The S&P 500’s 8.01% January rally reversed December’s 8.80% loss driven by dovish Federal Reserve commentary and improved prospects for a trade dispute resolution between the US and China that calmed global recessionary fears. Tangible positive developments on the US-China trade front should be reported by March 2nd and lead to a complete retracement of the fourth quarter “volatility event.” With a less restrictive Federal Reserve and global trade tensions abating, the global economy should begin firming as the year progresses. With successful US-China trade negotiations, the US economy could continue growing into 2022 and extend this decade-old bull market to new record highs.
The chart below shows the S&P 500 is fairly priced with a risk premium of 3.53. The middle panel shows (red line) a modest decline in 2019 S&P 500 earnings and those earnings will need to reverse upward before the S&P 500 index can resume solid growth.
The S&P 500 is trading at a modest multiple of 16.6 times its trailing earning and 15.4 times its forward earnings. Over the last 60 years interest rates on average have been higher which makes these earnings multiples better than average values.
US equity market fears remain, as reflected in the chart below, which shows the volatility index for the S&P 500 at 17. Fears have abated from the 35 level hit on “Mnuchin Monday” when the Dow Jones Industrial Average dropped 653.17 points following the Treasury Secretary’s weekend TWEET, that asserted banks were financially sound, backfired.
For the year, 2018 experienced 23% earnings growth, with no stock price appreciation, and occasional elevated equity market volatility. This US equity market behavior is consistent with the unwinding of the financial stimulus bubble.
To achieve broader equity diversification, we are investing in value away from the US equity markets. With a weaker dollar and firmer commodity prices, we favor gold and gold stocks, particularly if the emerging markets recover. We are adding the Van Eck Gold Miners ETF (GDX) to portfolios. For both high income and a recovery in the emerging markets, we continue to add the Templeton Emerging Market Income Fund (TEI) to portfolios.
Attention Activists and Congressmen:
January was a special month for American Midstream Partners, LP (AMID). On December 31, 2018, AMID announced:
|“On December 27, 2018, American Midstream Partners, L.P., a Delaware limited partnership (the “Partnership”) entered into that certain Second Amendment to Second Amended and Restated Credit Agreement (the “Amendment”) with American Midstream, LLC, a Delaware limited liability company (the “AMID Borrower”), Blackwater Investments, Inc., a Delaware corporation (together with the AMID Borrower, the “Borrowers”), the other Loan Parties party thereto, the Lenders party thereto and Bank of America, N.A., as Administrative Agent, to that Second Amended and Restated Credit Agreement, dated as of March 8, 2017 (as amended, supplemented or otherwise modified from time to time prior to the date of the Amendment, the “Original Credit Agreement”), among the Borrowers, the Partnership, the Lenders party thereto, and the Administrative Agent.” 1|
How many retired AMID unitholders would comprehend this on New Year’s Eve, let alone find it on EDGAR? Basically, the 8K explained that due to the “renegotiation” of a covenant with one of its creditors, AMID was suspending its fourth quarter distribution until its debt to EBITDA levels dropped below 5.0. This announcement led to a 36% drop on nearly ten times normal volume driving AMID units down from $4.33 to $2.75/unit. This seemingly terrible business announcement occurred on the last day of the year when tax-loss selling and window dressing would be most intense.
What most investors might not realize was that: AMID’s Debt to EBITDA was 5.65 on September 30, 2018, AMID had just closed a sale for its Refined Products Terminals for $125 million on December 20th, AMID was actively deleveraging its balance sheet, AMID had announced hundreds of millions in planned sales2 and that the $125 million sale was the second large asset sale in the last six months. Consequently, the elimination of the fourth quarter distribution was not the operating death knell, such distribution elimination announcements typically herald.
This was not lost by one smart institution, ArcLight Capital, a $21 billion energy private equity firm3 out of Boston. Its Managing Member and Co-Founder, Daniel Revers recently helped launch the Revers Center for Energy at the Tuck Business School at Dartmouth4 and has a big portfolio5. Beyond his philanthropy, Revers joined Michael Dell as a resident of the Millennium Tower6 in Boston with a $9 million penthouse purchase.
