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Credit FAQ: Our Approach To Holding-Company Leverage In The U.S. Midstream Energy Sector

The U.S. midstream energy industry appears to be moving toward a crossroads. The larger, diversified companies continue to have financial flexibility and growth opportunities, though perhaps that growth will be slower than in prior years. Meanwhile, smaller players are struggling to remain relevant to public investors who have shunned their equity and are becoming more selective about debt investments. This is against a backdrop of private-equity firms and infrastructure funds that are flush with cash to invest and willing to make bets on hard-to-replicate assets.

This is our second article that addresses our analytical treatment of debt consolidation and corporate structure. S&P Global Ratings has received market inquiries concerning our analytical treatment of holding-company debt when the holding company controls an operating subsidiary. And specifically, the recent transactions involving Tallgrass Energy Partners LP and Buckeye Partners LP have raised questions about financial leverage and its impact on ratings. Below, we discuss the rationale behind how we assess holding companies' own credit quality and that of their investments, as determined by the relevant criteria.

Frequently Asked Questions

How does S&P Global Ratings decide whether to analyze companies on a stand-alone basis or as a group?

Our treatment of holding-company leverage differs, depending on the company's corporate structure. If a holding company has debt and is solely reliant on upstreaming distributions from its operating subsidiary to service that debt, there are several key factors that determine our treatment of the debt at the holding company with that of its operating subsidiary. We deconsolidate when we consider the default risk of the holding company to be separate and distinct from that of its operating subsidiary and if all of the following factors are present:

  • The holding company or general partner (GP) must control the operating company.
  • Third parties own a material (generally, at least 33%) percentage of the operating subsidiary's equity.
  • There are limited business interactions between the holding company and the operating company, such as it not being a material customer and not serving as a material counterparty for financial derivative contracts.
  • The operating or partnership agreement provides the following protection for creditors: 1) limitation of upstream distribution to the general partner or holding company from debt issuance or asset sales and 2) requirements for fair and reasonable related-party transactions.

In the case of GPs and master limited partnerships (MLPs), we look for these factors:

  • Required approval of at least two-thirds of common unitholders for removal of the GP; and
  • A liquidation or bankruptcy at the GP would trigger a loss of control over the MLP.

If any of these factors (outlined in "Methodology: Master Limited Partnerships and General Partnerships," Sept. 22, 2014) are not met, we'd consider the GP and operating company part of the same group and consolidate the credit ratios. Accordingly, we'd use our group rating methodology criteria to determine the ratings on each.

Currently, we deconsolidate a limited number of issuers (see Table 1) from their parent company, after the midstream industry went through a wave of structural simplifications in the last several years.

Table 1

U.S. Midstream Energy Companies That Are Deconsolidated In Our Credit Analysis
--Leverage (x)*--
2018 2019 2020
EnLink Midstream LLC 4.3 4.9 4.5 - 4.75
GIP III Stetson I LP (Consolidated) 5.2 5.75 - 6 5.0 - 5.50
Tallgrass Energy LP 4.65 4.25 - 4.75 4.5 - 4.75
Prairie ECI Acquiror LP (Consolidated) 4.64 5.0 - 5.5 5.25 - 5.75
Summit Midstream Partners LP 5.47 5.04 4.76
Summit Midstream Holdings LLC (Consolidated) 6.23 5.5 - 5.75 5 - 5.25
Crestwood Equity Partners LP 6.7 5.5-5.75 4.75-5.0
Crestwood Holdings LLC (Consolidated) 7.5 6.25-6.5 5.25-5.5
EQM Midstream Partners L.P. 4.5 5.1 4.6
Equitrans Midstream Corp (Consolidated) 4.5 5.5-5.75 4.75-5.25
*Figures are adjusted by S&P Global Ratings.

Public ownership is a key consideration in whether we consolidate the holding company with the operating company. Although limited partner unitholders typically do not have the ability to directly influence the GP's decision making, we believe material public ownership does indirectly affect the GP's behavior and limits the potential for an aggressive financial strategy. If the GP takes actions that are deleterious to its public unitholders, the equityholders can sell and drive down the share price. We treat take-private transactions differently and consolidate because this check on GP behavior is removed.

How does S&P Global Ratings treat Tallgrass Energy LP and EnLink Midstream LLC?

Our ratings and outlooks on both operating entities are on a stand-alone basis, and we do not consolidate the leverage at the holding-company level. But when the acquisitions by their respective sponsors closed, the ratings impact differed.

