December 14, 2015
Crestwood Equity Partners LP 700 Louisiana Street, Suite 2550 Houston, TX 77002
Attention: Board of Directors
What can past market crashes teach us about the current one?
Raging Capital Management, LLC (“Raging Capital”) has a significant investment in Crestwood Equity Partners LP (“Crestwood” or the “Company”), with beneficial ownership of units and economic exposure to units through swaps representing an aggregate of 3,332,100 units, or 4.86% of the MLP. Today, we request that you consider implementing our “Crestwood Comeback” program. An outline of our plan is set forth below. Our more detailed overview of Crestwood is available at http://www.ragingcapital.com/crestwood-comeback/, which we urge you to review for a more comprehensive understanding of our views set forth in this letter.
First, we would like to compliment the Board and management of Crestwood for executing on two important initiatives, including the recent consolidation of the GP/LP structure and the entry into a highly favorable joint venture in the Delaware Permian basin.
Nevertheless, we strongly believe the public markets are still significantly undervaluing the Company. In fact, we believe Crestwood is not only undervalued using “MLP math,” but in our view, it is also classically cheap even by Graham & Dodd standards. The last time we saw an at-scale, quality MLP as undervalued as Crestwood and trading at a similar and sustainable 35-40% distribution yield was in 2009. That obviously proved to be an attractive buying opportunity.
It is important to note that Crestwood’s management and largest equity holder, First Reserve, recently announced a $100 million plan to buy Crestwood units for their own account. While this is clearly a positive vote of confidence in Crestwood’s value, we would much rather see the partnership itself buy back and retire units, thus directly benefiting the Company’s unitholders. In our opinion, a direct buyback would be tremendously accretive.
Raging Capital’s “Crestwood Comeback” Program
Today, we ask you, the Board of Directors of Crestwood, to consider taking advantage of the partnership’s financial strength and the current dislocation in the Company’s units to implement a comprehensive “Crestwood Comeback” program that includes:
A Reduced Distribution with Significantly Improved Coverage Ratio Substantial Direct Unit Buyback Program Opportunistic Debt Repurchases and/or Preferred Refinancing Self-Funding Future Growth Plans Exploring Accretive Asset Sales Setting Future, Highly Achievable Distribution Growth Targets We Believe Crestwood Units Are Significantly Undervalued
Even at a reduced $3.50 per unit annual distribution (an approximate -35% reduction from current levels), Crestwood would still have a 25% yield at current prices, an approximate 1.5x coverage ratio (after paying preferred dividends in cash), and substantial excess cash flows that would allow the Company to repurchase units. Crestwood would also be in an even better position to take advantage of the numerous growth opportunities in its portfolio, particularly in the Marcellus/Utica, Bakken and Permian basins.
In this $3.50 per unit distribution and buyback scenario, we believe MLP investors could value Crestwood at between $44 to $50 per unit, which is equal to a 7% to 8% market yield, or a 10.5% to 12% DCF yield – a valuation much closer to peers, even in this depressed MLP environment. This would also be a much more competitive cost of capital for the Company’s equity, and would likely lead to a lower cost of capital for its debt. A lower overall cost of capital could, in turn, further enhance the Company’s ability to grow, thus driving a virtuous cycle.
Why Are Crestwood Units Undervalued?
