Source: Seeking Alpha, July 7, 2020
Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) put a portion of their ~$140 billion war chest of available cash to work over the weekend with the announced acquisition of Dominion Energy’s (D) gas transmission and storage business for a $9.7 billion (sale price includes assumed debt). Assets sold under the agreement include the company’s ownership interests in Dominion Energy Transmission, Questar Pipeline (including Overthrust and White River Hub), Carolina Gas Transmission, Iroquois Gas Transmission System (50% interest), legacy gathering and processing operations, farmout acreage, as well as a 25% operating interest in Cove Point LNG. The acquisition ends Berkshire’s nearly two-decade absence from large midstream M&A transactions, dating back to their purchases of Kern River Pipeline and Northern Natural Pipeline in 2002.
Each of the gas pipelines in the transaction portfolio publicly reports their financials to the FERC. Figure 1 shows reported 2019 EBITDA for the included assets (adjusted for ownership %). East Daley estimates legacy G&P asset EBITDA using various disclosures from D’s latest 10-K. We assume no EBITDA contribution for the farmout acreage included in the acquisition. Based on these assumptions, a sale price (including assumed debt) of $9.7 billion would yield a ~10x cost-to-EBITDA multiple.
While certainly not expensive, the deal price is still a far cry from the fire-sale prices Berkshire got for its gas pipeline acquisitions in 2002. As shown in Figure 2 below, both Northern Natural and Kern River were purchased at a ~6-8x multiple based on prior-year EBITDA, a bargain compared to the 10x multiple paid for D’s assets. The multiples may have changed since the early 2000s, but so have U.S. natural gas commodity fundamentals. Natural gas is now the dominant fuel for U.S. power generation and shale assets are well positioned to provide low-cost natural gas for the foreseeable future. Regulatory and legal tailwinds today also shield existing infrastructure from the competition which can contribute to higher valuations. Additionally, Berkshire is flush with ~$140 billion in cash, earning next to nothing in U.S. treasuries, which lowers the hurdle rate for competing investments. The recent pandemic-induced downturn in energy markets also presents an opportunity for Berkshire to get a solid set of midstream natural gas assets for what they view as a fair price.
The D asset package is composed of mostly high-quality infrastructure with minimal near-term contract risk. As outlined below, Dominion Transmission, Questar, Iroquois, and Carolina Gas are essential assets for meeting natural gas demand in their respective markets. These assets are irreplaceable and would be nearly impossible to compete with given their size, scale, and existing regulatory hurdles. Cove Point LNG and Overthrust both have some legacy contract risk, but in the grand scheme of things, the legacy downside risk is longer-term and not insurmountable.
Dominion Energy Transmission: The crown jewel of this transaction is the massive pipeline and storage network that sprawls across Ohio, West Virginia, Maryland, Virginia, and New York and takes, in this case, the seller’s namesake. The Dominion Energy Transmission pipeline system serves a dual purpose, with ~60% of capacity held by end-users (local distribution companies (LDCs), utilities, municipalities, industrials) and 40% held by E&Ps and marketers. Dominion Transmission owns ~400 Bcf of working gas storage capacity, which is ~40% of the entire working storage in the Eastern U.S. The combination of their large sprawling transmission network with storage connectivity makes Dominion Energy Transmission essential to meet Northeast power and heating demand. On the supply-push side, contracted capacity provides a combination of in-basin transport and medium-haul capacity to various egress pipelines. Most of this supply-push capacity is also essential with little long-term contract risk.
Cove Point LNG: This asset is most well-known as an LNG export facility that is 2 years into a 20-year take-or-pay export agreement. However, the Cove Point LNG asset also provides LNG import, peak shaving, and transmission services. There is some contract risk on these assets, as ~$60 million in annual revenues via legacy LNG import contracts expire in August 2023. East Daley expects revenue from these LNG discharge contracts to go to zero at that time as importing LNG is no longer economic.
Questar Pipeline: Questar is the only major pipeline to serve Salt Lake City and other less dense areas in Utah, Idaho, and Wyoming. Over 70% of the capacity is held by end-users, mostly LDCs. Marketers and producers hold a fair amount of capacity as well (~30%), some of which East Daley is inclined to risk due to falling supply from the Uinta, Piceance, and Wind River basins over the long term. However, given the captive customers on the pipeline, Questar could raise rates if contract attrition from producers and marketers increased. East Daley currently estimates 2019 ROE was only ~9%, leaving significant room to raise rates if desired as allowable ROEs have trended toward ~12% over the past few years.
Overthrust Pipeline: This bi-directional bullet pipeline connects the Eastern and Western Rockies with 2.4 Bcf/d of capacity. The pipeline lost a large contract with Ovintiv (OVV) in early 2020, which we forecast to reduce EBITDA by ~$12 million vs. 2019. The Rockies Express Pipeline is Overthrust’s largest counterparty (~$30 million in annual revenue) and has a 20-year lease (8 years remaining) that allows them to move gas from the Western Rockies to the Midwest. East Daley risks this particular contract starting in 2028.
Iroquois: There are no significant contract risks on this asset and, as such, it is the best-positioned pipeline to feed incremental demand growth into New York City. The Iroquois Enhancement by Compression (“ExC”) project has been proposed to add 125,000 Dth/d of incremental capacity to NYC, which East Daley estimates will add $35 million in annual EBITDA to the Iroquois system. However, the project only helps fill the demand gap in the near term. Depending on Iroquois’s ability to enhance existing facilities, we could see an additional project in the near future.
Carolina Gas: This pipeline is a spiderweb of transmission lines all across South Carolina and benefits from ~100% demand-pull activity. There is little to no competition or contract risk apparent for this asset.
Berkshire’s acquisition of D’s gas transmission and storage assets will likely be viewed positively for the sector, as a $9.7 billion investment from Warren Buffett provides a large and very public vote of confidence to the long-term value of similarly classed natural gas assets. While not exactly expensive, the fact that Berkshire’s purchase price reflects a multiple that is a far cry from the 6-8x the holding company was willing to pay in decades prior further demonstrates Berkshire’s belief in the long-term value of these assets. The D assets certainly do not stand alone as much of our coverage universe contains high-quality midstream assets boasting long-term favorable outlooks. However, as illustrated by the contract risk outlined for Cove Point’s LNG and Overthrust assets, potential land mines also exist, but digging into asset-level fundamentals makes identifying those traps, along with potential upsides a more fruitful exercise.