Good day, ladies and gentlemen, and welcome to the Targa Resources Corp acquisition of Delaware and Midland Basin assets. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Jennifer Kneale, VP Finance. Ma'am, you may begin.
Thank you, Crystal. I'd like to welcome everyone to our call to discuss the exciting announcement made this morning that Targa Resources Corp, Targa or the company, has executed definitive agreements to acquire 100% of the membership interest of Outrigger Delaware Operating, LLC, Outrigger Southern Delaware Operating, LLC, together Outrigger Delaware, and Outrigger Midland Operating, LLC, which we'll refer to as Outrigger Midland, and collectively we will refer to the entities as Outrigger Permian, and to the acquisition of the entities as the transaction. We are also very pleased to announce that we priced an underwritten public offering of 8 million shares of our common stock at $57.65 per share, which was upsized from the previously announced offering of 7 million shares. Barclays also has a 30-day option to purchase up to an additional 1.2 million shares of common stock.
Targa expects to receive net proceeds of approximately $455.7 million or approximately $524.1 million if Barclays exercises in full its option to purchase additional shares of common stock. We published a press release and a presentation related to the acquisition announcement earlier this morning, and a press release related to the pricing of our common stock in the investors section of our website at www.targaresources.com. We will be referring to this investor presentation during our prepared remarks. I would like to remind you that any statements made during this call that might include the company's expectations or predictions should be considered forward-looking statements and are covered by the safe harbor provision of the Securities Acts of 1933 and 1934. Please note that actual results could differ materially from those projected in any forward-looking statements.
For a discussion of factors that could cause actual results to differ, please refer to our SEC filings, including the company's annual report on Form 10-K for the year ended December 31st, 2015, and quarterly reports on Form 10-Q. Please also note that Targa's acquisition of Outrigger is subject to customary closing conditions, including approval under the Hart-Scott-Rodino Antitrust Improvements Act. Speaking on the call today will be Joe Bob Perkins, CEO; Pat McDonie, EVP Southern Field Gathering and Processing; and Matt Meloy, CFO. Joe Bob will begin the prepared remarks with some highlights, and then we'll turn it over to Pat to discuss the assets and operations of Outrigger Permian, and then Matt will discuss the structure and financial aspects of the transaction. We will then open the line up to questions. With that, I will turn the call over to Joe Bob.
Thanks, Jen. I'd like to add my welcome and thank everyone for joining us this morning. It's been a busy weekend and a busy morning, as you can imagine, and I'm glad you're on the phone with us to share the good news. First of all, I want to tell you how excited I am to announce this morning that Targa has executed definitive agreements to acquire three Outrigger entities with assets across some of the most prolific Permian Basin acreage in an acquisition that is highly complementary to our existing Targa footprint. We are acquiring assets in the Delaware Basin and the Midland Basin for $565 million of initial consideration.
Based on the future realized performance of the existing contracts in place at about closing, Targa may make two additional payments to the owners of the Outrigger entities based on performance through the end of February 2018 and the end of February 2019. Matt will describe that structure in more detail in later comments. Concurrent with the transaction, as Jen mentioned, this morning we launched a seven million share bought deal offering of TRGP common stock. Based on demand, that deal was upsized to eight million shares. This is a strong statement of the support that the market has for Targa. That offering, combined with cash in hand from operations and equity issued via our ATM program during the fourth quarter, makes it such that we have no further equity needs relative to the initial payments for the Outrigger sellers.
You may have seen under the headline of our press release six bullet points that we wanted to highlight related to the transaction. I know six bullet points in the headline may be a little excessive, and it looks a lot like Joe Bob, but this is a very good deal. I'd like to describe the six bullet points in a little more detail. Beginning with bullet point number one. The $565 million initial cash consideration represents a 9x 2017 estimated EBITDA multiple. We think that this is an excellent example of buying well, creating a structure that works both for Targa and the sellers, and one with reasonable initial consideration based on this year's expected performance, and then to the extent that future expectations for growth are realized, additional payments will be made.
