Good morning. Welcome to the Antero Resources Investor Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note today's event is being recorded. I would now like to turn the conference over to Michael Kennedy, Senior Vice President of Finance. Please go ahead, sir.
Thank you for joining us for AR's Investor Conference Call to discuss our simplification transaction and share repurchase announcement. We'll spend a few minutes going through transaction highlights, and then we'll open it up for Q&A. I would also like to direct you to the homepage of our website at www.anteroresources.com, where we have provided a separate call presentation that we'll review during today's call, as well as a supplemental presentation on natural gas liquids. Before we start our comments, I'd first like to remind you that during this call, Antero management will make forward-looking statements. Such statements are based on our current judgments regarding factors that will impact the future performance of Antero Resources, Antero Midstream, and AMGP, and are subject to a number of risks and uncertainties, many of which are beyond Antero's control.
Actual outcomes and results could materially differ from what is expressed, implied, or forecasted in such statements. Today's call may also contain certain non-GAAP financial measures. Please refer to our earnings press release for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures. Joining me on the call today are Paul Rady, Chairman and CEO of Antero Resources, and Glen Warren, President and CFO of Antero Resources. Throughout the call, Paul, Glen, and I will be discussing details of today's announcement. With that, I will now turn the call over to Paul.
Thanks, Mike, and thank you to everyone for listening in to the call today. I'll begin my comments today with the transaction summary and how the midstream simplification benefits AR. We will move on to a discussion of the share repurchase program we announced this morning and conclude with commentary on natural gas liquids, given the substantial movement in prices over the last few months. Before getting into the numerous merits of the transaction, I want to highlight the key objectives for the special committee on slide number four, titled "Special Committee Process Objectives." When we tasked our special committee with evaluating potential transactions and alternatives among the Antero family, we focused on five key objectives. The first was evaluating an accelerated timeframe to return capital to shareholders.
Our second objective was to align the interests of management, our private equity sponsors, and all of our equity holders to address the perceived conflict of interest across the shareholder base. The third objective was to simplify the current corporate structure in order to unlock shareholder value and appeal to a broader base of investors. Fourth was achieving a win-win-win across the Antero family. We did not believe there was an entity that was disadvantaged or in a position of weakness. For that reason, any transaction had to improve the financial profile and deliver accretion to all entities. Lastly, we wanted to maintain our integrated strategy of the upstream and midstream business. We strongly believe in the tangible and intangible benefits of owning the midstream business and the value of the integrated model.
Our vision and long-term strategy remains unchanged. We believe this is the best way to create value and deliver it to our upstream and midstream shareholders. Glen will now discuss the details of today's announcement.
Thanks, Paul. Let's turn to slide number five, titled "AR Strategic Announcement." We are pleased to announce that we have completed the special committee process. The result of the process is a midstream simplification transaction where AMGP will acquire AM in a cash and stock transaction and eliminate the IDRs. We will discuss the details on how it impacts AR in a moment. We believe this transaction creates a best-in-class Appalachian midstream corporation in the most tax-efficient and investor-preferred structure. Additionally, AR announced its $600 million share buyback program to be completed over the next 12 to 18 months, which is expected to be fully funded by a combination of proceeds from the simplification transaction and expected free cash flow to be generated over that time period, starting in the fourth quarter this year.
Importantly, the share repurchase program is predicated on our standalone leverage being maintained at or below 2.25 times by year-end 2018 and at or below 2.0 times by year-end 2019. To get into the details of the midstream transaction, I'll direct you to slide number six, titled "Midstream Simplification Transaction Overview." AMGP is acquiring all of the outstanding public AM units, including units owned by AR. AR will receive all in consideration of 1.78 AMGP shares for $30.43 per AM unit based on yesterday's closing price. AR will receive approximately $300 million plus 1.6023 shares of new AM, subject to proration to ensure that the aggregate amount of cash consideration paid to all AM unit holders equals $598 million. That's the cash pool.
The simplification transaction eliminates the IDRs and represents a 3% premium to AR based on yesterday's close, and a 15% premium to the unaffected price prior to the formation of the special committee in February. The new entity, which will be renamed Antero Midstream Corporation, or New AM, will be treated as a corporation for both tax and governance purposes, meaningfully improving shareholder rights and voting power. The transaction is taxable to all AM unit holders, resulting in New AM receiving the benefit of a tax basis step-up, which will shield future corporate level taxes for New AM. Cash taxes at the AR level are shielded through the use of its $3 billion of NOLs as of year-end last year. Even with the utilization of the NOLs, AR does not expect to change its prior outlook as a non-cash taxpayer over its long-term forecast.
