MountainWest Pipeline, LLC (SWX) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Southwest Gas Holdings to Acquire Questar Pipelines from Dominion Energy Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. Ken Kenny, Vice President of Finance and Treasurer. Please go ahead.

Thank you, Jen. And thank you, everyone, for joining us this early evening. Southwest Gas Holdings, Inc. has entered into a definitive agreement to acquire Dominion Energy Questar Pipeline, its subsidiaries and certain associated affiliates, including Overthrust Pipeline, White River Hub and Questar Field Services from Dominion Energy for $1.545 billion in cash. Management on this call will discuss the details of the transaction. The call is being broadcast live over the Internet. For those of you who would like to access the webcast, please visit our website at www.swgasholdings.com and click on the call link. We have slides on the Internet, which accompany our discussion. Our lawyers have asked me to remind you that some of the information that will be discussed contains forward-looking statements. These statements are based on management's assumptions, which may or may not come true, and you should refer to the language on Slide 2 of our discussion materials for a discussion of the factors that may cause actual results to differ from our forward-looking statements. All forward-looking statements are made as of today, and we assume no obligation we will update any such statement. As noted on Slide 3, today's management participants include Mr. John Hester, President and Chief Executive Officer, Southwest Gas Holdings; Ms. Karen Haller, Executive Vice President, Chief Legal and Administration Officer, Southwest Gas Holdings; Mr. Greg Peterson, Senior Vice President, Chief Financial Officer, Southwest Gas Holdings; and Mr. Boyd Nelson, Vice President, Strategy and Corporate Development, Southwest Gas Holdings. Management will provide an overview of the transaction, including the strategic rationale for acquiring Questar Pipelines. Following our prepared remarks, we are happy to take questions. With that said, I'd like to turn the time over to John Hester. John?

Thanks, Ken. Before we go through our prepared materials, just briefly, I want to acknowledge, as you may have seen in media reports this morning, separate but related to our announced Questar Pipelines acquisition. We did receive a letter yesterday afternoon from an activist shareholder expressing opposition to this acquisition in addition to other issues regarding Southwest Gas Holdings. The shareholder letter was dispatched in advance of having the benefit of the information we're sharing with you today, which we believe convincingly demonstrates the strong value proposition Questar Pipelines provides Southwest Gas Holdings shareholders. We regularly get feedback from our shareholders and are interested and open-minded to their ideas. The latest shareholder letter was received only about 24 hours ago. So we're still reviewing it. And in conjunction with our Board of Directors, we'll be formulating a thoughtful response. That said, the shareholder's interest and concerns will have no impact on our company proceeding with the Questar Pipelines acquisition, and we look forward to sharing more information on our response with you in the days and weeks ahead. As such, the focus of today's scheduled call will be exclusively on Southwest Gas Holdings' acquisition of Questar Pipelines. If you would turn to Slide 4, we have an agenda for today's call. I'll start with an overview on the transaction and the significant benefits it brings to Southwest Gas shareholders. Next, Boyd will provide an overview of the Questar Pipelines business. I will speak to the strategic rationale and how Questar Pipelines supports our energy transition thesis. Greg will outline our financing plan. Karen will cover our transition plan, and I'll wrap up with a summary on the compelling investment thesis this acquisition provides for our shareholders. Moving to Slide 5. We're very excited about this transaction and the value proposition it presents our shareholders. We are acquiring this asset at a very attractive value equal to approximately 9.8x EBITDA after adjusting for $200 million of value relating to a tax step-up. While our price is a bit higher than the price from the previously proposed transaction, please keep in mind that pipeline company stocks have generally traded up significantly since July 2020, and we're very happy with the value proposition Questar Pipelines presents. Questar Pipelines is a highly attractive addition the Southwest natural gas infrastructure platform with strong and consistent rate-regulated cash flow that will help fund investment growth and drive significant shareholder value. The acquisition will also enhance our business mix and diversify our cash flow sources and demonstrates our commitment to growing our regulated business. We expect the acquisition to be accretive in the first full year after close, and we're confident that we will maintain a healthy balance sheet under our planned permanent transaction financing mix. Moving to Slide 6. Questar Pipelines is a highly complementary asset to our current business. It is a difficult-to-replicate asset that generates a consistent and strong cash flow from highly contracted, rate-regulated revenues and long-term customers. We share similar values and cultures of safety, reliability, compliance and operational excellence. Questar Pipelines brings significant value to our organization as it increases our regulated business mix, promotes diversification and delivers cash flow and financial stability. Importantly, Questar Pipelines reinforces our energy transition thesis that natural gas infrastructure will continue to play a crucial role in reducing greenhouse gas emissions through coal replacement, renewable power support and transportation of clean fuels, including renewable natural gas, responsibly sourced natural gas and hydrogen. I'll now turn the call to Boyd, who will overview the acquisition's asset base. Boyd?