Bullet number two: These are attractive fee-based natural gas gathering and processing and crude gathering assets in the Permian Basin backed by long-term contracts. There's a lot in that bullet. Permian Basin, fee-based, gas and crude, and backed by long-term contracts. Importantly, these are assets underpinned by dedicated acreage in some of the most geologically attractive areas of the Permian Basin, where producer results in and around these assets continue to get better and better, and where producers have a deep inventory of drilling locations with some of the best well economics in the world.
We have previously discussed our commercial focus on expanding the Targa footprint deeper into the Delaware Basin and some of the steps that we have already taken, such as the ongoing build-out of our Versado and Sand Hills systems further into the Delaware and the October 31st close of the acquisition of Chevron's 37% interest in Versado, so that we now own 100% of that system. If you look at the map on page six, and I like maps, page six of our investor presentation, the Outrigger Delaware assets are very well-positioned between our Versado system in the north and our Sand Hills system further to the south. Also, since acquiring the Badlands at the end of 2012, we've been interested in identifying opportunities to bring our crude gathering expertise to other basins.
We believe the Outrigger Permian crude assets in both the Delaware and Midland basins provide us with an excellent platform to add a new Permian business line with significant growth potential. With respect to that term long-term contracts, the weighted average contract tenure is over 13 years of remaining life. Moving to bullet number three. The acquisition increases Targa's gross processing capacity to approximately 2 billion cubic feet per day across the Permian Basin by year-end 2017. Importantly, looking forward, the combination of Targa's assets and Outrigger's assets will provide significant operational and capital synergies, which Pat will describe in more detail. Of course, Outrigger assets and customers will now soon benefit, as soon as we connect them, from being a part of a multi-plant, multi-system network in the Permian Basin. Bullet number four.
We are adding over 250,000 acres dedicated under long-term contracts from a strong mix of operators in the Delaware and Midland basins, further diversifying our already strong customer base and increasing our already high exposure to active rigs across the Permian Basin. We now estimate that Targa has approximately 2 million acres dedicated to us across the Permian Basin, and I believe that positions us very well for growth going forward. We have a bias, a continued bias that the Permian Basin is just about the best place to be in the hydrocarbon business in the world. Bullet number five. We have structured the transaction such that there are future potential performance-linked earn-out payments based on attractive multiples of gross margin from existing contracts in place at our closing.
To be clear, no additional consideration beyond the $565 million is guaranteed, and any other payments to the sellers will be based on the realized gross margin of the existing contracts. As you know, through 2015 and 2016, Targa took numerous key steps, for example, the MLP buyout and the preferred offering to improve our balance sheet strength. We are always looking for potential deals, especially the needle-in-the-haystack deal. This is a needle-in-the-haystack deal. A perfect fit at the right price, but with a priority focus on protecting our balance sheet. This transaction is a special opportunity using our relative financial strength and asset position to create a great fit. We are the natural owner of these assets and utilizing a structure that works well for Targa and the sellers. Lastly, and very importantly, bullet number six. This transaction is accretive to distributable cash flow in 2017 and beyond.
To reiterate what we mentioned earlier, with proceeds from our now upsized 8 million share offering of TRGP common stock, cash in hand, and availability under our revolver, we have no additional equity needs related to the initial payments for the transaction. By protecting our balance sheet, by over-equitizing the purchase, this transaction will actually reduce Targa leverage. As Pat and Matt discuss the assets and structure in more detail, I think you'll hopefully get even more of a sense for why this fits our needle-in-the-haystack criteria for the acquisitions in this environment, and why this is a really good deal for Targa and our investors. With that, I'll turn it over to Pat.
Thanks, Joe Bob, and good morning, everyone. We certainly think that if you look at the map on page six of our presentation, Targa looks like the natural buyer of Outrigger's assets, given how well they fit with our existing footprint. Looking forward, we have compelling opportunities to realize operational and commercial synergies across our combined footprint and are extremely well-positioned to capture increasingly active upstream activity. As Joe Bob mentioned, we have approximately two million acres dedicated to us in the most prolific basin in the world. Importantly, a strong platform to continue to grow our footprint and leverage our existing asset base. Over 50% of the rigs added in North America since the rig count hit its trough in May of 2016 have been added in the Permian, and the outlook feels like it is only getting stronger.
