As commodity markets continue to look for a floor, the Master Limited Partnership IPO window is open to issuers with high quality assets, low commodity exposure, and a large inventory of seasoned drop down assets.  Over the past three weeks, CONE Midstream, Dominion Midstream, and Shell Midstream have all come to market with strong institutional demand and double digit gains.  While the market has weakened due to the uncertain impact of falling crude and gas prices, these MLP’s have maintained their issuance premium.  

Antero Resources, a natural gas E&P company with assets in Marcellus and Utica, is launching Antero Midstream Partners on November 4th, which will own direct and indirect midstream assets primarily dedicated to servicing Antero’s gathering and processing needs across their acreage.  Antero, which only became a public company in October 2013, will rely on the MLP proceeds to fund additional capital projects.  Antero is the low cost producer in the Marcellus and Utica and has hedged production to realize natural gas prices above NYMEX strip prices for Q4 2014 through 2016, which has a premium value of $800MM.  Antero has invested $1.2B in their midstream infrastructure which generated $66MM of EBITDA in the first half of 2014, as detailed below:

Antero Midstream Partners will issue 37,500,000 units out of a total of 151MM, with a target midpoint yield of 3.4% ($0.68 annualized), 1.15x distribution coverage, raising $709MM of capital.   The peer group’s attributes are illustrated below

The Assets

The initial assets will consist of a 20 year agreement to provide gathering and processing services to Antero’s current and future acreage in West Virginia, Ohio and Pennsylvania.  Revenue is generated by charging Antero a low pressure gathering fee of $0.30 per Mcf and a high pressure gathering fee of $0.18 per Mcf.    The company forecasts $48MM in EBITDA over the next 12 months, requiring $129MM in capital expenditures.

Growth Opportunities

Apart from the organic increase of gathering and processing volumes from the dedicated acreage, Antero has identified two additional assets sets for a drop down into the MLP:

Fresh Water Distribution – Services which provide fresh water from the Ohio river to Antero’s Utica and Marcellus acreage.  These assets were originally part of the initial MLP launch, but Antero has not yet received an IRS Private Letter Ruling which would allow inclusion.  Presently, the IRS has put on hold any future PLR opinions.  Once the PLR issue is resolved, it will be a matter of months before the entity is dropped into the MLP, for what is expected to be a combination of cash and units totaling $600MM.  These water assets generate a similar EBITDA level as the current midstream assets and deliver 30-40% IRR, the highest returns across Antero’s midstream assets, albeit with Antero as the exclusive customer.

ET Rover and Regional Pipelines Options – Antero has the option to purchase up to 20% of a non-operating interest in the ET Rover pipeline, a valuable option received by signing on as an anchor shipper on this new pipeline, which is expected to enter service in 2017.

The illustration below suggests additional projects which may be developed by Antero and potentially dropped down to Antero Midstream Partners.

As with all of the others in the peer group, Antero Resources, will own the GP and the Incentive Distribution Rights, which will incent further drop downs to Antero Midstream.  Although some investors eschew such rights, they are necessary to enable these LP formations.  During long holding periods (8-10 years), such IDR rights can significantly increase the LP’s cost of capital, the driver to Kinder Morgan's recent decision to merge their LP into a C-corp structure.  By way of example, below is the current cost of capital for Phillips 66 Partners, a peer which has had a full year of drop downs and distributions.  In the early years of high distribution growth, the IDR burden on existing shares is just 15bps.  However, as the distribution and unit issuance grows over time, the cost of capital will accelerate.

Conclusion

Antero Midstream Partners will offer investors another captive LP unit with guaranteed sponsor cash flows and no commodity price risk.  Unlike the peer group, Antero has a smaller set of developed Midstream assets which are available to drop into the MLP.  Management expects to be “best in class” for distribution growth (20%), while managing to a lower coverage ratio than the peer group.   Due to the market reception of Shell Midstream Partners, we expect Antero to price on the higher end of the range and open trading at $30 with a target yield of 2.25%.  We expect another sizeable offering within 8-10 months to finance the Water Distribution assets, which will also provide investors and entry point.  Given the IDR structure and large asset inventory, Antero Midstream is best suited for total return investors with a 5-8 year holding period.