Thanks, John. On Slide 7, we provide a high-level overview of the Questar Pipelines business as an essential Rocky Mountain energy hub with interconnections to multiple interstate pipelines, integrated high-value storage assets, and access to multiple regional supply basins. These regulated pipeline assets are highly flexible in their ability to move gas efficiently and bidirectionally all throughout the region to serve a long-term demand-pull customer base. The business consists of 3 primary assets: the Questar Pipeline, Overthrust Pipeline and White River Hub. Also, the 54 Bcf Clay Basin storage asset is centrally located within the Questar Pipelines system. This unique, highly valuable storage asset provides essential storage services for customers in the region and has been 100% contracted at the maximum tariff rate since it came online some 40 years ago. All of the assets are highly contracted. Overall, 91% in 2021 expected revenue is sourced through firm take-or-pay contracts. And of course, the Questar Pipelines business is underpinned by FERC rate base and regulated ROEs, an area where we have real experience given our current ownership of Great Basin Gas Transmission Company, formerly known as Paiute Pipeline. Turning to Slide 8. We talk about customers. Since customer quality is a key value driver for any business, there was an important focus of our evaluation. Questar Pipelines has long-standing relationships with a very high-quality demand-pull customer base. The top 15 customers make up approximately 80% of total revenue. And on average, they have been customers for nearly 50 years, demonstrating the ability to recontract with customers over time. We show a breakout of the different customer groups. The business has a good, diversified mix of customers, from LDCs to power and industrials, from other pipelines to marketers and E&P shippers. 77% of overall system revenue is coming from investment-grade customers. On Slide 9, the largest anchor customer is the local LDC, Questar Gas, who represent nearly 1/3 of Questar Pipelines revenue. So Questar pipeline was originally constructed specifically to serve the Questar Gas Company's needs, and this relationship has lasted for more than 8 years. As an aside, very few gas utilities in the United States are adding customers at a faster rate than Southwest Gas Corporation. Questar Gas is one of them. This tremendous growth happening at such a high-quality anchor customer reinforces the underlying demand for gas transportation and storage infrastructure in the region. Somebody needs to own this valuable business, and we think it should be us. Back to you, John.

Thanks, Boyd. Turning to Slide 10. Our energy transition thesis is simple. In a world of significant market challenges, natural gas infrastructure does a better job than any other alternative of meeting customer needs in reducing carbon emissions. Customers demand reliability, energy security and affordability. At the same time, we all recognize we need to decarbonize the economy. The track record of natural gas is stellar, massive carbon savings from decades of coal replacement, ongoing support for intermittent renewables, pathways for renewable natural gas and responsibly sourced natural gas, and the promise of pathways for hydrogen and carbon dioxide. Low-carbon direct fuel is required for the deep decarbonization of certain industrial sectors. Questar Pipelines reinforces our realistic and proven approach to the energy transition. Moving to Slide 11. Questar Pipelines makes our company stronger by enhancing our regulated business profile. Our current regulated utility business has many attractive business attributes. Questar Pipelines brings additional attributes that we find highly attractive: additional FERC-regulated earnings, contracted cash flow, strong free cash flow, world-class contracted storage assets, and additional transportation and storage-oriented customers. Questar Pipelines also favorably rebalances our business mix with complementary regulated assets, resulting in an increased regulated EBITDA mix of 70% and a regulated EPS mix of 76%. Since CapEx needs at Questar Pipelines are modest, the large EBITDA contribution from Questar Pipelines translates to strong free cash flow, which benefits our entire organization. I'll now turn it over to Greg, who will discuss our financing plan.

