Master limited partnership spin-offs have been all the rage these days as various exploration and production (E&P) companies and pipeline firms look to increase shareholder value. After all, who wouldn’t want to shield their company from taxes while collecting big distributions? Usually, the market cheers such announcements to spin-off pipeline and other midstream assets.
That is, unless you’re QEP Resources (NYSE:QEP).
The E&P firm, itself a spin-off from utility Questar (NYSE:STR), made the decision to join the MLP parade — and the market wasn’t exactly thrilled. Overall, investors sold off shares of QEP hard, pushing the stock down almost 6% on Monday’s news. It remains below $30 as of Wednesday morning.
What gives? The market has been going gaga for value-creating measures like this. Is QEP a stock to avoid or a value in the making?
Denver-based QEP Resources has the pleasure of doing business in one of the hottest shale regions in the country — the Bakken. Its acreage in the region, plus its holdings in the Rockies and Texas Panhandle, have made it an unconventional resource darling among investors.
But not its decision to spin-off its gathering and pipeline assets into an MLP.
Via an IPO, QEP will initially contribute a majority of its gathering assets in Wyoming and North Dakota to the MLP. The MLP tax structure allows sponsoring firms to avoid double taxation on certain assets, while receiving generous incentive distribution rights. QEP hopes to raise roughly $400 million by offering investors a minority interest in its gathering system.
The problem is, its contribution to the MLP might not be enough.
QEP’s motives were telegraphed last month, when CEO Chuck Stanley suggested at Wells Fargo’s (NYSE:WFC) MLP & Energy Conference that QEP was looking at various ways of delevering its balance sheet. The company recently made a $1.4 billion acquisition of oil and gas properties in the Three Forks and Bakken formations. Those purchases put the firm’s debt-to-EBITA ratio above its “comfort” levels, and Stanley indicated that QEP would raise cash by spinning-off assets or selling them to private investors.
The company decided to go the MLP route, with Stanley saying “You get a little bit higher value from an MLP IPO than you do from a private buyer.” While the MLP is intended to support the growth of QEP’s midstream business, the plan disappointed analysts.
First, there’s no mention of the firm’s processing businesses — assets that are IRS-approved for MLPs and a major contributor to QEP’s overall midstream business. Spinning off those processing plants into the MLP would certainly bear fruit for the resource firm because they provide a steady source of payments. Such spin-offs are gaining urgency because the refining and processing sector expects stiffer regulations and higher taxes over the next four years. Shielding those assets makes real sense.
Second, the spin-off is being done to raise current cash to improve QEP’s balance sheet. While over the longer term, an MLP could mean a bigger jolt to QEP’s bottom line, the company needs cash today. The proceeds from selling the assets to a single investor or a group could be greater than $300 million to $400 million and provide more of a direct cash infusion. Analysts anticipate that even with the spin-off, QEP will need to sell other assets to hit management’s financial goals and reduce its debt-to-EBITA ratio.
Overall, analysts at Jefferies summed up the spin-off best when they said “the scope of partnership is more limited than expected.”
So, with its spin-off not going over too well with investors and its share price thrashed, the question is whether QEP is a buy.
I think it could be.
QEP said it plans to file for the IPO in the second quarter of this year, but it also warned that an IPO wasn’t guaranteed and that it had a “fleet of advisers” examining its options. Meaning, investors shouldn’t 100% count on having a new midstream firm to invest in.
However, “examining its options” could also mean QEP could be looking for suitors.
The firm owns plenty of quality energy-producing acreage, with proven reserves of around 3.61 trillion cubic feet worth of equivalent. While its mix tilts toward natural gas, QEP does have plenty of shale oil and natural gas liquids in its portfolio. Add in the company’s relatively small $5 billion market cap, and you have an easy-to-digest M&A target holding fields in the North America’s greatest shale oil play.
That’s just the kind of firm big boys like Exxon Mobil (NYSE:XOM) have been snatching up to expand their own production profiles.
So, if the MLP or a midstream asset sale happens, QEP will be a pure E&P play that’s just waiting to get eaten up at some point. For investors hunting for a possible future takeover target, the recent weakness in QEP shares could be an opportunity to load up.
And if a buyout doesn’t happen, QEP is still a pretty decent producer in its own right. Investors could do far worse.
As of this writing, Aaron Levitt didn’t own any securities mentioned here.