DBRS Places Veresen Inc. Under Review with Developing Implications Following Cutbank Acquisition Announcement

DBRS has today placed the BBB (high) Senior Unsecured Notes rating of Veresen Inc. (Veresen or the Company) Under Review with Developing Implications. This rating action follows the announcement that the Company has agreed to acquire the Cutbank Ridge (Cutbank) midstream assets from Encana Corporation (Encana, rated A (low) with a Negative trend) for a total consideration of approximately $920 million. This transaction (minimum average annual committed gathering fees over the first five years of over $72 million, net of operating and maintenance costs, and not including any potential fees from non-committed or third-party volumes) is expected to close in the first quarter of 2012 and is subject to normal closing conditions, including receipt of normal course consent under the Competition Act. The transaction is expected to be immediately accretive to distributable cash per share.

The Cutbank midstream assets include 100% interests in (a) the Steeprock and the Hythe gas plants, with combined functional capacity of 516 million cubic feet per day (mmcf/d) and (b) approximately 40,000 horse power of compression and 370 kilometres of gas gathering pipelines. These assets are located in the Cutbank Ridge region of Alberta and British Columbia. Natural gas and natural gas liquids in the region are produced from the Montney, Cadomin and other geological formations.

Veresen plans to initially finance the transaction with approximately $300 million in equity (through a subscription receipt bought deal offering) and $620 million in debt, specifically: (a) $250 million from new senior credit facilities (which rank equally with all of Veresen’s other unsecured and unsubordinated indebtedness) and (b) the balance of approximately $370 million under the existing revolving credit facility of Veresen. The Company intends to refinance any draws on its short-term credit facility through various capital market instruments during 2012.

In its review, DBRS’s analysis will focus on (1) the business risk profile of Veresen and (2) the financial impact of the deal on the Company’s credit profile.

(1) BUSINESS RISK PROFILE – NEUTRAL
Based on its preliminary review, DBRS views the acquisition as neutral with respect to Veresen’s business risk profile. Distributable cash from the acquisition is expected to be relatively predictable, underpinned by a long-term fee-for-service contract with Encana. Encana is expected to remain Cutbank’s major customer, accounting for over 72% (370 mmcf/d) of the functional capacity of the Hythe/Steeprock complex over the contract period. The long-term contract with an investment-grade counterparty effectively mitigates throughput volume risk. Furthermore, Veresen will benefit from a number of operational benefits including business line and cash flow diversification as well as potential future growth prospects. However, the acquisition imposes some operational risk given that the Company has limited experience in operating midstream businesses.

As Veresen’s pipeline business has experienced a gradual decline in earnings, largely reflecting the ongoing reduction in equity returns on Alliance’s investment base (which consists of Veresen’s 50% ownership in Alliance Pipeline Limited Partnership and Alliance Pipeline L.P.), and uncertainties exist beyond the contract period (only 8% of contracted capacity has been elected to extend to December 2016 or later), the Company has entered into the midstream business to further diversify beyond its core pipeline business. The pipeline business accounted for approximately 67% of EBITDA in the first nine months ended September 30, 2011. Pro forma the Cutbank acquisition (i.e., post-acquisition), DBRS estimates that the midstream business will account for 19% of Company EBITDA, with pipeline at 54%, natural gas liquids at 16% and power at 10%.

(2) FINANCIAL RISK PROFILE – NEGATIVE
DBRS expects the Company to fund the acquisition in a prudent manner by refinancing the initial debt assumed for the acquisition through various capital market instruments over the remainder of 2012. Furthermore, Veresen intends to permit eligible shareholders who are enrolled in its Premium Dividend and Dividend Reinvestment Plan to participate in the Premium Dividend component, which will ultimately reduce cash dividend payouts. However, pro forma the acquisition (i.e., post-acquisition), DBRS estimates that the significant increase in debt (partly due to a high EBITDA multiple paid for the transaction) weakens the Company’s ability to withstand cyclical downturns and reduces its financial flexibility. Any further material increase in leverage could cause Veresen’s credit risk profile to deteriorate to a level that is no longer commensurate with the current BBB (high) rating.

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

The applicable methodology is Rating North American Pipeline and Diversified Energy Companies, which can be found on the DBRS website under Methodologies.