Great. Thanks, John. Starting on Slide 12. Before I get into the details, let me start with a brief background of our capital structure policy. We target a long-term capital structure designed to preserve financial flexibility so that we can pursue the strategic objectives of growing our business segments to create value. We also want to be able to access the capital markets under both normal and turbulent conditions. The target profile at SWX consists of approximately 50% equity and 50% debt with a slightly higher target equity structure at our LDC Southwest Gas Corporation. For this transaction, we have arranged a fully committed financing of $1.6 billion, led by JPMorgan and Bank of America via a 364-day term loan. This interim funding backstop will provide us the flexibility to strategically time the takeout financing. Our permanent financing for the acquisition consists of $900 million to $1 billion of common equity and equity-linked instruments, including the potential use of forwards and mandatory convertible preferreds. The remaining financing needs will utilize investment-grade bonds. As part of the acquisition, we will also assume $430 million of long-term debt at Questar Pipelines with maturity dates ranging from 2028 to 2041. Our permanent financing structure will be refined as we move forward with the objective to optimize the sequencing and timing of the individual components. We will be working within the constraints of various blackout periods associated with quarterly and year-end financial filings. In consultation with our financing partners and subject to various market conditions, we could start issuing components of our permanent financing as early as November 2021 with the complete permanent financing expected to be in place by May 2022. We are utilizing a strong level of equity to permanently finance this acquisition and maintain a healthy SWX balance sheet. I should note that our expectation of EPS accretion in 2022, the first full year after close, does not include any synergies but does consider the range of equity levels I previously mentioned. We are not only excited about the EPS accretion that this acquisition provides but the strength that will provide to our balance sheet and cash flows in the future. With that, I'll now turn the call over to Karen Haller to discuss our transition plan.

Thanks, Greg. Throughout our valuation of Questar Pipelines, we have been focused on planning for a smooth transition. To that end, Dominion has agreed to enter into a transition services agreement prior to transaction close, which will ensure continuous operations while we establish systems and people. The structure of Questar Pipelines will be to operate as a stand-alone entity under Southwest Gas Holdings. As part of that structure, we will be rounding out local leadership and staffing needs. Following the close of the transaction, we will phase out use of the Questar name, which provides us a new branding opportunity. We certainly have lots of work to do, but we're planning ahead to ensure our transition is successful. With that, I will transition back to John.

Thanks, Karen. Turning to Slide 14. As you have heard, we're really excited by this acquisition because it makes our company stronger. The transaction reinforces our commitment to creating shareholder value through EPS growth from complementary businesses, dividend support, a healthy balance sheet and a proven approach to the energy transition. Questar Pipelines is a solid business and a great fit with our company. It increases our regulated business mix, provides regulatory diversification, earnings accretion and positions us for the adjacent energy transition opportunities. Our near-term focus areas will be to close the transaction, plan for the transition and deliver results. I'll now return the call to Ken.

Thanks, John. This concludes our overview of the Questar Pipelines acquisition. Our operator then will now explain the process for asking questions.

[Operator Instructions] Your first question comes from the line of Richard Sunderland of JPMorgan.

Maybe starting with the EPS accretion, could you speak a little bit to the magnitude of that or any ways to think about the high-low ranges that you spoke to a little bit in consideration of those financing scenarios?

Richard, this is Greg. Yes. We haven't provided and don't at this time want to provide the level of EPS accretion. We think that's an important part of this. But as John and others have mentioned today, in addition to that EPS accretion, this is really about strengthening our balance sheet and our overall strength at Southwest Gas Holdings. As we move towards the closing of this transaction, we'll certainly have additional information on the level of EPS accretion, but there's still quite a few moving parts before we get to that point.

Understood. Maybe just to follow up briefly there. You talked about accretion in the first full year but then some lag on the kind of full permanent financing. Do you see the trend into year 2 at similar levels for year 1? Or any kind of puts and takes in consideration of having the financing in place later in the year.

