DBRS Limited (DBRS Morningstar) notes that Pembina Pipeline Corporation (Pembina; rated BBB (high) with a Stable trend by DBRS Morningstar) announced today that it has entered into definitive agreements with Kohlberg Kravis Roberts (KKR) to combine their respective Western Canadian natural gas-processing assets into a single new joint venture entity (NewCo) (the Transaction).

Pembina will own 60% of the NewCo and KKR will own 40%. Pembina will serve as the operator and manager of NewCo.

Assets in the Transaction include the following:

Pembina's field-based natural gas-processing assets including the Cutbank Complex, the Saturn Complex, the Resthaven Facility, the Duvernay Complex, and the Saskatchewan Ethane Extraction Plant, as well as its 45% interest in Veresen Midstream. The Empress, Younger, and Burstall assets will remain 100% owned by Pembina, as well as the Veresen Midstream business (currently 55% owned by KKR and 45% by Pembina).

KKR will contribute its 49% interest in Energy Transfer Canada (ETC).

Concurrently with the close of the Transaction, NewCo will also acquire Energy Transfer LP's remaining 51% interest in ETC.

Collectively, the ascribed value of the Transaction totals $11.4 billion, excluding the value of assets under construction.

DBRS Morningstar has reviewed the NewCo's business and financing structure as well as the details of the Transaction and believes that the Transaction would have no material impact on Pembina's credit profile, reflecting the following factors:

(1)	The NewCo will increase Pembina's connectiveness in the Duvernay and Montney formations with the combination of Pembina's gas-gathering and -processing assets (gas services business unit (GBU)) and ETC's gas-processing network. Pembina will improve its exposure to growing Northeast British Columbia natural gas volumes in a capital-efficient manner through increased ownership in the Veresen Midstream assets. The Transaction is structured to create strong alignment between Pembina and KKR, a leading global investment firm. The NewCo's assets are adjacently located, and these assets are high-quality processing platforms, which will enable the NewCo to realize significant efficiencies and economies of scale.
(2)	Pembina will also receive strategic benefits through the diversification of its natural gas-processing asset suite and customer base. Diversification should improve in terms of product lines and in terms of production and service areas within Western Canada.
(3)	Pembina will effectively increase its ownership in Veresen Midstream from 45% to 60%. Veresen Midstream has five gas-processing facilities with a total capacity of 1.7 billion cubic feet per day (bcf/d) and approximately 1,300 kilometres (km) of gathering and transportation pipeline, which are under long-term fee-for-service with significant take-or-pay contracts and have generated strong and stable cash flow. Veresen Midstream's 2022 EBITDA is estimated to be $500 million.
(4)	Pembina will own a 60% interest in the NewCo, which means it will benefit from owning 60% cash dividends from the ETC assets. ETC currently owns five gas-processing facilities with approximate total capacity of 1.3 bcf/d and 1,400 km of gas-gathering pipelines and transportation. ETC's 2022 EBITDA is estimated to be $150 million. ETC has generated stable cash flow under long-term contracts with no commodity price risk.
(5)	All the benefits in (1) to (3) above would more than offset the loss of cash flow from reducing the ownership of GBU from a current 100% to 60% once the Transaction is completed. EBITDA for the GBU assets is estimated to be approximately $300 million (on a 100% basis) in 2022. GBU assets to be sold to the NewCo include 15 processing facilities with a total capacity of approximately 2.0 bcf and 650 km of gathering and transportation pipeline.
(6)	Pembina will receive approximately $700 million from the NewCo, which DBRS Morningstar expects to be used to reduce Pembina's debt and buyback shares. As a result, Pembina's consolidated debt would be reduced while cash flow for the remaining assets and projected dividends from the NewCo would increase Pembina's ability to service its debt.
(7)	Pembina will serve as the manager and operator of NewCo, enabling the NewCo to benefit from Pembina's operating capabilities, institutional knowledge, and management systems. With alignment being a governing principle, the joint venture includes area-of-mutual-interest provisions whereby Pembina and KKR have agreed to mutually pursue field-based natural gas-gathering and -processing assets in Western Canada within NewCo. The shareholder agreement includes customary governance and liquidity provisions and certain right of first offer, right of first refusal, and tag-along provisions.

DBRS Morningstar, however, recognizes that the following factor would significantly offset the above positive factors, resulting in the Transaction's credit-neutral impact on Pembina: As the NewCo will be independently financed and will issue its own debt for its own expansion strategy, cash dividends to Pembina will have to first service the debt at the NewCo. However, the projected cash flow from the remaining assets that are 100% owned by Pembina will continue to account for a substantial portion of Pembina's cash flow and continue to serve as a basis for Pembina's strong credit metrics post-Transaction to support the BBB (high) ratings. In addition, the debt to be issued by the NewCo will not be on Pembina's consolidated balance sheet and will not be included in DBRS Morningstar's calculation of debt-related credit metrics because Pembina will account its investment in the NewCo under equity-accounted investments. Dividends from NewCo will account for a modest portion of Pembina's total cash flow. Based on DBRS Morningstar's rating approach under these circumstances, debt from the equity-accounted investment will not cause the debt at Pembina to be structurally subordinated.

DBRS Morningstar expects the NewCo to have a capital structure, consistent with Pembina's financial guardrails, with target leverage of 3.5 times to 4.0 times debt-to-adjusted EBITDA. The NewCo will be independently funded and has obtained commitments for $4.75 billion of senior unsecured credit facilities. These commitments are composed of a five-year $3.9 billion term loan facility, a three-year $250 million revolving credit facility, a $50 million operating facility, and a dedicated $550 million revolving credit facility to support the construction of Key Access Pipeline System. No scheduled amortization payments are required on the facilities.

DBRS Morningstar expects the Transaction to be completed as currently planned by Pembina and consistent with DBRS Morningstar's expectation. A positive rating action on Pembina is unlikely in the medium term; however, the following factors, should they occur, could have a negative impact on Pembina's credit profile:

The NewCo implements expansion strategy in such a manner that its business risk profile would deteriorate significantly from the current level.

The NewCo aggressively expands its operations and in the event that dividends from the NewCo significantly increase and account for a significant portion of Pembina's consolidated cash flow. (Currently, dividends from the NewCo to Pembina are projected to account for a modest portion of Pembina's total cash flow.)

The ownership structure of the NewCo changes to a degree that Pembina would have control of the joint venture and would have to consolidate the debt issued by the NewCo to its consolidated balance sheet.

Notes:

All figures are in Canadian dollars unless otherwise noted.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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