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Tallgrass MLP lined up for 25% stake in Rockies Express after Sempra exit

The private partnership behind Tallgrass Energy Partners LP has offered it a $440 millionstake in Rockies Express PipelineLLC that it agreed to purchase from Sempra Energy.

The pipeline is battling to hold on to revenue and shippers strugglingwith the low-price environment and has filed a lawsuit seeking $303 million fromthe Rockies producer Ultra PetroleumCorp., which earlier defaulted on payments. Citing ","Sempra said March 30 that REX no longer fit its strategy and appetite for risk.

Tallgrass CEO David Dehaemers Jr. and his executives were pepperedwith questions during their April 28 first-quarter earnings call about the offerto take over Tallgrass Development'scontract to add the 25% stake. Tallgrass Development already owns 50% of the gasconduit between the Rockies and Ohio.

Deutsche Bank MLP analyst Kristina Kazarian liked the decisionto move REX quickly into the Tallgrass MLP, but, judging from the conversation onthe earnings call, others were not so sure.

"We model total REX [distributable cash flow] at $320m,suggesting a very favorable 5.5x multiple on this transaction," Kazarian toldher clients April 28. "To us, this is a solid positive for [Tallgrass Energy]as it pulls forward cash flow growth at an accretive multiple and should increasedistribution coverage."

But others worried about the ability of some shippers to paytheir bills as they get closer to, or already are, in bankruptcy reorganization.Tallgrass revealed the lawsuit against Ultra, while Appalachian producer andits midstream unit Triad Hunter LLCare reorganizing under court supervision.

Ultra accounted for 13% of REX's revenue in 2015, shipping gaswest to east, while Magnum Hunter had contracted to move 100 MMcf/d east to weston the 1.8-Bcf/d REX system.

"Outside of these two customers where there's some counterpartyrisk here — Ultra and Magnum — is there anything else out there that we should beaware of on counterparty?" Credit Suisse analyst John Edwards asked.

"None that's material, John," COO Bill Moler replied."We've got one or two cats and dogs that just don't have significant volume."

Adding to any discomfort was the decision by REX's remaining25% stakeholder, Phillips 66 Co.,to not exercise its option to buy into the Sempra stake being sold to TallgrassDevelopment.

The REX purchase and the decision to quickly drop it all intoTallgrass Energy is a long-term play on Marcellus and Utica shale gas productionthat needs access to more markets, Dehaemers told analysts, a need that is beingaggravated by the harsh reception new pipelines are receiving in New York and NewEngland.

Kinder Morgan Inc.canceled its $5 billion,2.44-Bcf/d Northeast Energy Direct pipeline project April 20, saying it could notget firm commitments from customers in New England. On April 22, the New York StateDepartment of Environmental Conservation announcedthat it would not approve a water-quality permit for 's 650-MMcf/d Constitutionpipeline from Susquehanna County, Pa., to Schoharie County, N.Y.

Tallgrass said it expects the additional stake to be immediatelyaccretive to the partnership and its general partner and to boost distributions.

"With regard to REX … there's really good news and thenthere's good news," Dehaemers said. "REX should have tremendous cash flowfor the next 3.5 years. The good news is that there is a lot more to be done anda lot of elasticity relative to REX's ability to move gas in all directions in 2020and beyond."

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"REX's Zone 3 east-to-west project is fully contracted,operational and flowing at its 1.8 billion cubic feet a day capacity in Zone 3 onmost days," Dehaemers added. "It's also interesting to note that the pipelinemoved 1.7 billion cubic feet a day from west to east in early April for a totalof 3.56 billion cubic feet on that one day. Meaning that, contrary to the popularbelief of some, the west end of REX is not empty, and in fact continues to be utilizedby its contracted shippers."

In comparison to the 1.8 Bcf/d of east-to-west flows out of Appalachia,REX's west-to-east shipments average between 800 MMcf/d and 1 Bcf/d, Moler said.

Because of the capacity constraints out of Appalachia, any newor released capacity has significant marginal value, Moler said. "Other projectsin the [northeast U.S.], if you pay attention, aren't having a lot of success permitwiseand certificatewise and other things, getting pushed out farther and farther. So,when Dave mentioned that the Magnum Hunter 50 million a day that's coming back tous has value, we believe it has increasing value."

The bulk of REX's west-to-east shippers are majors such as and ConocoPhillips Co. or major independents such as , according to SNL Energypipeline contract data.

There are questions about several east-to-west shippers, thelargest being 600,000 Dth/d of capacity held by Ascent Resources, the descendant of the late Aubrey McClendon'sAmerican Energy Partners LPUtica and Marcellus arms. Ascent had been funded principally by , but that fundingwas already reported to be in jeopardy at the time of McClendon's death March 2.

Tallgrass on April 28 reported that adjusted EBITDA increased58%, to $83.7 million, as revenue jumped 88% on the strength of an increased stakein the Pony Express crude oil pipeline. Operating income at its natural gas pipelineunit dropped 15%, to $10.7 million, the MLP said.

Tallgrass Energy Partners unit gained 8.2% on April 29 to closeat $41.10.