PE-backed midstream companies have ‘generally lower’ credit ratings

Private equity financial sponsors ‘take advantage’ of over-performance by paying themselves instead of repaying debt, according to a report from Standard & Poor’s.

Private equity-backed midstream companies receive “generally lower” ratings than those backed by infrastructure funds, Standard & Poor’s has said in a report on the US energy infrastructure market.

According to the report, financial sponsors, excluding those investing through infrastructure funds, follow “aggressive” strategies that use high amounts of debt to “maximise shareholder returns”. The ratings agency says such sponsors have average hold periods of five to seven years, while infrastructure funds have average time horizons of more than 10 years.

“The return-focused nature of financial sponsors incentivises them to favour higher distributions versus higher ratings,” the study states. “We expect financial sponsors to take advantage of over-performance by their portfolio companies by paying themselves a distribution as opposed to repaying debt.”

S&P ratings for sponsor-owned entities range from B- to BB- for corporate issuers and B to BB for project finance issuers. For midstream companies sponsored by infrastructure funds, corporate issuers are typically rated B- to BB+, while project finance issuers are rated CCC+ to BB-.

The ratings agency mentioned three firms for using short-term financing strategies to increase profits: Arclight Capital Partners, Energy Capital Partners and Blackstone Energy Partners. These firms are the most active financial sponsors within the rated infrastructure universe and account for 30 percent of debt issued in deals backed by financial sponsors or infrastructure funds. S&P pointed to a B-2 term loan Blackstone had recently issued to fund a distribution at BCP Renaissance, the holding company for its interest in Rover Pipeline.

According to the report, “highly rated midstream issuers are mindful of their balance sheets and cannot finance growth-focused acquisitions in a credit-friendly way that balances both their cost of capital and leverage while also preserving ratings. In contrast, financial sponsors do not hesitate to heavily debt-finance these acquisitions.”

Arclight and Energy Capital did not respond to a request for comment. Blackstone declined to comment for this story.