Targa Resources has completed the acquisition of Dynegy's midstream gas business, thanks to a $2.5 billion package of bonds and loans. The acquisition overcame hurricane season in the Gulf of Mexico, and an aggressive capital structure, to bring in strong interest from lenders. At a stroke, Targa moves from being a small independent start-up to a major player in the US midstream gas business.

Targa was formed in early 2003 around a core of former executives at Tejas Gas. Its mission was to pursue midstream acquisition opportunities in the Gulf Coast, Mid-Continent and Rocky Mountain regions. It lined up Warburg Pincus to provide equity to its potential deals under an agreement from 29 April 2003.

Its first acquisition, in April 2004, was of some of ConocoPhillips' midstream businesses. The sale, the size of proceeds from which Conoco has not disclosed, was funded entirely through Warburg's equity. It consisted of 1,200 miles of gathering lines in the Texan Permian Basin, and 700 miles of pipeline and processing capacity of about 260 million cubic feet per day and 14 million barrels of natural gas liquids raw mix production in Western Louisiana around Lake Charles.

But the Dynegy acquisition is of a much greater size – almost as large as the $2.5 billion that Tejas Gas was worth when its founders sold it to Shell in 1998. Former Tejas personnel include Rene Joyce, formerly chief commercial officer and now Targa CEO, Roy Johnson, formerly vice-president business development and now filling the same role at Targa, and Joe Bob Perkins, formerly director business development, and now president. Targa's CFO, Jeff McParland, was previously at Dynegy, while much of the rest of Targa's senior management is drawn from the ranks of Coastal.

Given the management's familiarity with such assets, the region, and in one case the seller, the Dynegy midstream assets were natural targets. Dynegy has been slowly and quietly divesting itself of its origins as Natural Gas Clearinghouse. It now wants to focus on being a merchant electricity generator.

The sale of Dynegy's midstream business was announced on 2 August, and consists of a cash payment of $2.475 billion, as well as the release of $125 million in cash collateral and $75 million in letters of credit. Dynegy was able to offset the gains on the sale against losses on earlier investments to provide a tax-free return and eliminate some of its outstanding debt.

Targa's advisers on the sale were Merrill Lynch and Vinson & Elkins, but CSFB managed to snare the mandate alongside Merrill as joint lead manager. The lead managers, joined by Goldman Sachs, launched the debt backing the purchase on 7 October.

The deal is much more of a conventional whole business leveraged financing than a project financing, although such was the size of the financing, and such has been the paucity of high quality assets, that it was pitched at a number of European commercial banks. In part this was a conscious move on the part of CSFB, which still has a reach among such lenders, but also reflects a steadily increasing interest at European lenders in such assets.

The timing was not the most auspicious that could be imagined, since much of the target infrastructure lies along the Gulf Coast. Hurricane Katrina had hit the New Orleans area on 25 August, and Hurricane Rita hit the mouth of the Sabine River on 24 September. The hurricane season disrupted gas production in the Gulf, and has led to insured losses among the Dynegy assets.

The bank debt consists of a $700 million two-year bridge loan, a $300 million synthetic letter of credit, a six-year $250 million working capital facility, and a seven-year $1.25 billion term loan. The leads increased the term loan from an initial $1.15 billion, and decreased a 144A issue from $350 million to $250 million.

However, the term loan did benefit from a slight flex of 25bp. All tranches were launched at 225bp over Libor, but the leads decided to flex the deal to 250bp to enable the loan to clear. Targa also issued $250 million in senior notes due 2013 with an 8.5% coupon, or a spread of 403bp over the equivalent treasury. While a direct comparison is difficult, the higher pricing on the term loan probably saved Targa relying on expensive bond debt.

The deal gained a rating of Ba3/B+ (Moody's/S&P) senior secured and B2/B- to the senior unsecured debt. The two agencies analysed the operations by looking at their competitive position and Ebitda numbers. This last comparison is important to the agencies in establishing likely recovery values. S&P arrived at an average annual Ebitda number of $310 million, used a valuation multiple of 7x, and thus gave the debt a recovery rating of 2, based on a recovery valuation of $2.1 billion.

Despite the low ratings, the deal did attract some interest from lenders outside of the circle of Houston oil and gas specialists. Increased interest from European lenders, in particular project finance banks, was evident. This trend reflects banks' search for attractive assets as power bank loans have become scarce, and their familiarity with commodity risk.

The Dynegy assets are closely integrated, and include natural gas liquids (NGL) operations. While Chevron will be a major supplier of the plants, low-rated Dynegy is a major customer for the NGL. NGL price exposure is very hard to hedge, although the scope of Targa's operations is such that it now possesses a marketing venture for NGL and propane. The assets also include a share of the VESCO gas processing facility, which will be a customer of the Targa operations.

Targa Resources
Status: Closed October 2005
Size: $2.475 billion
Location: Permian Basin, Rockies and Gulf Coast, US
Description: Leveraged acquisition of gas gathering and processing operations from Dynegy
Sponsor: Targa Resources, affiliated with Warburg Pincus
Debt: $700 million 2-year bridge loan, $300 million LC, 6-year $250 million working capital facility, 7-year $1.25 billion term loan, $250 million in 8-year unsecured notes
Lead arrangers: CSFB, Goldman Sachs, and Merrill Lynch
Financial adviser: Merrill Lynch
Legal adviser to the sponsor: Vinson & Elkins