On January 3rd, 2019, just two business days after this extraordinary distribution cut, ArcLight Energy V bid $4.5 per AMID unit. A nearly identical situation occurred on September 28th, 2019, when ArcLight Energy V bid $6.10 for AMID stock in the wake of the 75% distribution cut on July 27, 2018, before that time AMID Units were trading at $11.16. Unsolicited bids are generally welcome, but since this bid came from ArcLight Energy V and ArcLight Capital owns 80% of American Midstream’s GP, it appears to benefit ArcLight over the unitholders.
Further, AMID announced on July 26th, 2018 its revised asset allocation strategy:
| “Is intended to significantly reduce leverage, provide capital for strategic growth opportunities, and create long-term value…. the Partnership has identified attractive organic growth projects across all core segments. These opportunities will enable the Partnership to continue building an integrated midstream company with greater scale and density in its core operating areas as well as expanding its reach across growing resource developments. The identified projects will focus on the continued development of infrastructure along the Gulf Coast, which would further the Partnership’s ability to participate in the growing export market offshore and to Mexico. The aggregate of non-acquisition related growth opportunities ranges from $200 to $300 million through 2020 at a blended multiple near 5-times expected EBITDA.” |
This bid, however, aborts the chance for unitholders to recoup their lost capital via its long-term growth strategy described above. It currently appears ArcLight will acquire the American Midstream Partners at a significant discount to fair value and cause large losses on individual unitholders. Many investors in AMID units are retirement age and have bought AMID units in the last two years after hearing AMID CEO Lynn Bourdon make statements like “These accomplishments underscore the support that we have had and can expect from our sponsor ArcLight Capital Partners, as we move forward”7 and “Quite frankly folks, this train is leaving the station. I hope as investors, you are as excited as we are about our future….”7
Bloomberg’s Rachel Adams has twice written on this story. On October 8th Adams quoted Recurrent Advisors’ Bradley Olson8 “Even by the standards of the MLP sector, where shareholder governance is not as shareholder friendly as it is for a corporation, this deal still stands out for being aggressively quick after a dividend cut and with an aggressively low premium,” Olsen said. “This was a proposal that we think tilted the balance a little too far.”
Again, on January 4, 2019 Bloomberg again quoted Olsen “The initial read of the second bid is it seems to be using a set of circumstances that were created by an ArcLight board and ArcLight-appointed management team as an excuse to lower the bid.”
On January 9th, activist Thomas Craig, wrote that AMID units were worth $9/unit and that “The independent directors are the last line in defense against ArcLight and its tactics as they must approve a transaction. I along with other unitholders are supportive of standing firm. I encourage all unitholders to reach out to Peter, Donald, and Gerald [Mr. Peter A. Fassulo, Mr. Donald R. Kendall Jr., and Mr. Gerald A. Tywoniuk] in writing and encourage them to reject the two bids so that AMID has more time to bring Delta House up to full capacity, sell assets, and resume the distribution.”
All Unit Holders Encouraged to Directly Contact the Independent Directors to Voice Their Support of a Firm Stance
Estimates Full Value of AMID of at Least $9.00 per Common Unit
CHARLOTTE, N.C., Jan. 10, 2019 (GLOBE NEWSWIRE) — Craig W. Thomas, a concerned unitholder of American Midstream Partners, LP (“AMID”), encourages the three independent directors of AMID (Mr. Peter A. Fassulo, Mr. Donald R. Kendall Jr., and Mr. Gerald A. Tywoniuk) to reject publicly the two bids from AMID’s private equity sponsor and stay public for most of 2019 so that high-probability improvements in EBITDA, leverage ratios (and a reduction in debt), and a resumption of the distribution are realized.
