The Penn Virginia Resource Partners (NYSE:PVR) that you knew and loved is soon to be a very different company. With a large acquisition of a private midstream gas company, Penn Virginia is largely becoming a gas gathering and processing company that also happens to have coal assets. While this is a deal with solid rationale behind it, current investors may well be troubled by the dilution involved and the fact that company will move from its plans to be a balanced coal and midstream gas company to a gas-heavy partnership.

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The Deal of the Day
Penn Virginia announced Tuesday morning that it is going to acquire privately-held Chief Gathering LLC for $1 billion. While the company says that $200 million of the price will be paid in equity and the remainder in cash, that's not really true. $580 million of the "cash" is coming from the sale of common units and new Class B units that ultimately convert into common units.

All in all, then, only about $220 million of the deal price is being paid in cash (which will add to the company's debt load). Moreover, some back-of-the-envelope math suggests that once all of the special units convert, this will increase the units outstanding by close to 50%.

SEE: Mergers And Acquisitions: Understanding Takeovers

Is This a Good Deal?
While readjusting models prior to the conference call virtually guarantees a certain amount of error, it looks like this deal is about 10% dilutive to fair value in the short term, but should pay off nicely over the longer term.

PVR's pre-call presentation unfortunately does not give a lot of detail about Chief's recent financial results, but indicates that the partnership is paying about 6 to 6.5x 2014 EBITDA, which includes the anticipated benefits of growth-oriented capex in the Marcellus shale region. If that's accurate, then PVR is getting a pretty respectable deal - about a 25% discount to the going 2014 multiple for gas gathering and processing partnerships.

This deal also clearly gives the company a better angle on growth. Coal, particularly Appalachian coal, just doesn't look like a growth market anymore. Natural gas, though, is starting to get a fairer shake as companies like Chesapeake (NYSE:CHK) and Clean Energy (Nasdaq:CLNE) push forward with plans to facilitate wider adoption of natural gas as a vehicle fuel. What's more, this deal greatly accelerates the company's expansion in the fast-growing gas-rich Marcellus Shale region and adds companies like Chesapeake, Anadarko (NYSE:APC) and Exxon Mobil (NYSE:XOM) to the customer roll.

SEE: Natural Gas Industry: An Investment Guide

What Happens to Coal?
Penn Virginia still owns nearly 900 million tons of coal reserves, with nearly 600 million in the Central Appalachian region. What's more, the company has been doing deals of late to expand its holdings - particularly in areas like the Illinois Basin.

Admittedly, coal is not popular today and the long-term future of energy generation may well be with natural gas. That said, these coal assets are not worthless and since Penn Virginia leases to operators (and does not operate the mines themselves), there's little long-term risk to the assets.

Although management has not yet said anything to this effect, I expect that when coal prices rally (whenever that may be), Penn Virginia may well consider a sale or spin-off of those assets and offer investors their choice of two purer-play partnerships. That said, there's nothing wrong with keeping the business as is - a gas gathering business with a coal kicker.

The Bottom Line
This deal will definitely create some turbulence in the shares, but the high dividend yield is worth a serious look. What's more, the addition of Chief and its large fee-based business will ultimately reduce PVR's exposure to natural gas prices and lower the risk of the business. That said, investors who want to invest in coal may find it's time to move on to a different company like Natural Resource Partners (NYSE:NRP) or Alliance Resource Partners (Nasdaq:ARLP).

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.



Tickers in this Article: PVR, ARLP, NRP, CHK, APC, XOM, CLNE

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