Based on our estimates, approximately 65% of the rigs currently active in the Permian Are within a 10-mile radius of Targa assets. We view this transaction as a bolt-on to our existing assets. We had a position on the edge of the Delaware from a couple of our systems, but now have a much stronger position in the Delaware. In the Midland Basin, we have a great footprint in West Texas and SAOU. This was an opportunity to move further north into Howard and Borden Counties. Let's start with discussing the Delaware basin in more detail using page seven for reference.
First, I take my hat off to the Outrigger management team and employees for identifying opportunities in the Delaware ahead of others, taking some risk and putting themselves in position to work with a diversified group of producers across great acreage to gather and process natural gas and gather crude. We have seen a number of Delaware-based E&P deals get announced recently, and producer excitement over the rock quality and the high number of producing de-risked zones is contagious. With this transaction, we are adding more than 145,000 acres in Loving, Winkler, and Ward Counties under long-term fee-based dedications. We are also adding processing capacity with Outrigger's 70 million cubic feet per day processing plant in Loving County.
After closing the transaction, we expect to immediately begin construction to connect Targa's existing Sand Hills system with Outrigger's Delaware assets, we will be able to offload volumes into the Sand Hills system. Sand Hills is already connected to our SAOU system through our Midland County pipeline, our SAOU and WestTX systems are already connected. We will now be able to integrate the Outrigger Delaware assets into that expansive super system. This will provide us with significant flexibility, allowing us to more efficiently use capital as we continue to further expand our footprint. This will provide our customers benefits from being part of a multi-plant, multi-system Permian Basin network. At that point, Versado will be the only Targa system not connected to the rest of our Permian Basin systems.
We have growth plans for Versado as well and expect that over time, all of our Permian systems will be connected. We will also be assessing opportunities to add processing capacity, given our expectations for future growth. Additional expansions will be planned to optimize the entire western part of our assets. Turning to page eight of the investor presentation, you can see that similarly in the Midland Basin, Outrigger management and employees identified opportunities to work with producers on great acreage. As activity in the Midland Basin has continued to extend to the north and acreage has continued to prove up, Outrigger developed an attractive system for both crude and gas. With this transaction, we are adding more than 105,000 acres in Howard, Martin, and Borden Counties under long-term fee-based dedications.
We are also adding a little bit of additional processing capacity with Outrigger's 10 million cubic feet per day processing plant in Martin County. We'll begin the process of connecting Outrigger's assets to our WestTX system. Again, where the assets and customers will benefit from being part of a multi-plant, multi-system network. Joe Bob mentioned that we have been looking for the right opportunity to add crude gathering in the Permian as a commercial business line for Targa. With this transaction, we are adding pipeline infrastructure with capacity to gather approximately 80,000 barrels per day of crude and 20,000 barrels of tank storage. Looking forward, we expect to be able to use that infrastructure to grow our crude gathering footprint across our dedicated acreage and to leverage the assets in place to compete for additional opportunities.
We will combine the new assets and customer contracts with expertise and infrastructure that we already have at Targa related to crude gathering as a result of our Badlands operations and really think that this is a business line that has significant growth potential with our deep customer relationships across the Permian Basin. With that, I think we've covered the high-level asset points that I wanted to make, I'll turn it over to Matt to discuss transaction structure and financing. Matt?
Thanks, Pat. Before I go over the transaction structure, I wanted to make sure that everyone saw our 8-K, which included some preliminary fourth quarter and full year 2016 results. We announced that we expect to report that LPG export volumes for the fourth quarter of 2016 averaged approximately 205,000 barrels per day or approximately 6.3 million barrels per month. We also expect that our fourth quarter performance is expected to result in dividend coverage that exceeds 1.2 times. For 2016, we expect annual dividend coverage to exceed 1.05 times. I'd like to provide some brief color around our thinking related to the structure of the transaction. I'll go into the details around consideration and earn-out.