New AM is also not expected to pay material corporate-level taxes through at least the year 2024. This tax efficiency is key to the transaction, as it allowed for accretion to both parties and enabled New AM to target a dividend policy that keeps AR whole on the existing distribution targets on a per unit basis through the year 2022. The transaction is subject to a majority of minority vote and is expected to close in the first quarter of 2019. Slide number seven, titled Antero Simplified Pro Forma Structure, portrays the current Antero family corporate structure on the left-hand side of the page and the pro forma structure on the right. This transaction simplifies Antero's corporate structure into one upstream and one midstream entity, both structured as C-corps.
Importantly, through this transaction, we have aligned the ownership of sponsors and management and Antero Resources, each owning the same security in New AM. As co-founders with a significant ownership, we will remain highly aligned with both our upstream and midstream investors and will continue to operate the business with our proven integrated strategy and long-term vision.
Moving to slide number eight, titled New AM Same Cash Distribution Targets. New AM will target a dividend of $1.24 per share in 2019. Using the $1.24 per share in 2019, multiplied by the AR unit holder exchange ratio of 1.776 times, results in a distribution to AR of $2.21 per unit, the same as AM's previously communicated status quo 2019 distribution target of $2.21 per unit. In 2020, New AM will continue to target distribution growth of 28%-30%, year-over-year distribution growth remains the same at 20% in both 2021 and 2022. The cash consideration from the transaction, along with the dividend policy, keeps AR whole on all of the previously communicated distribution targets and year-over-year growth rates at AM.
Additionally, Antero Midstream will target an increased DCF coverage ratio of 1.2 times to 1.3 times to maintain financial flexibility and for further delevering into the low 2 times range, which is the same 2022 leverage target as status quo AM.
Turning to slide number nine, titled Share Repurchase Program Details. The AR board has approved an initial $600 million share repurchase program, which represents over 10% of shares outstanding based on yesterday's closing price. The program is expected to commence in the fourth quarter of 2018 and is authorized over the next 12 to 18 months, providing the flexibility to be opportunistic with respect to market conditions. The program is expected to be fully funded through a combination of at least $300 million in cash proceeds from the midstream simplification transaction and from a portion of the expected free cash flow generation over the next 12 to 18 months.
It is important to note that we will maintain a disciplined approach and be opportunistic about buying back shares as our balance sheet remains the top priority, with standalone leverage expected to be at or below 2.25 times by year-end 2018, and that's including some share repurchase, and at or below 2 times by year-end 2019 with the same, which is in line with our prior targets. Slide number 10, titled Share Repurchase Program Funding, provides a summary of this fully funded program.
Directing you to slide number 11, titled Compounding Leverage to Improving NGL Prices. I want to briefly discuss our leverage to liquids pricing as it serves as a key driver in our ability to generate free cash flow.
As depicted with the green bars, Antero's C3+ NGL production has increased by approximately 84% from 2015, which translates to a 22% CAGR. Over the same period, C3+ NGL prices have improved by 94%. The combination of significant NGL production growth with increasing liquids pricing results in compounding exposure to improving NGL prices. As you can see on slide number 12, titled "Leader in Leverage to NGL Prices," based on 2018 consensus estimates, Antero is the top NGL producer in the U.S. With NGLs accounting for 33% of pre-hedged commodity revenue, AR currently delivers the highest exposure to rising NGL prices among top producers.
Before I review the substantial revenue uplift from liquids that AR is positioned for, I want to remind everyone that these liquid slides being reviewed today are a subset of a new, more comprehensive liquids presentation that we uploaded to our website today that details our premier liquids plan and platform. Slide number 13, titled "Powerful C3+ NGL Pricing Upside Exposure," details this compounded pricing leverage and how it drives cash flow growth. The chart illustrates the impact on C3+ NGL revenue for the second half of 2018 and 2019 with respect to increased volumes, improved prices, and pricing uplifts from our Mariner East 2 commitments. As shown on the chart, every $5 per barrel change in NGL prices is expected to generate an incremental $170 million in revenue.