When affiliates of Global Infrastructure Partners Inc. (GIP) acquired Devon Energy Corp.'s ownership interest in EnLink for $3.125 billion, we downgraded EnLink by one notch to 'BB+' from 'BBB-'. This downgrade, which took the rating to speculative-grade from investment-grade, was not directly related to the leverage at the holding company. Rather, it was due to EnLink no longer being controlled by a strategic sponsor. Our rating on EnLink had benefited from one notch of ratings uplift based on our view that the partnership was strategic to Devon and that Devon would support EnLink during periods of stress. This benefit reflected our view that Devon would not relinquish its control in EnLink. Thus, when the transaction closed, the 'BB+' rating reflected its stand-alone credit profile with no additional ratings uplift, as we generally do not provide any ratings uplift for financial sponsors. To partially finance the acquisition of EnLink, GIP raised a $1 billion term loan B at the holding-company level, which has an excess cash-flow sweep mechanism structured to improve consolidated leverage year-over-year.

When affiliates of Blackstone Infrastructure Partners L.P. (BIP) acquired the general partner of Tallgrass Energy LP and an approximate 44% economic interest in Tallgrass from affiliates of Kelso & Co., The Energy & Minerals Group, and Tallgrass KC, LLC, for approximately $3.2 billion, we affirmed the 'BB+' rating and positive outlook. In our analysis of Tallgrass' credit measures, we didn't include the $1.155 billion term loan B at the holding company, Prairie ECI Acquiror (Prairie). Similar to the structure of EnLink's holding company, the debt at Prairie also includes an excess cash-flow sweep.

On Aug. 27, 2019, Tallgrass announced that the board of directors of its GP received a nonbinding preliminary proposal letter from BIP, its partners, and respective affiliates to pursue a take-private transaction. As a result, we placed our ratings on Prairie on CreditWatch with developing implications to reflect uncertainty around the potential financing of this transaction. When the transaction closes, we expect to consolidate Tallgrass into Prairie in our analysis.

How does the analytical approach affect financial ratios?

With both EnLink and Tallgrass currently analyzed on a stand-alone basis, their credit ratios are notably stronger than if we consolidated the leverage at the holding companies (see Table 2). The forecasted consolidated metrics in Table 2 assume the operating company continues to pay dividends to the holding company, which improves consolidated credit ratios. That said, if the sponsor no longer distributes cash to the holding company, it would reduce the availability of excess cash to reduce leverage at the holding company. As mentioned earlier, if the sponsor pursued a take-private transaction or if the percentage of outstanding public units fell below 33%, we would generally consider analyzing the companies on a consolidated basis. For both companies, consolidated leverage is above 5x for multiple years.

How might such an event affect the anchor rating? Charts 1 and 2 show the hypothetical impact. For EnLink, assuming the same debt balance, a hypothetical take-private at the outset could have resulted in a 'b+' anchor (compared to the 'bb' anchor at announcement). For Tallgrass, this could have resulted in a 'bb' anchor (compared to 'bb+' at announcement). With many midstream energy companies focusing on maintaining stand-alone leverage in the low to mid-4x area, an additional $1 billion of debt for a company that generates EBITDA of approximately $1 billion would add approximately one full turn of leverage. Such a turn often translates into a deterioration in the financial risk profile assessment by one category, which--in the case of many midstream energy companies--would likely lead to us assessing their financial risk profile as highly leveraged.

Table 2

Leverage At EnLink And Tallgrass When Consolidated At The Holding Companies
--Leverage (x)*--
2018 2019 2020
EnLink Midstream LLC 4.3 4.9 4.5 - 4.75
Consolidated EnLink 5.2 5.75 - 6 5.0 - 5.50
Tallgrass Energy LP 4.64 4.25 - 4.75 4.5 - 4.75
Consolidated Tallgrass 4.64 5.0 - 5.5 5.25 - 5.75
*Figures are adjusted by S&P Global Ratings.

Chart 1 – EnLink Midstream

image

Chart 2 – Tallgrass Energy

image

Does the controlling owner matter?

In both transactions, the new sponsor that acquired control of the operating company was an infrastructure fund. If a financial sponsor acquired control of the operating entity, this could have resulted in an immediate negative ratings impact due to the aggressive strategies of financial sponsors, which generally use leverage to maximize shareholder returns. We expect financial sponsors to operate under a higher magnitude of operating leverage due to their aggressive track record, which often results in leverage exceeding 4.5x. This could result in a financial risk profile assessment similar to what would result if we consolidated the leverage with the holding company. Thus, they would likely lead to similar rating outcomes.