From our perspective, this was a really attractive way for us to structure an acquisition of developing assets. The initial consideration of $565 million represents an estimated 9 times multiple of 2017 expected EBITDA. Going forward, if producers continue to be active on the dedicated acreage and volume growth materializes, we will pay the Outrigger sellers up to two additional earn-out payments, up to a cap where the total consideration of the initial payments and the earn-out payment cannot exceed $1.5 billion. The earn-out payments are attractive multiples of less than 10 times realized annual gross margin on existing contracts in place at our estimated closing. As Targa continues to add new contracts and continue to grow these footprints further, gross margin from new business contracts and acreage would not be included in the earn-out payments.
Looking forward two years, we will be paying the Outrigger sellers appropriate earn-out payments based on the performance of their current contracts. Strong performance from those contracts would be very good for the sellers and very good for our Targa shareholders, who will find their accretion increasing as we pay toward or at the maximum through significant volume growth materializing on the Delaware and Midland Basin systems. Based on our forecast, supported by our decision to over-equitize through our initial 7 million share offering that was upsized to 8 million shares, this transaction is expected to be accretive to distributable cash flow in 2017 and beyond. The structure of the transaction helps support Joe Bob's needle in a haystack comment.
We are acquiring systems across attractive acreage in a deal that has been de-risked through the earn-out structure and are over-equitizing the initial payments to improve our strong balance sheet while providing expected accretion to our shareholders. Let's now turn to some of the specifics of the structure, which are summarized on page nine of the investor presentation. As we have said previously, the initial consideration is $565 million. Turning to the earn-out, let's walk through all the pieces. First, the timing. The potential earn-out payments are structured for two 12-month periods that end in 2018 and 2019. The first 12-month period ends at the end of February 2018, and the second period ends at the end of February 2019. The earn-out payments for each 12-month period are based on a multiple of gross margin realized over those periods from only the existing contracts.
Any contribution from new contracts is not included. The specific gross margin earn-out multiples for each system are as follows. The Delaware Basin multiple for the first 12-month period is 9.75 times. The Midland Basin multiple for the first 12 months is 9.25 times. For both systems, the multiple for the second 12-month period is 8.75. Any earn-out payments made in 2018 and 2019 are reduced by the initial consideration and by any previous earn-out payments paid. To reiterate, the gross margin used is only for those contracts that come with the acquisition. The margin for new deals that Targa adds is not included. As previously mentioned, as contingent payments increase from existing contracts in place, Targa shareholder accretion also increases. As Targa adds new commercial contracts, accretion associated with the transaction is even higher.
Again, there is a total cap such that combined, the initial consideration and potential earn-out payments to the Outrigger sellers cannot exceed $1.5 billion. Strong performance from existing contracts above that contingent payment level only accrue to the benefit of Targa shareholders. In summary, we believe that for TRGP shareholders, this transaction represents the bolt-on of attractive assets in areas where we want continued strong exposure with long-term fee-based contracts across a diverse and attractive group of producers. Opportunities to leverage our expertise, relationships, existing assets, and infrastructure to support continued operational and capital-efficient development of our footprint, which should translate into continued growth.
A transaction that is accretive to distributable cash flow in 2017 and beyond, a transaction that we are funding significantly with equity, which will reduce risk and leverage, and a de-risk structure where growth is only paid for the extent it materializes and is realized and is only based on current contracts. With that, we would like to thank you all for your interest and open the call up to questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once again, to ask a question, please press star and then one now. Our first question comes from T.J. Schultz from RBC Capital Markets. Your line is open.
Great. Thanks, guys. Congratulations. Are there any processing expansions out at Outrigger that need to be completed or additional CapEx transferred to Targa? Or are your near-term incremental costs primarily just to connect the two systems?