Yes. We expect that the EPS accretion will still be strong in the second and forward years after that. We thought it was important to indicate to the market that in the year 1 after the acquisition, that would be EPS accretive because there are some things that are sometimes nominally amortized in that early period. So EPS accretion is expected from this transaction not only in '22 but forward.

Understood. And then just for my second question here, could you speak a little bit to the equity financing and the shareholder approvals or any other approvals needed there? And maybe alongside that, just the overall path to close with timing for regulatory approvals.

Yes. I'll certainly address that. The first item, given the levels that we're talking about, we should not need any shareholder approval to issue this equity. And again, we'll be using various instruments. So those will really be subject to the market conditions that exist. That's why we wanted to have that 364-day term loan so that we could have the flexibility to time and sequence those equity issuances.

Understood. And then sorry, just on the path to close, just the regulatory approvals, could you outline what those are and the expected timing of each?

This is Karen Haller. I'd be happy to answer that. We do not have any state regulatory approvals required. We will be seeking Hart-Scott-Rodino approval.

Next question comes from the line of Julien Dumoulin-Smith of Bank of America.

This is actually Kody Clark on for Julien. So building off the prior earnings question, I'm just wondering, do you expect earnings and cash flows to kind of stay the same, increase or decrease over the next 5 years in light of the 5-year weighted average contract length? Like are there material above-market contracts expiring? And then kind of within that, how should we think about the amount of synergies within this profile?

I will certainly start, Kody, and just indicate that, that information on the lower right-hand corner of Slide 11 that talked about the strong cash flows, the bar chart and shows that consistency, we expect that consistency to continue. It's great, as Boyd mentioned, to have a strong, stable customers who have been around and recontracting for numbers of years. And so we expect that to continue into the future, and that will provide solid and stable cash flows with relatively minimal CapEx over that same period of time.

Okay. Got it. And then have you had any conversations with the rating agencies on the transaction? The structure of the financing is heavily weighted towards equity, but it shifts your earnings mix to even less utility and presumably raises your business risk profile from their standpoint. So how are they viewing this? And especially given kind of how they're viewing the business profile post RDC acquisition.

Yes. I'll certainly start by saying that we have had communications with the 3 rating agencies. That's certainly a prudent move on our part. We want to alert them to the transaction and get some feedback and provide them some of the information that we've provided to you and the investment community today. I won't speak on behalf of the rating agencies. I think that would be best done by them. It would not surprise me that reports will be coming out with their viewpoints on this. And they have their various credit metrics and other considerations that they have. But we think we provided a good, solid support for why this acquisition of a regulated -- FERC-regulated asset will be beneficial to the overall SWX mix.

Okay. Got it. And then last one from me, if I can just sneak it in. It's -- I'm wondering if there's any opportunity for growth in the system just kind of given the backdrop that we've seen in the natural gas market. Or are you kind of just viewing this as an annuity?

Kody, this is John. I think that we do believe that there are some growth opportunities. There is some additional CapEx that we'll be investing into the business. It really is a very well-maintained system. So there aren't really a huge amount of dollars that will be associated with that pipeline integrity, et cetera. But as we indicated earlier in the presentation, Salt Lake Valley is just growing like crazy, has a very strong economy. And we think that there definitely are prospects for continuing to grow in the future.

Next question comes from the line of Chris Ellinghaus of Siebert Williams.

Can you discuss sort of your planned use of the storage and how maybe the February weather event might have influenced your thinking?

Sure, Chris. This is John. I'll let Randy Gabe, who is our VP over Gas Supply and participated in the due diligence efforts, to talk a little bit about how that gas storage asset is used on the Questar Pipelines system. Randy?

Thank you, John. This is Randy Gabe, Vice President of Gas Resources. So with regard to the storage asset, that asset, as Boyd mentioned, has been fully contracted since it went into service many decades ago, and it's anchored by several utility customers. So we expect that contracting to continue in the future. With regard to leveraging that facility for Southwest Gas in particular, I don't necessarily think that, that facility is positioned to help the Southwest Gas utility, but it's an absolutely vital component of the overall pipeline network for the Questar Pipelines. So it's right in the center of the network, has high withdrawal, has high delivery, high storage capacity and also interconnects with Northwest Pipeline as well, which they use extensively.

