DBRS Comments on Veresen Inc.’s Formation of Veresen Midstream with KKR & Co. L.P.

DBRS Limited (DBRS) notes that Veresen Inc. (Veresen or the Company, rated BBB with a Stable trend) has announced the formation of a new entity, Veresen Midstream Limited Partnership (Veresen Midstream), which will be owned equally by Veresen and affiliates of Kohlberg Kravis Roberts & Co. L.P. (KKR), a global investment firm. Veresen Midstream has entered into definitive agreements to acquire certain natural gas gathering and compression assets supporting the Montney development in the Dawson area of northeastern British Columbia from Encana Corporation (Encana, rated BBB with a Stable trend by DBRS) and the Cutbank Ridge Partnership (CRP). CRP is a partnership between Encana and Cutbank Dawson Gas Resources Ltd., a subsidiary of Mitsubishi Corporation. Veresen has also agreed to undertake up to $5 billion of new midstream expansion for Encana and CRP in the Montney region under a 30-year fee-for-service arrangement. Veresen Midstream is expected to be Veresen’s primary growth vehicle for its Canadian natural gas and natural gas liquids midstream business. These transactions are expected to close in Q1 2015 and are subject to normal closing conditions, including receipt of approvals under the Competition Act and the Investment Canada Act.

POTENTIAL IMPACT ON VERESEN

DBRS expects that this agreement will have no material impact on the credit risk profile of Veresen. Based on its preliminary review, DBRS views the agreement as neutral for the business risk profile of the Company. The business risk profile of Veresen Midstream is supported by the Hythe/Steeprock firm’s long-term take-or-pay contract with Encana and the Dawson assets (current and future expansion) which are under long-term contract with CRP. Veresen would also modestly benefit from a more diversified portfolio of assets situated in the rich gas Montney basin, which is one of the most prolific gas plays actively targeted by major producers; however, this benefit could be offset by the significant financing requirements at Veresen Midstream, as DBRS notes that cash distributions will be available to Veresen after debt servicing at Veresen Midstream.

DBRS views the overall impact of the agreement as neutral for the Company’s financial risk profile. Based on DBRS estimates, Veresen’s non-consolidated pro forma credit metrics resulting from this agreement will be consistent with its current ratings. For 2015, the agreement is expected to be cash flow neutral as the cash flows related to the Hythe/Steeprock assets being sold are expected to be replaced by cash distributions from Veresen Midstream. The agreement does not entail an initial cash outlay as Veresen Midstream will be funded through non-recourse debt and cash equity contribution from KKR. Furthermore, the $420 million in proceeds from the sale of the Hythe/Steeprock assets are expected to be used to reduce debt at Veresen. DBRS notes that the significant growth capex program at Veresen Midstream will require future equity injections from Veresen and expects Veresen to fund future equity requirements for Veresen Midstream prudently in order to maintain credit metrics commensurate with its current ratings.

TRANSACTION OVERVIEW

Veresen is expected to fund its interest in Veresen Midstream by contributing its Hythe/Steeprock gathering and processing assets valued at $920 million and, in exchange, receiving $420 million from Veresen Midstream, resulting in a 50% equity position valued at $500 million. KKR will fund its 50% interest in Veresen Midstream by contributing $500 million in cash. All of Veresen’s and half of KKR’s Veresen Midstream equity will be held in partnership units that are eligible to receive cash distributions. The remaining half of KKR’s initial equity investment will be in the form of payment-in-kind units that are convertible to cash-paying units after four years at either KKR’s or Veresen’s option.

Concurrently, Veresen Midstream will acquire gathering and compression infrastructure and ongoing construction projects from Encana and CRP in the Dawson region of the Montney basin in British Columbia (Dawson assets) for total cash consideration of approximately $600 million, plus actual costs accrued in 2015. Veresen Midstream and CRP will also enter into a midstream services agreement with respect to the newly acquired infrastructure and future infrastructure to be constructed within an area of mutual interest. Veresen will provide day-to-day management of Veresen Midstream. The existing midstream services agreement between Veresen and Encana relating to the Hythe/Steeprock assets remains unchanged, with Veresen Midstream operating these assets.

FINANCING

The acquisition of this infrastructure is expected to be funded with new Veresen Midstream senior secured credit facilities. These facilities, which are non-recourse to Veresen, include a USD 600 million term loan B, a $1.275 billion non-revolving expansion facility to fund future growth, and a $75 million revolving credit facility for operating and working capital requirements. Veresen Midstream expects to fund approximately 55% to 60% of its growth program with debt and the remainder with future equity contributions from Veresen and KKR. All future equity requirements for Veresen Midstream will be funded by the partners in cash-paying units on a pro rata basis.

Veresen intends to use the $420 million in cash proceeds it will receive on closing to repay the majority of the bridge credit facilities related to its acquisition of a 50% convertible preferred interest in the Ruby Pipeline in November 2014.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are Rating Pipeline and Diversified Energy Companies (January 2014), Criteria: Rating Holding Companies and Their Subsidiaries (January 2014) and DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers (December 2014), which can be found on our website under Methodologies.