Tailwater Capital began looking at options for portfolio company Tall Oak Midstream III (Tall Oak) about eighteen months ago, including a potential exit strategy for 2024.

“The business has performed well over the last couple of years” said Stephen Lipscomb, a partner at the Dallas-based sponsor. “It was an opportunistic time for us to evaluate exiting the investment.”

Ultimately, after several months of talks, the energy-focused GP agreed on a bespoke cash-and-stock transaction with Summit Midstream [NYSE:SMC] that will see it take part in the next phase of Tall Oak’s growth as a major shareholder in the acquiring company.

Talks between Tailwater and Summit, which was itself in the midst of a strategic review, about potential options for Tall Oak began in January 2024. They accelerated over the summer after the Houston-based company had completed the sale of its assets in the Marcellus and Utica shales and closed a debt refinancing.

“We started discussing what it would look like to merge this asset into their company, and it was a really interesting fit,” said Lipscomb.

Talks centered on a deal that would see Tailwater receive cash and take a stake in Summit. Initially, a potential USD 525m deal, comprising of USD 142m in cash, and USD 383m in equity was discussed in July, according to Summit’s preliminary proxy statement. A deal was eventually struck at around USD 450m, with USD 155m paid in cash and approximately 7.5m in shares, representing an around 40% stake in the pro forma company, according to a press release.

“If the business earns certain metrics over the next 12-18 months, Tailwater will receive additional value in the form of cash considerations,” said Lipscomb. Tailwater could receive up to USD 25m, according to the press release.

The sponsor’s shares are convertible to common stock in Summit after the deal closes later this quarter and are subject to a one-year lock-up period. Tailwater Energy Fund III will own approximately 35%, and Tall Oak’s management will own approximately 5%, Lipscomb said.

A recent conversion from a Master Limited Partnership structure to a C Corporation has resulted in Summit’s average daily trading volume double to 70,000. Tailwater has no plans to sell the shares for now, however.

“We will not be selling our stock and then sending cash back to our investors for a while because we have a long-term view on the business and believe it is poised for meaningful growth going forward,” said Lipscomb.

For Summit, which divested its assets in the gas-heavy Marcellus and Utica shales earlier this year,  one of the main attractions was Tall Oak’s mid-continent gas exposure, said the company’s CFO, William Mault. The deal will allow it to achieve a balance between gas-weighted and crude oil-oriented drilling.

“What really appealed to us about the mid-continent and Tall Oak was its proximity to the Gulf Coast,” he said. “We think that that is going to be a long-term demand center.”

The Tall Oak deal was valued at approximately 5.6x the company’s expected adjusted EBITDA for 2025. Summit Midstream itself currently trades around 7x.

A further benefit for Summit is that the deal will help bring its leverage down from 4.4x to 3.8x after closing, noted Mault. The transaction was structured so that Tailwater received sufficient cash to pay down Tall Oak’s USD 150m debt, said Lipscomb.

The deal also comes after several years of Summit playing defense after a COVID-19-induced downturn, added Mault. Among measures taken to bolster its balance sheet, Summit had also sold assets in the Delaware Basin in New Mexico and North Dakota’s Williston Basin in 2022.

“It was a neat opportunity for us to do a win-win transaction,” said Liscomb. “There’s just not that many mid-market, publicly-traded midstream companies today where you could do something like this.”

Looking ahead, further midstream acquisitions could be on the horizon. Tailwater is currently deploying Fund IV, which closed on USD 1.1bn in 2020.

The sponsor, which looks at opportunities for companies with EBITDA of USD 25m up to USD 175m, is particularly focused on potential opportunities for assets in the Eagle Ford, Permian, Eagle Ford, Haynesville, Bakken and Denver-Julesburg basins, noted Lipscomb.

“The midstream market today is incredibly compelling,” he said.

Tudor, Pickering & Holt was Tailwater’s financial advisor on the deal. Kirkland & Ellis provided legal advice.