And as you mentioned, Chris, that storage asset up there was really key to that area weathering the price fluctuations that were experienced with Storm Uri. So it's a really important part of the system, and the customers appreciate its value.

Can I ask the previous question about recontracting in the reverse? Given Uri, do you envision that recontracting has incremental value after the events this year?

Chris, that's a possibility. When we did our modeling for moving forward with the asset, we were pretty conservative on what we thought the recontracting rates would be. So we really haven't baked any of that in. I think that's a good theoretical point and something that we'll certainly want to continue to explore once we are the owners of the facility.

Okay. John, can you give us any more color on how you perceive dividend policy may be changing with this transaction and the incremental regulated earnings characteristics?

Chris, we think it's going to be continuing to be very supportive of our dividend policy. So I think that that's one of the benefits of bringing this asset on. Greg, any other commentary?

That's one of the great things, Chris. This provides the support for the dividend we currently have and continues -- will provide support for increase in the dividend going forward. We're still targeting that 55% to 65% level of consolidated earnings. And so I think that this well positions us to continue both the payment and the growth of the dividend.

Okay. One last question, Greg. Do you envision transmission being a new segment for reporting purposes?

That is something that we will certainly look at as to whether we want to bifurcate or even if we're required to bifurcate that. We want to again get through the rest of this process to close the transaction and then see what will be most beneficial to us as management in monitoring and managing this process as well as the information that's needed by the external world to properly invest and assess what goes on here. So it's something that we look at. It's certainly of a magnitude. We do have pipeline activities right now, FERC-regulated. They are small and we encompass those within the natural gas LDC utility. So we will look to bifurcate that if it makes sense for management to review it that way and the outside community.

Next question comes from the line of Ryan Levine of Citi.

What's the strategy to leverage the platform? Or is there a defined strategy at this point to benefit from hydrogen trends over time?

Ryan, this is John. I think that, that is something that we're looking at really across our system. We think that's a possibility in the future for the pipeline system to move that. We also think that those are big opportunities at our existing LDC footprint. As you know, we have a number of partners throughout our service territory that we are putting in place renewable natural gas projects. We also have hydrogen pilot programs on the LDC side that we are looking at implementing at ASU and UNLV. We think that -- again, as you look at this so-called energy transition, you look ahead at the interest in having lower carbon emissions, we think that the future will move from conventional natural gas to some of these renewable products and then ultimately to a hydrogen future. And we think that this pipeline system is well situated for making that conversion over time. So the thesis is that these assets, pipeline assets are crucial to enabling the energy transition and that Questar Pipelines will be part of that big picture.

And then in your presentation, there wasn't much mention of synergies. Can you speak to the cost and management potential synergies or dis-synergies that this transaction may have associated with it?

Ryan, we didn't really focus on synergies. We think there may be some of those available. As Karen was mentioning earlier, we've got a transition services agreement in place with Dominion of some of the services that were provided to the Questar Pipelines asset, were provided by Dominion. So when that transition services agreement ends, we'll have to -- rather along that path, we'll be adding some employees. So we think that as we take over it, as we get more familiar with it, we think that there may be synergies that we will discover, but we haven't included any of those in our modeling for our due diligence rationale of acquiring the asset.

Okay. And I guess given that answer, you, in your prepared comments, mentioned that you saw Southwest Gas as the logical owner of these assets. Can you a little -- can you elaborate on what the advantages of your platform are in owning this given some of the comments you just made?

Sure. We think that -- we like it because we're in the natural gas business and we believe in the natural gas business. As we mentioned a little bit earlier, we do have a couple of pipelines and storage facilities that we operate. We're very enthusiastic about the West and the Rocky Mountain region. As I mentioned, Salt Lake area is growing significantly. That's another similarity with Southwest Gas' service territory. And this is an asset that is literally right in our own backyard. It's not a property that's located in Texas or halfway across the country. So we think it's really well situated for us. We've met with the management team. As I mentioned earlier, we've got a similar culture. We just really are excited about having this asset join the Southwest Gas Holdings family.

