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LDC Equitable Merging into Peoples Gas

December 24, 2012
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SteelRiver Infrastructure Partners, owner of Peoples Natural Gas, is acquiring Equitable Gas Co. LLC from EQT Corp. in exchange for $720 million and "select midstream assets and commercial arrangements" in the Marcellus Shale region, the companies said Thursday.

Peoples said adding local distribution company (LDC) Equitable to its existing LDC system "will greatly benefit the western Pennsylvania community, and beyond, by creating significant operational efficiencies..." By dropping its LDC business, EQT will have more time and capital to focus on Marcellus Shale exploration and production (E&P) and midstream activities, it said.

Equitable provides LDC service to 275,000 customers in Pennsylvania, West Virginia and Kentucky, and owns about 4,000 miles of pipeline. Peoples Natural Gas and sister company, Peoples TWP, serve about 420,000 homes and businesses in 18 western Pennsylvania counties. Both companies are based in Pittsburgh.

"This agreement involves two longstanding western Pennsylvania energy companies working together to embrace our strengths and build the best future we can for our customers, our region and our nation," said Peoples CEO Morgan O'Brien. "The combined utility will yield substantial benefits to the western Pennsylvania community by creating significant operational efficiencies, relative to the pipeline systems; promoting greater competition for gas marketers; and continuing to support local gas producers. Combining the companies' respective pipeline systems will result in a more streamlined and efficient operating system for customers. Furthermore, the greater aggregation of customers will be more attractive to marketers and is expected to attract more marketers that will create greater competition for customers' supply needs."

The pairing was the second gas utility deal last week after the Laclede Group Inc. agreed to buy Southern Union Co.'s Missouri Gas Energy and New England Gas Co. for $1.035 billion (see related story). EQT said the midstream assets it is to receive from Peoples will generate at least $40 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) per year. The company also is cutting its dividend to 12 cents/share to reflect the character of its two remaining core businesses: midstream and exploration and production (E&P).

"Today's announcement allows us to focus on and reinvest in our rapidly growing natural gas production and midstream businesses," said EQT CEO David Porges. "The proposed transaction provides capital to accelerate the monetization of our reserves beyond 2013 and also adds to our Marcellus midstream assets."

Wells Fargo Securities analyst Gordon Douthat said the sale was positive for EQT "as it creates a cleaner story for investors, funds [a] capex gap in 2014 while allowing for acceleration in the Marcellus." Douthat said an asset sale had been on the company's agenda, but the deal came earlier than expected. "We had previously valued the entire distribution business at $874 million, or eight times EBITDA."

BMO Capital Markets analyst Phillip Jungwirth said the sale of the LDC business puts EQT on track to achieve 30% or better production growth next year, followed by an expected 20% growth in 2014 and 2015, without assuming more debt or any master limited partnership (MLP) dropdowns. "That said, we believe EQT is likely to accelerate production growth, leading to upward revisions in estimates, and can finance such growth with a low cost of capital in the form of MLP dropdowns. Bottom line, EQT continues to make all the right moves and is ideally positioned to execute on its Marcellus value-acceleration strategy."

EQT investors cheered the deal, sending the company's shares up nearly 4% last Thursday when the deal was announced. Volume was more than three times the average.

EQT is to receive about 200 miles of regulated transmission pipelines, as well as four storage pools that have a total of 15.1 Bcf working gas capacity. These assets are located across multiple counties in Pennsylvania and connect to EQT's existing transmission assets, which will increase the company's transportation and storage capabilities, EQT said. Peoples Gas has also agreed to enter long-term contracts for gas transmission, supply and storage services with EQT, and these agreements will secure supply of local Marcellus gas of approximately 35 Bcf per year to Peoples.

Moody's Investors Service placed the "Baa2" senior unsecured ratings, the "Prime-2" commercial paper rating and other ratings of EQT under review for downgrade. The outlook was previously "negative." The action was in response to the Equitable transaction and for "existing high leverage and challenging fundamentals" in EQT's exploration and production business, Moody's said.

"The announced transaction represents EQT's final step in its long transition to an independent exploration and production company," said Moody's Vice President Pete Speer. "EQT's concentration in natural gas and elevated financial leverage was already pressuring its 'Baa2' ratings, so the announced sale of its lower-business risk gas utility operations makes a rating downgrade likely."

Porges told financial analysts during a conference call Thursday that the company is "comfortable" with whatever credit rating it winds up with. "We're going to let the rating process play out," he said. "...We really have no concerns about certainly being able to serve our debt obligations."

Moody's gave a nod to EQT cost efficiencies on the E&P side of its business but let it be known that the LDC will be missed. It said EQT has a "very low cost structure" relative to its E&P company peers, which helps to generate returns in a weak natural gas price environment. "Its credit profile benefits from the ownership of strategic transportation and storage assets that enables its growing production to reach the market at low costs," Moody's said.

"EQT's rating has also been supported by its LDC operations, which have provided earnings stability, a lower business risk profile and knowledge of the local regulatory environment that have benefited its production and midstream segments. These positive attributes had served to mitigate the risks of the company's limited geographic and basin diversification and much smaller production scale relative to other investment grade-rated independent E&Ps."

Peoples is owned by SteelRiver Infrastructure Partners, an investment management firm that invests in North American infrastructure. As a result of the Equitable transaction, SteelRiver expects to control, through its managed funds and co-investment vehicles, three natural gas regulated utilities operating in contiguous service territories in Pennsylvania, West Virginia and Kentucky, serving about 700,000, mostly residential, customers.

"The acquisition of Equitable attests to our appetite for continued capital deployment in regulated utilities, our ability to work with our portfolio companies to secure unique transactions, away from competitive auction processes, and the desire to continue to attract incremental investor capital and grow our franchise as an owner and operator of core infrastructure assets in North America," said SteelRiver Senior Managing Partner Dennis Mahoney.

Equitable is expected to be merged into Peoples, with Peoples as the surviving entity. The deal is subject to regulatory approvals from the Pennsylvania Public Utility Commission, West Virginia Public Service Commission and Kentucky Public Service Commission, as well as the Federal Energy Regulatory Commission and federal antitrust authorities. The transaction is expected to close in the second half of 2013.

"The natural gas industry is quickly evolving into the cleanest and most economical solution for meeting this country's future energy needs," O'Brien said, "and western Pennsylvania is at the heart of this economic boom."

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