How is this approach different from the one S&P Global Ratings used for Buckeye Partners LP?

In October 2019, IFM and Buckeye Partners LP launched a $2.25 billion term loan B to fund IFM Investors' take-private acquisition. In comparison to EnLink and Tallgrass, IFM purchased 100% of Buckeye's public units versus purchasing the GP, which still gives IFM control. Rather than issuing leverage at a holding company, the senior secured term loan was issued by Buckeye Partners L.P. and was immediately leveraging, adding 1x-1.5x turns of leverage to our long-term expectations. This resulted in us downgrading Buckeye to 'BB' from 'BBB-'. In addition, due to the secured nature of the term loan B and the new $600 million revolving credit facility, the ratings on the existing senior unsecured notes are structurally subordinated, and so we lowered those three notches to 'BB-' from 'BBB-'.

Unlike Tallgrass or EnLink, Buckeye does not have leverage at the holding company, which relies on distributions to service debt. This provides Buckeye and IFM the flexibility to suspend distributions, allowing Buckeye to use excess cash flow to repay debt and reduce leverage over time.

Table 3

Buckeye Partners L.P.'s Leverage Metrics
2018A 2019F 2020F 2021F
Leverage (x)* 4.6 6.3 5.25-5.75 4.75-5.25
*Figures are adjusted by S&P Global Ratings. F- Forecasted

Are more leveraged buyouts on the way?

Although we are not going to predict a quickening trend toward industry consolidation, we do believe that further opportunistic mergers or buyouts could occur. Midstream equity prices have not yet reasonably recovered from the industry trough in 2016, as some of the market capitalizations and equity yields demonstrate (see Table 4). This could present an opportunity to acquire a competitor in an all-equity deal. However, taking on a business that could add volume and counterparty risk--as well as indirect exposure to commodity prices--could lower the combined entity's credit quality.

Private-equity sponsors or infrastructure funds may also seek to acquire assets that can add to asset footprints which their funds already own, or possibly fill in a geographic area that can link systems into an integrated network. In certain cases, they may not require control, and could consider taking a 50% stake in a midstream energy company. The final transaction details and pro forma corporate structure will determine if incremental debt used to partially fund the purchase will increase consolidated financial leverage and lead to lower ratings.

Table 4

Market Data For U.S. Midstream Energy Companies As Of Oct. 29, 2019
Company Market cap (Mil. $) Enterprise value (Mil. $) Equity yield (%) Enterprise value/EBITDA

Antero Midstream Partners LP

3,755.2 6,273.7 16.5 8.6

Crestwood Equity Partners LP

2,540.0 2,550.0 6.8 6.6

DCP Midstream LP

3,409.5 9,917.5 13.1 12.1

Enable Midstream Partners LP

4,394.6 9,233.6 13.1 8.1

EQM Midstream Partners LP

6,226.2 12,765.9 14.9 10.1

Genesis Energy LP

2,552.1 6,995.2 10.6 11.6

Global Partners LP

683.5 2,448.3 10.3 9.1

Martin Midstream Partners LP

196.3 838.0 19.8 7.3

MPLX LP

28,105.5 43,877.5 10.3 13.4

NGL Energy Partners LP

1,428.9 4,758.2 14.0 11.2

NuStar Energy LP

3,017.4 7,899.8 8.6 12.0

PBF Logistics LP

1,322.3 2,071.5 9.7 11.2

SemGroup Corp.

1,261.2 5,064.5 11.9 16.2

Summit Midstream Partners LP

403.6 2,070.4 23.6 8.6

Sunoco LP

2,738.2 6,251.2 10.0 10.1

Targa Resources Corp.

9,562.6 20,001.0 8.9 15.1

USA Compression Partners LP

1,689.5 3,983.4 12.0 10.0

Western Midstream Operating LP

10,070.4 17,735.4 11.2 14.4
Source: Capital IQ.

This report does not constitute a rating action.

Primary Credit Analyst:Mike Llanos, New York (1) 212-438-4849;
mike.llanos@spglobal.com
Secondary Contacts:Michael V Grande, New York (1) 212-438-2242;
michael.grande@spglobal.com
Jacqueline R Banks, New York + (212) 438-3409;
Jacqueline.Banks@spglobal.com

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