DBRS Confirms Pembina Pipeline Corporation at BBB and Pfd-3, Stable Trends, Following the Veresen Inc. Acquisition Announcement

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Notes rating of Pembina Pipeline Corporation (Pembina or the Company) at BBB and the Company’s Preferred Shares at Pfd-3. All trends remain Stable. The confirmations follow Pembina’s announcement that it has entered into an agreement to acquire Veresen Inc. (Veresen) for $9.7 billion, including the assumption of Veresen’s debt (the Acquisition or the Transaction). The confirmations reflect DBRS’s expectation that the Acquisition would not have a material impact on the Company’s current credit profile. On March 3, 2017, DBRS confirmed all of Pembina’s ratings with Stable trends reflecting its solid financial performance in 2016 and the continued improvement of its business risk profile. Veresen was rated BBB by DBRS. However, On August 4, 2016, DBRS placed the ratings of Veresen Under Review with Negative Implications pending the completion of the sales of its power generation assets.

THE ACQUISITION
Under the terms of the arrangement agreement, Pembina is offering to acquire all the issued and outstanding shares of Veresen by way of a plan of arrangement under the Business Corporations Act (Alberta). The Transaction is valued at approximately $9.7 billion, including the assumption of Veresen's debt (including subsidiary debt, which will not be consolidated into Pembina’s balance sheet and will not be recourse to Pembina) and preferred shares.

Pembina is offering to acquire all of the outstanding Veresen common shares in exchange for either (1) 0.4287 of a common share of Pembina or (2) $18.65 in cash, subject to proration based on maximum share consideration of approximately 99.5 million Pembina common shares and maximum cash consideration of approximately $1.523 billion. Assuming full proration, each Veresen shareholder would receive $4.8494 in cash and 0.3172 of a common share of Pembina for each Veresen common share. This offer represents a 21.8% premium to Veresen's 20-day weighted-average price of $15.31 and a 22.5% premium to Veresen's closing share price of $15.23 on April 28, 2017. The Acquisition was unanimously approved by the Board of Director of both companies and is expected to close late in the third quarter or early fourth quarter of 2017. The Acquisition is subject to approval of at least 66.67% of Veresen common shareholders, regulatory approvals in Canada and in the U.S. and all other customary conditions. The closing of the Acquisition will not be subject to the approval of Veresen’s preferred shareholders.

VERESEN ASSETS
Veresen’s principal assets are as follows: (1) a 50% interest in Alliance Pipeline System (Alliance); (2) a 50% interest in convertible preferred shares in the Ruby Pipeline Holding Company, L.L.C. (Ruby), which owns the Ruby Pipeline; (3) a 100% ownership of Alberta Ethane Gathering System in Alberta and a 47.2% interest in Veresen Midstream; (4) a 42.698% interest in Aux Sable U.S. and Canadian Marketing; (5) a 50% interest in Aux Sable Canada; and (6) a 100% interest in the Jordan Cove project.

FINANCING
Based on the agreement between Pembina and Veresen, the maximum cash portion of the consideration is approximately $1.523 billion. Pembina is planning to finance the cash portion of the Acquisition with its credit facility and preferred shares. The remainder will be financed with common share exchanges as indicated above.

DBRS believes that the Acquisition will not have any material impact on Pembina’s Business Risk Assessment Factor because of the:
(1) Larger size and scale: The Acquisition will significantly increase the size and scale of Pembina’s assets and operations. Post-Acquisition, Pembina would generate adjusted EBITDA of between $2.55 and $2.75 billion (2018 pro forma) compared with $1.1 billion adjusted EBITDA in 2016. DBRS estimates that Pembina will account for approximately 77% of post-Acquisition adjusted EBITDA while Veresen will account for approximately 23%. The combined entity is expected to generate approximately 85% of its cash flow from either fee for services, cost of services or firm contracts. The combined entity would have stronger access to the capital markets and enhanced ability to carry on large-scale capital projects.
(2) Improved diversification: The Acquisition is expected to improve Pembina’s diversification with respect to the gas production basin. Through Alliance, Pembina will gain access to the Chicago markets with strong demand and supply fundamentals. In addition, the Acquisition is expected to significantly improve Pembina’s asset mix between natural gas and liquids. Currently, Pembina has more exposure to liquids and Veresen has more exposure to natural gas.
(3) Complementary and Integrated Services: The combined asset base is highly integrated across the value chain and could leverage Pembina’s ability to negotiate future contracts. The majority of the combined asset base is already physically connected or presents the opportunity to be connected with relative ease in the future, which allows for operational integration, the potential to realize synergies and overall enhancements to customer services.