Mr. Thomas believes that the private equity firm ArcLight Capital Partners and its affiliates (“ArcLight”) have engaged in a campaign of self-interested tactics and timing designed to take AMID private at an extremely low price per unit while AMID’s profitability and distribution are at temporary and short-lived lows. Mr. Thomas believes that under ArcLight’s stewardship of AMID (given its effective control of the partnership through six of nine board seats and a current 51.0% ownership interest on a fully converted basis):
- ArcLight sold a 15.5% interest in the Delta House Offshore Production System in October 2017 to AMID that within the same quarter of deal closing announced major expected shortfalls in throughput. Mr. Thomas estimates that ArcLight’s support payments to AMID fall short of the actual EBITDA deficit. EBITDA and credit ratios have suffered as a result of the temporary shortfall and contributed to distribution cuts which lowered the unit price.
- Oversaw an AMID finance department that has been routinely delinquent in filing Form 10-Q’s and Form 10-K’s denting AMID’s credibility in the markets.
- AMID pursued the Southcross Energy Partners, LP and Southcross Energy GP, LLC (“SXE”) transaction without committed financing that required a break-up fee.
- AMID filed the required documents to pursue an equity offering creating a further overhang. Many investment banks were restricted in their research coverage of AMID during this period further limiting the ability of AMID to attract new investors.
- AMID cut the distribution by 75% in July 2018, causing the closing unit price to fall from $11.55 per unit to $6.60 on the day of the announcement.
- AMID announced the termination of the SXE transaction on August 1, 2018 requiring the payment of the $17mm break-up fee.
- ArcLight made a non-binding offer of $6.10 per unit on September 28, 2018.
- AMID suspended investor Q&A on the Q3 2018 earnings call in November 2018.
- AMID eliminated the distribution on December 31, 2018, causing the closing unit price to fall from $4.33 per unit to $3.03 on the day of the announcement.
- ArcLight lowered its non-binding bid to $4.50 per unit on January 3, 2019, four days after AMID eliminated the distribution (many institutions and index funds require their MLP’s to pay a distribution and are forced sellers on distribution suspensions).
- AMID did not extend the maturity of its credit facility (while ArcLight is likely negotiating its take private facility at the same time). Instead, AMID agreed to eliminate the distribution until total leverage returned to less than 5x.
- ArcLight timed its effort during quarters when EBITDA is artificially low due to one-off factors and used the dividend suspension and subsequent price action to set a low bar for its take-private offers.
Mr. Thomas suggests that the independent directors take the following steps:
- Demand full payment from ArcLight for the entire EBITDA shortfall from Delta House.
- Hire bankers (now) and shop AMID to non-affiliated entities later in 2019.
- Publicly reject AMID’s two offers as insufficient.
- Allow Delta House to reach its nameplate capacity in early 2019 (we believe Delta House is close to reaching 135,000 barrels per day) and allow the financials to reflect these improved results to potential acquirors and credit facility lenders.
- Allow more time for AMID to remain public so that AMID’s EBITDA can normalize and for the substantial investments made in 2018 and the option in the Enterprise Products gas-processing plant to be exercised (there is a one-quarter lag for improved EBITDA at Delta House to show up in AMID’s financials in the form of “Distributions from Unconsolidated Affiliates”, thus, a normalized Q1 2019 will not be reported until the Q2 2019 results in August 2019).
- Allow AMID to remain public until at least August 2019 so that AMID can sell additional non-core assets at more that 10x EBITDA, harvest the benefit from investments made in 2018, have Delta House demonstrate its full earnings power, lower total leverage below 5x through all of the above, and resume the distribution.
- Extend AMID’s current credit facility by one year
Mr. Thomas believes AMID’s future is bright from here (even with the possibility for below normal EBITDA in Q4 2018 and Q1 2019 due to Delta House) and the common units are worth at least $9.00 based on Delta House normalizing and these additional investments coming to fruition ($180mm in normalized run rate EBITDA at a multiple of 10x which is less than what AMID sold the Marine Products Terminals and the Refined Products Terminals). Mr. Thomas further believes that AMID should remain public to realize improvements that are at hand (Delta House is likely at full capacity today).
Mr. Thomas believes that additional asset sales and the normalization of EBITDA will allow AMID to resume a distribution in short order and that this price swoon will be short-lived.
