• EROC plans to reduce debt by $75-$100 mm annually and bring debt balance to $650 mm: Given EROC has not violated its debt covenants; there has been no increase in fees or re-pricing of its revolver, which stands at LIBOR+175 bps. EROC has a $1 billion revolver facility that matures in 2012. EROC had 3.7x Debt to EBITDA ratio at the end of 4Q08. Management goal is to bring Debt balance to $650 mm and maintain debt to EBITDA of 3-3.5x. With the distribution cut, EROC expects to pay down debt by $75-$100 mm annually. As such, we believe EROC will maintain $0.10/year distribution till mid-late 2010. • EROC has 20.7 million subordinated units that have not converted to common units: The sub units are owned by EROC’s GP Natural Gas Partners. As part of the partnership agreement, when distribution falls below minimum quarterly distribution of $1.45, the sub units cannot receive distribution until the commons have received MQD. As such, the common unit holders will have arrearage rights during the period EROC pays below MQD. Assuming EROC pays $0.10/unit per year for the next 8 quarters and reinstates MQD for all unit holders thereafter, EROC will have to pay an aggregate of $150 mm to its common unit holders before it can start to pay distribution to its sub unit holders. • We value EROC units at $4.00 based on 6x multiple on EROC’s assets: Given our EBITDA estimate for EROC up to year 2011, we do not believe EROC can pay arrearage to the common unit holders out of its distributable cashflow. Unless EROC gains access to reasonably priced capital to pay out common unit holder’s arrearage rights, we believe it is possible that the GP liquidates EROC’s assets to claim residual value of its ownership. Using EV/EBITDA multiple of 6x we believe EROC units should be worth $4.00 per unit, which is an average of three points estimates based on our EBITDA assumptions from 2009-2011. Given debt makes up a large portion of the enterprise value, the equity value will have small but magnified impact on the overall valuation which should lead to volatile unit price movements. Our model assumes EROC not paying distribution till year 2011.
Investment Conclusion We reduce PT to $4 based on EV/EBITDA multiple of 6x. EROC cut 1Q09 distribution by 94% to $0.025 from $0.41 per quarter, or annual distribution of $0.10 per unit. Given EROC's plan to pay down $150mm of debt, we believe EROC will pay $0.10/year distribution until end of 2010. Summary EROC cut distribution drastically to improve liquidity in light of weak 2009 EBITDA outlook and borrowing base reduction. Mgmt expects to report Q1 EBITDA of $40 mm (31% below our est of $58 mm and consensus of $57 mm) and $40-$45 mm of qtrly EBITDA in 2009, implying annual $160- $175 mm, down 33% YoY. Borrowing base reduced by $70 and redetermined at $135, vs $179 mm of liquidity at 4Q08. By cutting distribution, EROC plans to pay down debt by $75-$100 mm annually. Goal is to reach $650 mm debt balance from current $800 mm. While Q1 results report on May 8th, it appears weakness came from midstream segment driven by reduced drilling as well as ethane rejections in Texas Panhandle and East Texas. We reduce PT to $4 based on EV/EBITDA multiple of 6x. Our previous PT was based on distribution of $1.45 and 18% target yield.
04/30/09 02:54 pm ET ... S&P DOWNGRADES OPINION ON LP UNITS OF EAGLE ROCK ENERGY PTNRS TO HOLD FROM BUY (EROC 3.85***): EROC announces that it will cut its quarterly distribution to $0.025 per unit from $0.41 per unit. EROC believes that the cut will enhance its liquidity position as it expects lower cash flows resulting from the decline in commodity prices and drilling activity.We are concerned that the cut in the distribution will lead to EROC shares becoming less attractive to other master limited partnership companies which have not reduced their distributions.We lower our '09 earnings per unit forecast to $0.60 from $0.75, and drop our target price to $5 from $7. /T.Shafi