned Schlotterbeck's reasoning that EQT Midstream would be better off without an upstream sponsor. Midstream peers like the Anadarko Petroleum Corp.-owned Western Gas Partners LP have prospered under their upstream parent companies.
CBRE Clarion Securities analyst Hinds Howard agreed that EQT Midstream's relationship to EQT is a crucial component of its value to investors. "I don't get quite what the logic is of seeing that as a bad thing. I think we've seen that as a very successful model so far," he said in an interview. "There's probably some argument that EQT has not seen as much value uplift as it would have liked in its stock price for what it owns and this is a way to give a public marker value price for that."
"I don't know that there are a lot of the advantages [to the spin-off]," he noted in an interview. "Part of why you like EQT Midstream is because they have such a supportive sponsor, so if you're going to go away from that model then EQT Midstream is sort of forced to fend for itself."
Wall Street also held off on rewarding EQT Midstream for the strategic shift. Investors' initial reaction to the deal was positive as shares opened the market session on Feb. 21 at $66.05 per unit after closing at $65.78 the previous day, but the stock closed off 3.3% at $63.59.
It was parent EQT's lackluster stock performance in recent years that drove the country's largest natural gas producer to evaluate its options. Activist investors, including D.E. Shaw & Co. LP and JANA Partners LLC, pressured the board to split its businesses, and D.E. Shaw also urged EQT Midstream to merge with Rice Midstream.
D.E. Shaw portfolio manager Quentin Koffey applauded EQT's strategic plan in a Feb. 21 statement, asserting that the split represents "the best path forward for ... all shareholders," while SunTrust Robinson Humphrey analyst Welles Fitzpatrick said in a note to clients that he expects the separate businesses to "unlock material value."
MUFG's Blaschke, on the other hand, said he was "not necessarily reassured" by the decision to maintain EQT Midstream's required cash payments to EQT GP Holdings at a time when many holding companies are relinquishing their incentive distribution rights, or IDRs. These payments, which can total 50% of a partnership's incremental quarterly cash distributions, can hamstring MLPs' capacity to retain cash for reinvesting in the business by increasing their cost of capital. EQT Midstream CFO Robert McNally said the payments have not yet become prohibitive.
"We do recognize that the structure won't last forever, and we do obviously see the movement in the market away from IDR structures, but because the cost of capital is not a hindrance for as at this point, it's not urgent that we change the structure," he said during the call.
CBRE's Howard acknowledged that preserving IDRs could increase cash flow to the general partner, but he noted that the decision to keep EQT Midstream and EQT GP Holdings as separate entities under the new midstream corporation could deter midstream investors looking for less complicated structures and make that new corporation an acquisition target.
"I think in the long term they continue to simplify and then someone buys [it]," he said.