We believe Crestwood’s units are undervalued due to a combination of technical factors and several fundamental misunderstandings that we address in our detailed presentation (available at http://www.ragingcapital.com/crestwood-comeback/), including:
Failed Strategic Alternatives Process: In late 2014 and early 2015, Crestwood ran a strategic alternatives process. Even though multiple potential partners emerged at that time when Crestwood traded at a split-adjusted range of $60 to $140 per unit, the Company did not consummate a transaction. Some investors were disappointed in what appeared to be a failed process, leading to selling pressure. MLP Asset Class Pressure: MLPs broadly have sold off significantly in 2015, due to low energy prices and concerns about future growth and capital funding. This has led to selling pressure by retail investors, ETFs and levered funds, regardless of the core fundamentals or valuations. For example, Crestwood’s 2016 DCF yield after preferred payments is 37% versus 13.3% for Kinder Morgan (NYSE: KMI), with significantly less leverage. It is also important to note that Crestwood is primarily a distribution and storage company with strong “take-or-pay” contracts and therefore has less direct exposure to energy prices than most MLPs, including KMI. Also, Crestwood has no General Partner Incentive Distribution Rights (“IDRs”) and is therefore structured much more favorably for the public unitholders than most MLPs. Bakken Rail & Barnett Gathering Exposure: We believe investors have decided to “sell first and ask questions later” when it comes to Crestwood’s exposure to these two assets. In reality, as we discuss in our detailed presentation, Crestwood’s assets in both basins are strategically located and not at risk of material impairment. Additionally, these assets account for only ~25% of Crestwood’s total EBITDA, and many other assets in the Company’s portfolio are stable or growing. Tax-Loss Selling & Reverse Stock Split: ‘Tis the season, and when your units are down -80%+ since January 1, 2015, investors of all stripes are going to sell for tax reasons regardless of fundamental value. On top of that, Crestwood implemented a reverse stock split in November. Even though this had no impact on intrinsic value, many investors dislike reverse splits. Both of these non-fundamental developments are temporary in nature, and we expect will be corrected by the market. Crestwood Owns Numerous High-Quality, Scarce Assets
Crestwood is an at-scale MLP with scarce and/or strategically advantaged assets with a $4+ billion enterprise value. The Crestwood partnership owns a number of very strong assets including:
Northeast Natural Gas Storage: These scarce assets are strategically located and currently account for approximately 25% of Crestwood’s EBITDA. We believe these assets could fetch a multiple of 14-15x EBITDA, or $2.1 billion, in a sale – this is equal to roughly half of the Company’s current enterprise value! Marcellus/Utica NGL Marketing: This comprehensive marketing and logistics platform is able to profitably arbitrage the oversupply of NGLs in the Marcellus/Utica region. Bakken Gathering: The Arrow system is located in the heart of the highest-return areas of the Bakken: Dunn and McKenzie counties. These two counties grew production in 2015 and recent bullish permitting activity suggests that they could grow again in 2016. Highlighting this asset’s value, Hess’s similarly located gathering system in the core of the Bakken recently fetched an 18x forward EBITDA multiple in a JV transaction in June. Bakken Rail: Contrary to knee-jerk perceptions, Crestwood’s rail facility is strategically located and able to capitalize on the lack of West Coast-bound oil pipelines as well as strict rules against oil tanker imports. Tesoro’s massive Vancouver Energy crude-by-rail project, which is scheduled to go online by the end of 2017, gives assurances that a tremendous amount of cost-advantaged Bakken crude will be heading to West Coast refineries by rail for many, many years to come. Marcellus/Antero Gathering: This 140,000 acreage dedication represents a large portion of Antero’s best Marcellus acreage. Notably, Antero’s own midstream business, which services the balance of Antero’s acreage, is currently worth $4+ billion – that is roughly equal to the entire value of Crestwood! Niobrara Gathering: Includes the 50% ownership of a substantial 300,000+ acreage dedication in the core of the Niobrara basin that receives a guaranteed 15% return on capital invested. Permian Build-out: Crestwood owns assets in the prime Delaware Permian basin and recently announced a favorable $500 million joint venture with First Reserve. The Delaware Permian basin is regarded as the most attractive shale oil basin in the current commodity price environment. We believe this basin could be the next big growth driver for Crestwood, with many years of potential future growth projects. Crestwood also has a very strong balance sheet, with no maturities until 2020, plenty of room under its covenants, and a brand new revolver agreement that it entered into in September 2015. While Crestwood’s debt does trade at a discount to par, thus creating an opportunity for the MLP to de-lever by buying back debt, it trades close to other high-quality MLP peers and is not stressed.
A Golden Opportunity for Value Creation
Crestwood is a scarce and unique MLP with many assets of great value. We view the current market dislocation as irrational and reminiscent of the 2008/2009 era.
Today, we ask the Board to consider implementing our “Crestwood Comeback” program in order to take advantage of this golden opportunity. We believe Crestwood units could appreciate significantly by implementing a comprehensive program that includes 1) a reduced distribution; 2) a substantial direct stock buyback program; 3) opportunistic debt repurchases and/or preferred refinancing; 4) self-funding future growth; 5) exploring accretive asset sales; and 6) setting future, highly achievable distribution growth targets off of a lower base.
Thank you for your consideration and ongoing stewardship.
William C. Martin Chairman and Chief Investment Officer Raging Capital Management, LLC