Mr. Thomas encourages the independent directors to stand-up to ArcLight and immediately implement the above suggestions. He further encourages all unitholders to reach out to the three independent directors and share their views in writing at:
2103 City West Boulevard
Houston, TX 77042
Mr. Thomas said, “The independent directors are the last line in defense against ArcLight and its tactics as they must approve a transaction. I along with other unitholders are supportive of standing firm. I encourage all unitholders to reach out to Peter, Donald, and Gerald in writing and encourage them to reject the two bids so that AMID has more time to bring Delta House up to full capacity, sell assets, and resume the distribution.”
Mr. Thomas is a professional investor with more than 15 years of investing experience, including as a portfolio manager and a Director of Research at S.A.C. Capital Advisors and an analyst at Goff Moore Strategic Partners and Rainwater, Inc. He is currently the co-founder of Shareholder Advocates for Value Enhancement (S.A.V.E.) and manages various investment partnerships.
Craig W. Thomas, firstname.lastname@example.org
The critical valuation distinction and potential for injustice are that hard assets’ fair valuations can deviate widely from standard cash flow multiple valuation-based models when cash flows are interrupted. When a hard asset has a temporary disruption in cash-flows (e.g. it can be remedied by repair) the cash flow multiple method will reflect a sharp drop in value that is more extreme than one which would be determined by a comparable valuation method or an actual auction–where other sophisticated hard asset buyers can fully evaluate the future cash flows to properly value the entity.
In the American Midstream and ArcLight situation, the hard asset property value level should not have changed after the distribution cut on July 26, 2018. From one day to the next, AMID’s asset values did not change and nor did their cash flows. The shares dropped due to the distribution being cut 75% and most investors reflexively sold the Units as they were interested in the distribution. Since volume jumped to 20 times normal levels there was a temporary supply demand imbalance as trading jumped. This was likely compounded by the decision not to have a conference call, which seems extraordinary in-light-of the size of the cut and new asset allocation policy. Certainly, ArcLight and AMID are best positioned to accurately assess their properties’ values and long-term growth potential whereas retired or elderly AMID unitholders are at a disadvantage. AMID’s Gulf of Mexico properties are long-lived natural gas assets (compared to typical fracked wells), which, in combination with properties owned by ArcLight and Enterprise Products Partners, LP (EPD), could be a major long-term high-value natural gas asset like the Permian Basin is for oil.
Please Write the Independent Board Members:
We encourage you to follow Craig Thomas’ suggestion. If direct and indirect shareholders write to the independent directors, and they reject the two ArcLight bids, wait until the Delta House production levels return and reinstate the distribution, AMID unitholders could soon be rewarded with a return of over 100%. More importantly, the prospect that other MLP General Partners might copy the distribution cut and bid for the LP units strategy might not be repeated to the detriment of the sector.
The 1986 Tax Act created MLPs. It streamlined the energy partnership structure, removed abuses in the industry and generated hundreds of billions in capital for the development of the US energy infrastructure. The Act helped make the US energy industry into a top global producer which helped carry the US economy through the Great Recession. Over the last several decades, retirement-minded MLP Unitholders have enjoyed outstanding tax-advantaged returns and the US benefited from this win-win legislation.
If a trend of distribution cuts followed by opportunistic bids continues at the expense of elderly or retired MLP investors, Congress should enact legislation to rescind the favorable tax benefits which accrue to private equity funds and hedge funds who execute such strategies. This would help retirees, the deficit, the US energy industry, and prohibit a grotesque abuse of the “top one percent” benefiting from the average Joe.
We welcome all questions and comments.
Tyson Halsey, CFA
The cut announcement was not on AMID’s website rather the SEC electronic filing system.
- AMID’s website July 26, 2018 “Further, the Partnership has engaged in a review of additional non-core assets and has identified approximately $350 – $400 million of other high-value non-core assets that are geographically peripheral to the Partnership’s core footprint or could offer greater strategic value to third parties.”
- ArcLight website: Invested $21 billion in assets since 2001.
- Dartmouth Alumni Magazine
- Company Overview of ArcLight Capital Partners, LLC on Bloomberg.com.
- $9mm purchase in Millennium Tower Boston.
- November 8, 2017 Third quarter AMID conference call transcript. Source: Seeking Alpha.
- Bloomberg Rachel Adams-Heard.