Kinetik Holdings Inc. (KNTK) Earnings Call Transcript & Summary

Good afternoon. Thank you for attending today's Kinetik Strategic Transactions Conference Call. My name is Jennifer, and I'll be your moderator today. [Operator Instructions] I would now like to pass the conference over to your host, Alex Durkee, Investor Relations. Alex, please proceed.

Thank you. Good afternoon, and welcome to Kinetik's call to discuss the series of strategic transactions that were announced earlier today. Jamie Welch, our President and Chief Executive Officer, will discuss this period of transactions; and Trevor Howard, our Chief Financial Officer, along with other members of our senior management team are also in attendance for Q&A. The press release we issued this afternoon, strategic transactions presentation and access to the webcast for today's call are available at www.kinetik.com. Before we begin, I would like to remind all listeners that our remarks, including the question-and-answer section will provide forward-looking statements, and actual results could differ from what is described in these statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. We may also provide certain performance measures that do not conform to U.S. GAAP. We've provided schedules that will reconcile these non-GAAP measures as part of our earnings release. After our prepared remarks, we'll open the call to Q&A. With that, I'll turn the call over to Jamie.

Thank you, Alex. Welcome back, everyone. I promise you this was not planned. Here we go for an encore performance for today. It was totally unexpected that we would actually get to this place. But I think what you have seen as far as the press release is concerned and the commentary and materials that we'll talk about, this is a pretty transformative day for Kinetik, and it very much reflects the next chapter. So we announced a series of interrelated in some respects, but highly strategic, very financially accretive transactions that enhance Kinetik's New Mexico position and further reinforce our Permian pure-play platform across the entire Delaware Basin. First, we have agreed to acquire Durango Permian's gathering and processing system in Eddy, Lea and Chaves counties for an aggregate $765 million, with up to $75 million of contingent consideration tied to the capital cost of the Kings Landing processing complex, which is currently under construction. Following the expected completion of Kings Landing in April 2025, the Durango system will provide 420 million cubic feet per day of incremental processing capacity, bringing Kinetik's total Delaware Basin processing capacity to over 2.4 billion cubic feet per day. The acquisition further diversifies Kinetik's geographic footprint. It significantly increases our scale in New Mexico and adds over 60 new customers with long-term high-margin contracts, many of whom are private producers, including the most active player in the Delaware Basin. The transaction is structured with upfront consideration of $315 million of cash and approximately 3.8 million Kinetik Class C shares issued to Durango sponsor, Morgan Stanley Energy Partners, which are subject to a 364-day lockup from closing. Deferred equity consideration of an additional 7.7 million shares to Morgan Stanley Energy Partners on July 1, 2025, and contingent consideration of up to $75 million tied to the actual capital cost of the Kings Landing complex. The contingent consideration is subject to downward adjustments for any costs in excess of Durango management's budget. The consideration structure is highly advantageous to Kinetik shareholders as only 60% of total consideration is owed at closing, with the remaining 40% deferred until July 2025. The initial setup valuation for the Durango acquisition is approximately 6.5x 2024 EBITDA and steps down to approximately 5.5x following the start-up of Kings Landing. The transaction, subject to regulatory approvals, is expected to close in the second quarter. I would be remiss to not mention that Durango provides multiple midstream services across the natural gas value chain, such as gathering, compression, processing and treating. When combined, the margin supporting Durango's fee-based revenue is extremely attractive. Lastly, like with Kinetik system-wide front-end treating, Durango's ability to treat high levels of CO2 and H2S is a real competitive advantage in Northern Eddy and Lea counties, where today's processing and treating solutions are operating at near full capacity. In addition to the Durango acquisition, we announced a new 15-year low pressure and high pressure gathering and processing agreement with one of our largest existing customers who has a substantial position in Eddy County. Total expected capital investment through 2026 is approximately $200 million. That project represents a 5x investment multiple and is expected to be placed in service by the end of this year. Collectively, the planned products produced from the natural gas gathered on the Durango system and the new Eddy County agreement are fully controlled by Kinetik. These transactions are expected to increase our controlled residue and natural gas liquids by over 350 million cubic feet per day and well over 60,000 barrels per day, respectively. This affords Kinetik with substantial upside value, not included in our underwriting economics nor in the financial metrics disclosed today. Finally, we announced the direct sale of our nonoperated 16% equity interest in GCX for $540 million to one of our partners, ArcLight. Kinetik will receive $510 million of cash upfront followed by an additional $30 million cash earn-out contingent upon a GCX expansion FID. The transaction is expected to close in the coming weeks. So taken together, Kinetik will efficiently and accretively recycle approximately $990 million of proceeds at an approximately 10.5x 2024 EBITDA multiple from the divestiture of our GCX interest and the issuance of $450 million of equity in 2 installments into nearly $1 billion of operated midstream logistics assets at approximately a 5x investment multiple. These strategic transactions further our expansion into New Mexico and significantly increased our footprint in Eddy and Lea Counties. Since 2021, Delaware Basin gas production has grown by nearly 3 billion cubic feet per day, with Lee and Eddy Counties contributing roughly 2/3 of this growth. Pro forma Kinetik stands well positioned to support future volume growth in the Northern Delaware and Northwest Shelf, given highly economic stacked-pay inventory underlying the system, coupled with strong producer demand for regional processing and treating capacity. I would also note that our operations team that has extensive familiarity with these assets, has identified several highly capital-efficient system capacity upgrades that we look forward to updating you in due course. We remain committed to maximizing value for our shareholders. The transactions check all the boxes. Firstly, they are immediately deleveraging and achieve our long-term leverage target of 3.5x. Also the transactions are accretive to free cash flow per share estimates. Specifically, we estimate accretion to be over 10% on a free cash flow per share basis beginning in the second half of 2025 and increase substantially thereafter. This will likely coincide with an acceleration of capital returns at that time to our shareholders. These transformative transactions represent the next chapter for Kinetik and our shareholders. We're excited to build upon the already tremendous success we've had with our system expansion into New Mexico earlier this year and continue to build strong partnerships with our existing and new customers. We look forward to updating the market with revised 2024 guidance following the closing of the Durango acquisition. And with that, I would like to open the line for Q&A.

