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CONE Midstream Partners Preview

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The initial public offering of CONE Midstream Partners LP (CNNX) is expected to price on September 24th, offering investors another choice for a growth-oriented midstream MLP.   CNNX is the result of a 50/50 sponsorship by CONSOL Energy Inc. and Noble Energy, Inc.. The two sponsors have a joint active natural gas and NGLs drilling program in the Marcellus Shale play and are forming the MLP to drop down, and develop, assets to service their Marcellus production.

 

CNNX will operate on a fee-based revenue model, with initial assets that include natural gas gathering pipelines, compression, and dehydration facilities along with condensate gathering, collection, stabilization and stabilization facilities. All of the partnerships' revenues will initially come from the sponsors' on long-term, fee-based gathering contracts. The gathering agreement initially covers 496,000 acres in the Marcellus Shale. The IPO proceeds will go to the sponsor companies and CNNX will have a $250 million revolving line of credit to provide liquidity. The management team comes from senior leadership at CONSOL and Noble.

 

IPO, Distributions, and IDR Details

 

With the IPO, 17,500,000 common units, representing 29.4% interest, will be sold to the public. Through the CONE Gathering LLC joint venture subsidiary, the sponsors will retain 11,663,121 common units, 29,163,121 subordinated units, for 68.6% of the LP interest, and a 2% general partner interest. Underwriters have the option to purchase an additional 2,6250,000 common units. At the midpoint of the $19 to $21 per unit expected pricing range, CNNX will have a market cap of $1.2 billion and a target yield of 4.25%.

The minimum distribution rate will be $0.2125 per unit quarterly, for an annual rate of $0.85. The first 15% IDR tier will be reached at a quarterly distribution of $0.24438, and the top 50% IDRs kick in when the distribution exceeds $0.31875, or $1.275 annually. The general partner retains the right to reset the IDRs if at some point in the future the IDR payments reduce the company's ability to competitively add on assets.

 

 

Three-Tier Asset Set

 

The midstream assets held by CONE Gathering have been divided into three categories. Here are the descriptions from the prospectus:

Anchor Systems include our midstream systems that generate the substantial majority of our current cash flows and that we expect to drive our growth over the near term as we increase average throughput on these systems from our Sponsors' growing production.

Growth Systems include our high-growth, developing gathering systems that will require substantial expansion capital expenditures over the next several years, the substantial majority of which will be funded by our sponsors in proportion to their retained ownership interest.

Additional Systems include several gathering systems primarily located in the wet gas regions of our dedicated acreage that we expect will generate stable cash flows and require lower levels of expansion capital investment over the next several years.

 

With the IPO, 75% of the Anchor systems and 5% each of the Growth and Additional systems controlling interest will be transferred to CONE Midstream Partners.

 

First-Year EBITDA and DCF Expectations

 

The three tiers of midstream assets are forecast to produce EBITDA of $113.9 million for the 12 months that will end on September 30, 2015. The CNNX share will be $67.4 million, resulting in DCF of $58.2 million. To cover the minimum distributions, the company needs EBITDA of at least $59.8 million and DCF of $50.6 million.

 

The total EBITDA for CONE Gathering in excess of the CNNX share represents an initial amount that could be dropped to the MLP.

 

Growth Capex Spending Plans

 

CONSOL and Noble have aggressive drilling plans for their acreage holdings in the Marcellus. From 111 wells drilled in 2013, the two expect to complete 177 in 2014. There are over 5,700 drilling locations in the acreage dedicated to CNNX. All of the new wells are expected to be connected to the CONE midstream system. For the 12 months ending in September 2015, the companies forecast $621.1 million of midstream expansion capex spending. Of that total, CNNX will be responsible for $114.8 million and the sponsors will pay the remaining $506.3 million. The growth capex spending will increase the fee revenues of the Growth and Additional systems, which can then be dropped down in steps to CONE Midstream Partners, propelling steady distribution growth.

 

Conclusion

 

CONE Energy Partners offers income and total return investors stable cash flow access to the largest Marcellus acreage without commodity exposure. The sponsors' Natural Gas E&P 15% ROI target is realized when NG is equal to and above the $2-$3 range, well below the natural gas spot and forward curves. The sponsors expect to fund 95% of the future growth capital, which will allow the LP to benefit from the increase in gas volume without DCF dilution from unit issuance. Once the new sponsor assets are providing stable cash flows, the LP will purchase the assets and will need to access the capital markets, which management expects will not be for a few years. With a midrange yield of 4.5% and implied 14% growth, CNNX is an attractive addition to your portfolio up to $26 prior to their first distribution.

 

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