Based on the current strip prices and approximately 20% production growth, this translates to incremental 2019 revenue of $330 million to $500 million as compared to 2018. Similarly, on slide number 14, titled "Antero's Ethane Exposure All Upside," portrays Antero's exposure to ethane pricing upside. Using strip pricing and assuming 20% production growth in 2019, every $0.10 per gallon increase in ethane price translates to approximately $40 million in incremental revenue. Based on strip prices and expected ethane volume growth, this projects to approximately $100 million of incremental revenue in 2019 relative to 2018 from ethane alone. Given these liquids pricing tailwinds, it is important to highlight that Antero offers substantial liquid scale and exposure to improving prices at a discounted value.
As you can see on slide number 15, titled "Antero's Liquid Scale at Attractive Value," Antero's liquid scale, inclusive of ethane, C3+ and oil for both production and revenue, compares favorably to that of well-known Permian operators, as shown on the chart on the left. With Antero being the only producer that trades at or below five times despite its growth and scale, the chart on the right highlights the significant valuation disconnect between Antero and these producers.
The aforementioned exposure to strong NGL prices, combined with tremendous production growth in the second half of 2018, a focus on operating efficiencies and capital discipline has brought Antero to an inflection point. Antero's standalone free cash flow profile is outlined on slide number 16, titled "Near Term Free Cash Flow Inflection Point." As highlighted by the yellow arrow, Antero is at an inflection point with sustained free cash flow generation beginning this quarter, the fourth quarter of 2018. During 2019, we expect to generate at least $500 million in free cash flow, which will be used in part to opportunistically return capital to shareholders through the announced share repurchase program. Over the next four-year period, we anticipate free cash flow of $1.6 billion based on year-end 2017 prices and the five-year drilling and completion capital forecast.
Slide number 17, titled "Capital Discipline Leads to Free Cash Flow," further illustrates our commitment to sustained free cash flow generation through capital discipline. With a 48% reduction in drilling and completion capital and a 15 rig reduction since 2014, we have been able to close the gap on outspend versus free cash flow. Now that we have reached an inflection point, our future capital budgets and rig programs are designed to be measured and consistently within cash flow. Staying on the topic of financial discipline, slide number 18, titled "Financially Disciplined Repurchase Program," emphasizes our priority to reduce our standalone net debt to EBITDAX multiple to at or below 2.25 times by year-end 2018 and at or below two times by year-end 2019.
With these disciplined leverage parameters in place, AR has the potential to return $3 billion to $3.5 billion of capital over the next four years, which represents 50%-60% of AR's current market cap based on current prices. Looking at only the approved 18-month share repurchase time period, we have the capacity to return upwards of $1.3 billion while maintaining leverage at or below two times. We continue to differentiate ourselves by executing on our long-term strategy. We remain committed to creating value for our shareholders by focusing on our extensive liquids-rich inventory and delivering on our long-term targets, including a declining leverage profile to at or below two times by the end of next year.
As shown on slide number 19, titled "Antero Profile to Drive Multiple Expansion," this momentum will place Antero in an elite group of just five other E&P companies that have scale, double-digit production growth, low leverage, and generate free cash flow, all of whom trade at premium multiple valuations relative to Antero. Given the steep valuation discount to our peers, we believe share repurchases are an extremely attractive use of our projected free cash flow.
Turning to slide 20, titled Simplification Transaction Highlights and Benefits to AR, today's announcement provides significant benefits to AR's long-term outlook. First, AR will receive at least $300 million of cash from the midstream simplification to fund a portion of the share repurchase and de-levering program. Secondly, the elimination of the IDRs, along with AR's ownership of the same midstream security as the sponsors and management, addresses the perceived misalignment of shareholder interest. Third, the creation of a midstream C-corp will broaden the investor base and improve stock liquidity. Lastly, AR will maintain its integrated strategy as the largest shareholder of Antero Midstream with a 31% pro forma ownership, which we believe is a key competitive advantage. With that, operator, let's open the lines for questions.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Holly Stewart of Scotiabank. Please go ahead.
Good morning, gentlemen.
Morning.
Maybe first, Paul, just thinking about how the changes to the midstream structure, how this could change your long-term ownership thoughts of midstream.
Well, there's really no change in the sense that really gives AR a good competitive advantage to be so integrated with AM and with the just-in-time capital and so on. It doesn't change its long term. We do feel that AR will continue to hold a significant ownership in AM.
