Summit Midstream: Refinancing And Conversion To C-Corp Could Mean A Double In Stock (SMLP)

Impact of Refinancing and New Corporate Structure:

Summit Midstream (NYSE:SMLP) has had a busy couple of months. Following the asset sales in the Marcellus Basin, the company has completely restructured its debt, thereby lowering interest expense and boosting future cash flows. I believe the lower and now extended maturity debt plus higher cash flows will allow the company to pay accrued preferred distributions and then recommence common distribution. Also, yesterday (Thursday July 18th), the company’s shareholders voted to convert from an MLP to a c-corp, which will broaden the possible shareholder base. A dividend and a broader base that can buy the stock in addition to a cheap valuation should lead to material moves higher in the units (soon to be converted into shares).

New Capital Structure and Valuation:

The company has done a lot of heavy lifting restructuring its balance sheet since the capital was provided from the Marcellus Basin asset sales. I’ll use the table below to compare the old capital structure from the new one. I assume $185 million of EBITDA for the year to calculate leverage in the right hand column.

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Not only is debt lower, as you can see the debt is decently cheaper. Interest expense was $127 mm over the trailing twelve months. Keeping the debt stack as it is above, I believe the total net interest cost will be around $75 million next year. That means $50 million of incremental cash flow available to $388 million of equity (assuming past current taxable losses and old tax losses can shelter that extra cash).

Using the lower interest rate (and bringing EBITDA up to $200mm in 2025), I believe pro-forma and 2025 free cash flow will be:

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On that basis, SMLP would be able to pay a 10% common dividend and still have plenty of money left over to pay down the rest of the preferred or pay down some of the revolver. Even holding the valuation constant at 7.69x this year’s EBITDA, that would mean another 5% capital appreciation this year and using next year’s $200mm EBITDA would mean about another 40% appreciation.

C-Corp’s Get Higher Multiples:

We are long past the days when MLP structures attracted premiums to c-corps. Many investors (including most institutions) can’t own MLP’s because of the tax issues (K-1’s, foreign withholding, etc). The best example of this is forward EV/EBITDA multiple of MLP’s Enterprise Products (EPD) and Energy Transfer (ET) versus c-corps Targa Resources (TRGP) and Oneok (OKE).

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My experience has been that c-corps trade 2-3x higher EV/EBITDA multiple than MLP’s. Every 1x turn of EBITDA on SMLP at the current valuation is 50% appreciation. While SMLP generally has secondary quality assets and is nowhere near the quality and scale of TRGP and OKE, I can easily see it trading close to 8.5x forward EBITDA instead of 7.11x forward EBITDA (7.69x current). Put that higher multiple together with the accretion that comes with paying down either the preferred or the debt and a 10% dividend to boot, and the stock can easily double over the next twelve months.

Risk:

The main risk here is crappy weather in the company’s main geographies (Colorado and the Permian), weak oil and natural gas prices curtailing drilling, and or an idiosyncratic problem with a counterparty. The company had a crappy Q1 because of bad weather in the Colorado, and gas prices are not great right now. So, we can see volatility in numbers going forward. My experience with these pipeline companies has been, however, that a bad quarter is usually corrected fairly quickly, and cash flows are rarely impacted more than mid-single digits in any one year.

Conclusion:

EPD and ET, my two favorite picks in pipelines have been great sleep at night stock that pay compelling distributions and have appreciated handsomely over the past few quarters. I still think they’re cheap and will grind higher as cash flows grow. There are no major catalysts to drive them materially higher though. I think SMLP can easily double and a likely imminent dividend on top of the c-corp conversion coupled with a cleaned up balance sheet should act as catalysts for the stock to rise.

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