T.J., you sort of answered the question. Our immediate focus will be to connect the two systems. That's our advantage relative to a standalone owner, making it part of the existing Targa systems. At that point, capital benefits the Outrigger system, our larger multi-plant systems, and the multi-systems that are part of the overall Targa network. We have an advantage in terms of meeting producer needs by spending capital more efficiently and having our operating costs be more efficient relative to a standalone player. We'll be doing that to keep up with producer needs. There are no capital project transfers. We're going to continue doing the same good things that Outrigger was doing, with the benefit of being able to connect to our existing systems. The faster producer development occurs, the more capital we will have to spend to keep up, that is virtuous.
We built that into our statement that the accretion will increase as the contingent payments increase. We're not going to be giving you capital guidance for the Outrigger system that is now one of the fingers fitting inside of the Targa glove. We may, at our next earnings call, provide some 2007 CapEx, as we disaggregate that, it's more likely to look like Permian CapEx than Outrigger CapEx.
Okay. That makes sense. Next question is, I appreciate the advantages of the earn-out structure, clearly volumes look poised to ramp. I think when I consider, or when you guys consider potential synergies in the basin and further downstream, what I'm trying to get to is there an EBITDA multiple? You gave the multiple on the initial payment for 2017, as we look kind of further out, once things have grown, is there an EBITDA multiple you are targeting once the assets have ramped over the next few years?
No, there's not a target EBITDA payment. The structure of multiples on gross margin is articulated. In many ways, that's a fairly short-term contingent payment based on what does the success look like to that point. Any increasing contingent payments up to and at the cap are bringing additional accretion to our shareholders. Beyond the cap is all to our shareholders. Beyond existing contracts is all to our shareholders. Operational and capital synergies are all to our shareholders. There's not a target multiple. I would describe the initial EBITDA multiple, which we publish, as attractive, and it gets more attractive from there.
Okay, fair enough. Just lastly, on the producer profile, on the acreage dedications from Outrigger, if you could just give a little more color, how many producers, kind of what's the mix of private and public operators and as they move into development mode, just any commentary on expectations for rig activity. I'll leave it there. Thanks.
Okay. We described it in the script as a attractive mix of producers. They're both public and private. Some recent transactions have occurred around the Outrigger system, and there's some public statements that say that Outrigger was their midstream company. The only ones I'm aware of doing that are RSP Permian and Jagged Peak, which I guess would be an example of private going to public. Aside from that strong mix has proved their success at developing and exploiting oil in the Midland Basin and the Delaware Basin. That's probably all I have to say about customers. You know our policy, T.J. We tend not to talk about our producer customers unless they're acknowledging that we are their midstream provider.
Thank you. Our next question comes from Brandon Blossman from Tudor, Pickering Holt. Your line is open.
Good morning, everyone.
Good morning, Brandon.
Good morning.
Matt, is there any more color on the line items between EBITDA and gross margin here in terms of your 2016 and then 2017 and 2018 multiples?
Yeah, sure. The lion's share of that is going to be operating expense. It's really OpEx. We don't allocate G&A down to the business unit, and I don't see much incremental G&A, so it's really just operating expenditure. Or, I'm sorry, OpEx.
OpEx. In order of magnitude, how should we think about that relative to the gross margin?
Yeah. We don't break out for you OpEx by system. I would say if you look out in this area, we have our Sand Hills system and our Versado system, which those are older facilities that have higher OpEx. If you've been able to parse in the past OpEx for some of those systems, you'd probably come up with a little higher number than what we'd be experiencing here on this system. This will be new equipment, new facilities, which will have lower OpEx. I would say probably on average for the Permian, this will be lower than our average OpEx would be, and we'll be able to tie it into existing Sand Hills, which will just be then suffering from incremental OpEx, which is generally on the margin. Margin OpEx is lower than a fully burdened OpEx.
Okay. Thank you, Matt. Just one more for you. The cash payments for the earn-outs, are those due February in 2018 and 2019 or before or after that?
