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Private equity leaves midstream assets on the table as exit becomes difficult

Private equity firms have become more discerning buyers of midstream infrastructure in the risky market of 2019, and their reluctance to pounce on pipelines and other assets is expected to persist into the new year.

The pace of dealmaking has slowed considerably since 2017 and 2018, when EnCap Flatrock Midstream and ArcLight Capital Partners LLC dominated the markets for buying and selling midstream assets. Only eight acquisitions of public U.S.-based assets by private capital have been announced in 2019, and private firms have struggled to unload the assets they already own as portfolio companies run into roadblocks.

Declining stock prices and dimmer volume growth forecast for the midstream sector in 2020 have created a disconnect between the buyers and the sellers who want to be paid rates similar to those transacted in 2017 and 2018, according to several experts who spoke with S&P Global Market Intelligence. This dynamic is already forcing private equity to retool exit strategies for investments closer to the wellhead.

"We're seeing more in upstream that company sponsors are realizing there's not a traditional exit," Colton Bean, an analyst at energy investment bank Tudor Pickering Holt & Co., said in an interview.

"Historically, you would have flipped these packages to the public operators, but that hasn't really been available as an option, so a lot of these companies in places like the Mid-Continent and the Haynesville are combining their different management teams to get scale on the asset level and build cash flow distribution models," Bean said.

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A similar reckoning is already happening farther down the value chain, particularly when it comes to gathering and processing infrastructure linked to producers with at-risk credit profiles.

"People are trying to figure out, 'What am I buying from an upstream and rig count perspective?' … It's hard to put your finger on how much more downside there is," Energy Spectrum Capital partner Michael Mayon said in an interview. "The market's working through a full reset."

MLPs in the penalty box

That reset is taking a toll on for-sale master limited partnerships such as Noble Midstream Partners LP and Western Midstream Partners LP, dragging down equity values regardless of the quality of their assets.

In October, Reuters reported that Occidental Petroleum Corp. pushed back its plan to off-load an interest in Western Midstream until 2020 because of the partnership's declining stock price. This came after reports that investment firms including The Blackstone Group Inc. and Apollo Global Management Inc. were considering bidding to acquire a majority stake.

Noble Energy Inc., meanwhile, decided in November to sell its remaining midstream portfolio to Noble Midstream Partners for $1.6 billion and eliminate the MLP's required payments to the general partner. The decision followed months of speculation that Noble was putting the MLP up for sale and after reported interest from Williams Cos. Inc. and Global Infrastructure Partners.

"I thought [Noble Midstream] was an interesting marker for the space," Bean said. "Noble would have preferred to off-load that entirely. That weighted-average price came in at a combined [8.0x transaction multiple] ... so the idea that you couldn't get a private equity bid to come in above that does draw a little bit of question mark versus what we were seeing a year or two ago."

Disappointing M&A activity is a factor in private capital's reticence to invest in MLPs.

Since Blackstone purchased a 100% interest in Tallgrass Energy LP's general partner and a 44% economic interest in the pipeline company in March, Tallgrass shares have dropped nearly 15% to settle at $18.18 per unit Dec. 6. A subsequent offer to take Tallgrass private was not well received by shareholders due to the gap between what Blackstone would pay public unit holders and some members of Tallgrass' management.

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"Private equity is finding that returns they underwrote on the entry into midstream companies are underperforming expectations," CBRE Clarion Securities portfolio manager and MLP expert Hinds Howard said in an email. "I think lower returns and some public midstream challenges are steering private equity away from midstream to the extent they have a choice."

EnLink Midstream LLC has seen a severe decline in stock price since Global Infrastructure Partners acquired a 46% stake in the partnership in 2018, cutting the value of the private firm's equity investment by $2.13 billion to just over $1 billion as of the end of trading Dec. 6.

Some willing buyers

That does not mean there are not other prospective suitors for midstream partnerships. Scott Peak, a managing partner at Brookfield Asset Management Inc.'s infrastructure arm, said in an interview that his firm plans to focus on select take-private opportunities and "large corporate carve-outs" in 2020.

"We're really looking for a partner that wants to work with us," Peak said. "We're going to be rational actors in the boardroom, we're going to be patient partners of the business, but we're looking for someone that actually wants our help in developing and growing the business over the long term."

Brookfield in October agreed to acquire a 25% stake in Dominion Energy Inc.'s Cove Point LNG export terminal for $2.0 billion.

Even with the uncertainty surrounding gathering and processing assets, particularly those located in the Northeast, Mayon said the gathering and processing sector remains the firm's "bread and butter."

"We're buyers right now," Mayon said, noting that Energy Spectrum is looking at several acquisition opportunities.

The challenge for private equity firms that want to buy midstream infrastructure, however, is a longer runway to paying back their investors.

"I think the three-to-five-years from an underwrite to an IPO [timeline] — those days are probably gone from most private capital investors' models in the infrastructure space," Peak said in an interview. "I think it's going to evolve into more of a longer-term hold" approach.