Okay, great. Maybe just a follow-up to that. I guess maybe Glen, if you could remind us what level of ownership, and maybe this changes that level of ownership that you have to have to keep it consolidated.
Yeah. Consolidation is not really driven by the ownership level here. From an accounting standpoint, it's really driven by the contract situation between AR and AM. AM is essentially a sole provider for AR and vice versa. The contracts are long-term contracts in place, and AM doesn't have a lot of third-party business at this point. That's really the key driver. I think that longer term, if AM had quite a bit more third-party business, that would be a driver towards the consolidation, Holly, but not the % ownership.
Okay. I was just trying to make sure that this change in structure didn't change that at all.
It didn't.
Okay, great. Maybe just since you guys pointed out the NGL exposure, could you just talk a little bit about where you stand currently on recovery versus rejection of ethane?
Yeah. Today we're recovering between 40,000 and 43,000 barrels a day of ethane. We have about that De-ethanizer space. We have a new De-ethanizer that's coming on within the next month that gives us at least another 20,000 barrels a day of ability to recover. We'll probably climb in ethane recovery. Meanwhile, we are rejecting about 85,000 barrels a day of ethane and leaving it in the gas stream. We will be recovering more. The frac spread, of course, has improved dramatically for TCO equivalent net of De-ethanizer for our ethane. We do see more recovery in our future. There are successive De-ethanizers that are being built for us at Sherwood and our new processing complex at Smithburg. I think as long as frac spreads stays strong for our ethane, we'll continue to climb in our ethane recoveries.
Great. Maybe just one final one from me. Could you just tell us where you stand or where the project, I guess, stands right now for ME2 and those volumes starting to move?
Yeah. ME2 is almost there. As you're probably aware, they have an approved workaround for the very short segments that were delaying them in the Philadelphia area. Energy Transfer has forecast a November 1 opening for ME2. We can see the light, we can see their reasoning. We support that and are planning for it to increase. With that, rather than selling our C3+ into the Northeast market or railing it to other destinations, we'll be moving at least 50,000 barrels a day of C3+ through ME2 for international export beginning in early November.
Great. I appreciate it, guys.
Thank you, Holly.
Thanks, Holly.
Our next question comes from Sean Sneeden of Guggenheim. Please go ahead.
Hi. Good morning, and thanks for taking the questions.
Morning, Sean.
Glenn, maybe for you. Can you talk a little bit about how you weigh the trade-off between debt or leverage reduction in share buybacks as you go through the plan that you guys have articulated here?
Yeah. I'd say the bias is towards leverage reduction in the near term. We're on a great trajectory for investment grade here before too long, and we want to stay on that trajectory. We're just at such a nice inflection point with the free cash flow coming in and very much being driven by liquids prices and our exposure to liquids. It puts us in a great position to be balanced and to be able to repurchase shares opportunistically, but first and foremost, continue to delever.
Okay. That's helpful. I guess, is there a point that you'd feel extraordinarily comfortable in terms of leverage? Is that like a one and a half times type of number, or how do you guys think about the trajectory there?
Yeah. I think under two times, and that's why we set that threshold level where we don't plan to repurchase shares if leverage next year is looking to end up at two times or more, we'll not be repurchasing shares. I think you can see from our forecast that we expect it to be well below that. There's quite a buffer there, assuming current commodity prices to both repurchase shares and delever. I think you're right that the one and a half to two times is a nice target for an entity of our size.
Got it. That makes sense. Maybe just lastly, when you think about the strategy when you laid it out at Analyst Day, compare that to how you think about the post-simplification world. Does the trajectory towards investment grade look accelerated at this point, or how are you guys thinking about that playing out?
No, I think it's pretty similar because, at the time, year-end commodity prices last year, you had quite a backwardation in NGL prices. The starting point was lower. You've had quite a run in NGLs. While C3+ makes up about 33% of our revenues, we also have ethane exposure as well as oil production is now up in the 10,000 barrel plus per day range. Quite a liquids contribution that's up in that 40% range now and climbing. We expect that with the current forecast to climb up towards 50% of revenue here over the next year or two. I'd say we're in a stronger position overall in terms of being able to both delever and to repurchase shares.
That's helpful. Thank you very much.
Thanks, Sean.
Ladies and gentlemen, this concludes our question and answer session.