Despite these positive factors, DBRS view that the Acquisition would have a modestly negative impact on Pembina’s contracts and counterparty risk profile. Currently, the average length of Pembina’s contracts is estimated to be over ten years. Post-Acquisition, Pembina’s average contract length will decrease as Alliance, Ruby and AEGS currently have shorter contracts, with average lengths of approximately 5.3 years, six years and two years, respectively. DBRS expects Pembina’s counterparty composition to be neutral post-Acquisition with investment-grade counterparties, based on revenues, increasing marginally to 81% from the current 80% level.

With respect to the potential impact of the Acquisition on Pembina’s financial risk profile, DBRS has reviewed Pembina’s financing plan and performed a pro forma analysis and is of the view that the Acquisition would modestly weaken Pembina’s credit metrics in the near term but would not have a material impact over the medium term. DBRS expects that Pembina’s financial ratios would weaken modestly in 2017 reflecting:
(1) Higher consolidated debt levels as a result of new debt to be issued for the Acquisition and the assumption of Veresen’s corporate debt. DBRS does not include the debt at Veresen’s invested subsidiaries into its pro forma calculation because it will not be recourse to Pembina and will not be consolidated into Pembina’s balance sheet.
(2) The current year, 2017, will not benefit from full-year cash flow contributions from the Acquisition. However, over the medium term, Pembina’s credit metrics would return to its 2016 levels as it benefits from full-year contributions from the Acquisition as well as additional cash flow from Veresen Midstream’s capital projects that are expected to be completed in 2017. DBRS recognizes that Pembina’s year-end 2016 credit metrics were strong for the current ratings.

Post-Acquisition Pembina faces the following challenges:
(1) Managing project execution risk as Pembina is continuing a number of large capital projects in 2017. Most projects are supported by take-or-pay or fee-for-service commitments from the producers for a majority portion of the designed capacity. Pembina’s stand-alone capital expenditure (capex) for 2017 is estimated to be $1.9 billion. In the meantime, Veresen Midstream is currently carrying on a few expansion projects at its Steep/Rock complex. Capex in 2017 for Veresen Midstream is expected to be $1.4 billion (Veresen’s portion is estimated to be over $600 million). As a result, DBRS expects post-Acquisition Pembina to generate substantial free cash flow deficits in 2017.
(2) Pembina will finance free cash flow deficits in a manner as to maintain its credit metrics at or close to current levels. DBRS recognizes that during this period, the Company’s credit metrics are expected to deteriorate modestly but should improve starting in 2018, once the major projects are in service.
(3) Risk associated with the liquefied natural gas Jordan Cove project. The estimated cost of the project is approximately $7.4 billion. The project is still in the early stages. To date, approximately $400 million has been spent. The risk associated with developing this project is viewed as high. The Jordan Cove project is progressing toward key regulatory approvals. However, based on Pembina’s announcement today, it is silent on how it would advance and finance this project. DBRS’s confirmations of Pembina’s ratings today are based on its expectation that the Jordan Cove project will be appropriately financed and will not incur significant cost overruns. In the event that this project incurs significant cost overruns and/or lengthy delays, it would have a negative impact on Pembina’s ratings. DBRS will continue to monitor the development at Jordan Cove and will assess its impact on Pembina’s credit profile accordingly.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The principal methodologies are Rating Companies in the Pipeline and Diversified Energy Industry and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers, which can be found on dbrs.com under Methodologies.