And then last question from me. What type of response to the shareholder letter that you received were you alluding to in the beginning of your prepared comments?

Well, as I mentioned, Ryan, we received -- that letter, we received it yesterday and we barely had it in 24 hours. We have forwarded it to our Board. We've talked a little bit to our Board about it. But essentially, what we will be doing is -- we received the letter, and so we will be formulating a response to that letter. And that's probably something that -- it may be done by the end of the week, but it's going to be a formal response to the letter that we received, addressing the points that were raised in it.

Next question comes from the line of Sarah Akers of Wells Fargo.

To start, can you just remind us of the starting point on credit ratings and FFO to debt thresholds and then whether this deal helps or hurts your credit metrics?

I'll start, Sarah, by just reminding that we are investment-grade-rated by all 3 rating agencies at both SWX and at Southwest Gas Corp. As I mentioned earlier, we had discussions with the rating agencies, and they have their individual credit metrics that while we endeavor to assess and put our pro forma information, that will ultimately be up to them to decide where we are. We think we're in a good place for those metrics but we will again hope -- it's probably more prudent for us to wait for rating agencies themselves to give their overview of what they see versus me telling them what their metrics are supposed to be.

But what about just from a modeling standpoint, are you seeing -- what you have seen from your FFO to debt on a base level versus pro forma, do you see the deal being positive or negative just to your forecasted FFO to debt?

Yes. As we move forward, again, as we've modeled it, it is progressively better overall to where we stand today. And we think that that's important -- an important consideration. As we indicated, when you start at the beginning, there are some costs that come through, and those are taken into account. We also know that by having the backstop of the term facility that, that will also be dependent and may be a consideration that the rating agencies will use in looking at those metrics, but we see improving metrics across the board for us.

Got it. And I appreciate the comments on the accretion from this deal in 2022, but wondering if you have a more detailed update on accretion from the Riggs Distler deal or when we might expect that.

That's a wonderful question now. As you can probably tell, we've been a little busy with this acquisition in getting it ready to go. So we will be forthcoming -- and I'll just say in the next couple of weeks, to provide that information that I said we would with the Riggs Distler acquisition. We think that that's great, and a lot of it will be what the impact will be for 2021. And then we will package this information together for 2022's review, which will likely come out in our year-end earnings conference call in February or early March of 2022.

Got it. And then last question, are you able to give an approximate cost of the transition service agreement for '22, and whether that's material for earnings in the first year, if that's a drag we should think about?

So yes. As we start out, I think we're going to have -- to look at that, a lot of it will be dependent on the level that we ultimately need in doing this transaction. So material -- again, some costs that used to be allocated to this Questar Pipelines group from Dominion, as was mentioned earlier, will now be, in essence, compensated with or taken care of by the transition agreement.

Next question comes from the line of Tim Winter of Gabelli Funds.

I was wondering if you could ponder a little bit the thought of separating the infrastructure services business perhaps to satisfy some of the equity needs. Is that a possibility or something on the table?

Tim, this is John. Long time no see. We appreciate your long-term ownership in the company. We don't see separating the infrastructure services company as a method of financing this acquisition. That said, I think that the acquisition does provide increased optionality for the infrastructure services of the company, whether that's from a perspective that we want to continue to grow it and we've kind of reestablished that much higher regulatory portion of the business mix or if at some point we see that the shareholder would get more value by having that asset spun off. So we don't have any expectations to spin that off at this time. We don't have any need to sell it to finance the transaction, but we'll continue to look at what makes the most sense in terms of value for our shareholders.

Okay. And then I just have a follow-up. Just a clarification and maybe just a little bit of a further explanation. So you do not need any regulatory approvals, not from FERC or any of the states or shareholders?

This is Karen. That's correct. We do not need FERC or state regulatory approvals. The only approval that we'll be seeking is the Hart-Scott-Rodino. There's no shareholder approval either.

I am showing -- there are no further questions at this time. I would now like to turn the conference back to Mr. Ken Kenny. Please go ahead.

Thank you, Jen, and thank you all for your time today. This concludes our call, and we appreciate your participation and interest in Southwest Gas Holdings, Inc. Everyone, have a great evening. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.