[Operator Instructions] Our first question comes from the line of Tristan Richardson with Scotiabank.

Congratulations on the transaction. Maybe just with respect to controlled barrels, should we think about the 60,000 a day as pro forma for the Kings Landing plant?

Yes.

Super helpful. And then also just thinking about connectivity between the New Mexico system that you just brought online and Durango, are there other downstream synergies we should think about longer term between the 2 systems, given your pipeline logistics business to Houston?

So Tristan, I think as far as connectivity between what I'll call North and South, it is a work in progress. This is, as you know, Lee County for us was quite a long time in the making. This itself has been a long time in the making, and it became clearer given the number of customers we have in our system, which is well over 30 and the conversations that have been had they continue to migrate on March north. And so we point out, obviously, one of them, which was one of our largest customers, and we have this new 15-year agreement, which is very synergistic with Durango. But it is not lost enough that the ultimate intent here is to think about the potential interconnectivity to create what is a super system in the Delaware Basin. Unlike anybody else, and to really give producers opportunities for diversification, right, and bring a new entrant into the marketplace.

Our next question comes from the line of Michael Blum with Wells Fargo.

Thank you. So I wanted to ask about the liquids that you're controlling that come off these plants. Can you say to what pipelines they are contracted today and for how long?

They're all pretty short term. I think just given where we are in the process, we'll give you more details at a later point in time, but at a relatively short-term arrangements. So I think that gives us, again, it fits really nicely within the stack of our overall commitments and how we think about our overall NGL basket, much like how we think about our residue basket, right? We're adding over 350 million cubic feet a day of residue. So we made our commentary earlier that we have significant proponents and advocates for more egress out of the basin. And we will continue to work with our customers and work with other midstream companies to find the right solutions. That's on the residue side. On the NGL side, we'll continue to evaluate all our options and to work out and determine what is the most value-added strategy that we can implement.

Okay. Great. And then do you have to put any capital into these assets just to kind of get them up to Kinetik standards? And then related to that, what...

I love that. I love that. Kinetik standards. Can we coin that phrase? Kinetik Standards. The short answer is, sorry, Michael, not to cut you off. We say in the press release, we got about $76 million, $78 million, I think it is net capital to basically get Kings Landing finished. There is some further capital already in underwriting that we have as it relates to, I would say, just maintenance and various other bits and pieces that we think can make the system be more reliable, more efficient and improve overall performance.

Our next question comes from the line of Neel Mitra with Bank of America.

I just wanted to follow up on some of the capital needs with the new system, maybe the cadence of new processing, how many processing plants you need in New Mexico. And then also, I know you're contemplating it, but can you give any broad details about how you can maybe connect this asset with the broader super system that you have in the Texas Delaware and how long that would take? And any broad capital needs do you need for that?

Totally. I would say, first off, gentlemen, I made one comment earlier in my prepared remarks, Neel, and I'll get around to this. I promise you in the context of answering your question specifically. Many members of our senior leadership team within the operations and engineering ran this business. They have an incredible familiarity with it. So [indiscernible], we know a lot of things that we can do to improve overall performance and reliability. Two, as it relates to what we see in the context of Kings Landing when it comes online, I think we have -- we are hard-pressed to have yet ever seen a system that has 100 million cubic feet a day curtailed, curtailed until Kings Landing comes on. It's crazy. The commercial guys are like "This is -- wow, we've never seen this." So that -- when this thing starts up, I think we mentioned this is going to fill up really fast. And what we're really seeing the opportunity here with the -- some of the private producers or many of the private producers, most of whom will be new customers for us. Some of the larger customers like [indiscernible], which is -- for them, we're really looking to developing that relationship. And I think this will be incredibly advantageous for everybody where we are prepared to invest and what obviously watch these guys all obviously invest in the drill bit. So I think we certainly see the ability to get Kings Landing up and underway. And then we will see exactly how quickly the need for incremental capacity. We have ironically a spare cryo that we can actually go stick up there. It's a 60 a day cryo. We have [indiscernible]. So we've already been thinking about expansion opportunities here that actually would significantly increase the amount of processing capacity that exists on that system. Then as it relates to the third aspect of your question, I'll leave that to Trevor and Chris to just talk about how we think about the ultimate prospects for connectivity, both on the Lea County side, but also as we think about Eddy County and where we go from here.