Highlights
• Targa Resources (TRGP) will purchase the midstream assets of Atlas Energy (ATLS), a US natural gas MLP, next month in a cash / stock deal. Atlas will spin-off it’s upstream assets as a new MLP.
• Falling natural gas prices since the deal was announced October 13th have provided investors a wonderful opportunity to obtain a high yielding MLP (ATLS currently 7.6%).
• The Spin-off company is being ignored at current prices.

The Opportunity:
Atlas Energy, lead by CEO Ed Cohen, have a history of creating shareholder value:

On October 13th, after entertaining at least 3 offers from competing firms, Atlas announced it would be acquired by Targa Resources (TRGP), a midstream MLP. The Merger Agreement provides that each ATLS common unit will be converted into the right to receive (i) 0.1809 of a share of TRC common stock and (ii) cash in amount of $9.12. In addition, ATLS unitholders will own 100% of the new Spin-off company (“New Atlas”) – which will consist primarily of Atlas’ upstream energy holdings.

As of yesterday’s closing prices the deal is valued as:

We know the value of the cash offer – $9.12 per share.

Regard to the new TRGP, there are a number of geographic and operational benefits with the merger. Targa expects the addition of ATLS to be immediately accretive to TRGP unitholders.

The real value I believe is in the Spin-off. Atlas management believes the “New Atlas” can support a $1.10 per unit distribution. That’s a 39% yield. If we apply a conservative future dividend yield of 8% to the $1.10 in annual dividends that the new spin-off company will pay, this will give us a value per share of this new company of $13.75 per share. In a December investor presentation, Atlas offered these potential values of the Spin-off:

Compare the above valuations to today’s $2.85 offer in the market. I believe the “New Atlas” may become a vehicle for Ed Cohen to continue his winning ways.

Sentiment of Company Insiders:
Insiders are very positive right now – Famed investor Leon Cooperman, the largest shareholder, has been purchasing ATLS shares aggressively this past month.

And CEO Ed Cohen during the Q3 2014 Earnings Call:

“I’m afraid that Mr. Market is giving slight if any value to the new Atlas Energy Group, which will be spun-off to unitholders immediately prior to the Targa acquisition. This is in my opinion a big mistake.”

The Risk:
Due to their structure, MLPs often pay out a higher dividend than they actually earn by issuing more stock and debt, which can lead to disaster when energy prices collapse. In the long run MLP’s must be able to maintain a distribution-coverage ratio above 1 — which allows them to pay distributions with free cash flow instead of issuing stock and debt. The primary upstream asset of the Spin-off “New Atlas” is it’s 35% stake in ARP – Atlas Resource Partners. Due to low gas prices, ARP is struggling maintain a debt covenant, and may need to reduce distributions further in 2015. This is already well-priced in the market, with ARP itself now offering a 25% yield.

Timing / Technical Analysis:
In December 2014 the natural gas etf ‘UNG’ completed a long-term buy signal as I describe here and here. If natural gas moves up from this point as expected, the timing couldn’t be better for this trade.