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Rice's $2.7B Vantage purchase good news for midstream MLP

Appalachian shale gas driller intends to use a $2.7billion purchase of an adjacent operator in Pennsylvania to drill longer laterals,lower well costs and lift production to 2 Bcf/d in the next few years, companyexecutives said.

Rice Energy will use its own affiliateto gather and process all those flows, the executives said on a Sept. 27conference call to discuss the deal. "Combining our twopositions significantly increases the size and scale of our Appalachianleasehold by 55% and nearly doubles our inventory of Marcellus drillinglocations that generate single-well returns of 110% at strip pricing with50-cent [drilling and completion] costs per Mcf," CEO Daniel Rice IV toldanalysts.

"In addition to this being the biggest, blockiest coreacreage opportunity available in Appalachia, it's also the largest undedicatedmidstream opportunity in the Marcellus dry gas core, meaning this deal isequally compelling to [Rice Midstream]," Rice said.

The deal, announcedafter markets closed Sept. 26, has Rice purchasing about 85,000 netcore Marcellus Shale acres in Greene County, Pa.; rights to the deeper UticaShale on about 52,000 net acres; and 37,000 net acres in the Barnett Shale fromthe privately held Vantage EnergyLLC and an affiliate. The assets produced 399 MMcfe/d in the secondquarter, Rice said, with almost two-thirds in Appalachia and the rest in theBarnett Shale. Added to Rice's 758 MMcf/d of second-quarter 2016 production,the deal would vault Rice into the rare 1-Bcf/d club of Appalachian drillers.

"We believe today's larger strategic acquisition is alogical extension of Rice's existing Greene County, Pa., footprint deepeningthe company's core Marcellus inventory," Stifel analyst Daniel Guffey saidbefore the call. "Additionally, incremental value from the Vantage assetscould be derived from the leverage Rice's midstream platform provides; 100% ofthe acquired acreage will be dedicated to [Rice Midstream Partners] forgathering, compression and water infrastructure."

Analysts at Capital One Securities said they, too, like thedeal, which "adds both upstream and midstream scale and takes out aprivate Greene County competitor."

The deal is to be financed with $1.02 billion in cash, $700million in assumed debt and 40 million shares of new Rice stock, which waspriced overnight at $25.50 per share (totaling $1.15 billion including theunderwriters' overallotment). Rice shares were down 7.6%, dropping below that$25.50 mark, in mid-afternoon trading Sept. 27.

Analysts said the deal is particularly good for RiceMidstream, which is 55% owned by Rice, in addition to Rice's generalpartnership interest.

"Rice dedicating 100% of acquired (and adjacent) GreeneCounty, Pa., acreage to [Rice Midstream], which we believe will strengthen thepartnership's core midstream footprint, while providing a solid runway forbolt-on midstream growth for RICE and other local producers," the CapitolOne analysts said.

Asked whether there are plans to spin off the generalpartnership interest into a separate company with its own stock, Rice CFOGrayson Lisenby said it would add value, but he was not ready to commit.

"It relates to solidified long-term value and growthpotential that you would expect long-term uplift in GP, and I think we guided a$10 million uplift in 2020," Lisenby said. "That trend will continuebeyond 2020, but not only in dollars but also in longevity of GP growth. Sothat is an asset that we think will continue to come into play on the rightside."

The Rice executives said they are going to shop for 20,000to 40,000 acres of land in Greene County that sit in the combined Vantage-Riceleasehold and start drilling 45 more wells per year than originally planned ina push to add 1 Bcf/d of gas production that they think they can drill out atcosts significantly below strip pricing.

It is that pricing that worried analysts at the energyinvestment bank Tudor Pickering Holt & Co. With one eye on prices below$1/Mcf across the Appalachian hubs in trading Sept. 27, they said, "Thereis upside potential via infill leasing (20-40k net acres, per Rice), in ourview, though company is now more exposed to in-basin pricing in the short-termgiven Vantage production is ~65% Marcellus with limited takeaway."