They're due after that. There's a window. It'll likely happen in Q2. We'll have some time to get through the 12 months, prepare what we think the number is, and then deliver that to the sellers. We'll have a period of time there, and Q2 would be the target for when that happens.
The preparation is not complicated, but it takes a little bit of time after the end of the period.
Right.
It only applies to the existing contracts, those contracts that are in place at about close. There obviously will be parts of operating margin that are not included in the calculation.
Understood. Then the last one for me. It sounds like there's some fairly clear line of sight operating synergies here. Probably for Pat, what's the timeline to recognize those near-term operating synergies?
Really immediately. The Delaware system basically crosses our Sand hills system, we will implement an interconnect there almost immediately. Again, on the Midland system, we will integrate that into our WestTX system, we'll do that pretty quickly also. Pretty quick.
All right. Awesome. Thank you, guys.
Okay, thank you.
Thank you. Our next question comes from Gabe Moreen from Bank of America Merrill Lynch. Your line is open.
Hey, good morning, everyone.
Good morning.
Nice announcement. Couple questions from me. Can you just fit into context how this transaction may help you further downstream in terms of expansion, specifically with the fracs? Or frac expansions, if I'm correctly understanding this is mostly fee-based barrels here, that you don't really have equity barrels per se, that you can, I guess, backstop future some downstream expansions?
Obviously, we have benefits from control of NGL barrels from any place in our system. These two system acquisitions would be similar in that Targa having control of those barrels, is better than not having control of those barrels, and we would expect to benefit from some of them downstream in our operations.
Does that accelerate in your mind, Joe Bob, the potential frac expansions out there?
Directionally, yes.
Other question from me, just is in terms of the crude oil marketing business, you mentioned you felt you kind of had the personnel and the skill set there to have that be another potential business platform. Can you just talk about, I guess, how your fees are derived from that at the moment? Can you talk about whether there's any basis risk within that business and/or whether you feel you need further assets downstream, I guess, to build up that business?
The current business is a simple fee times volume, gathering crude to a point or points for their customers, just as we do in the Bakken. That is our initial focus in the Permian Basin. In fact, we've looked at trying to do crude business in the Permian Basin for some time, either greenfield or acquisition. This is a nice come with in the acquisition. A terrific starter set of assets in both the Midland Basin and the Delaware Basin, and an opportunity for us to build that business from those assets, the capabilities we already have from the Bakken, and very importantly, with the customer relationships that we have across the Permian Basin.
Thanks. Then just last one, if I could squeeze it in. In terms of water handling and who's doing the water disposal here, I assume that's just other third parties. Is that fair?
It's fair to describe the acquisition as having almost no water component on the produced water side or on the need for frac water side. There is a small asset within the acquisition that is a water line that's not operating right now. It may operate in the future for the benefit of a producer, or we may sell it to someone.
Got it. Thank you.
Okay, thank you.
Thank you. Our next question comes from Jeremy Tonet from J.P. Morgan. Your line is open.
Good morning. Congratulations.
Thanks. Good morning.
Thank you, Jeremy.
I was just curious on the CapEx side, maybe coming at a little bit of different angle. Recognizing that you're not going to parse it out anymore in the future, Was just curious, as of right now with this deal, could you quantify how much more CapEx you expect to spend?
No, we haven't done that. It's going to take some more capital. Hopefully, it takes a lot more capital, because if it's taking a lot more capital, that means there's a whole lot more oil being produced, gas being gathered and processed, and oil being gathered and processed. That additional capital's being deployed at an attractive rate of return.
Gotcha. Makes sense. Just when you think about M&A right now, are there other opportunities out there that you guys are still pursuing, or you feel this was a big deal right here. Are you guys kind of all set for right now?
We look at deals all the time, and I think we've said that, we look at deals all the time. About the only thing that's probably changed in that story is we're mostly looking at deals in and around our assets, in the basins where we're currently doing business. That's natural. I use the term again, and I know I used it in the future, a needle in the haystack acquisition. That's what this is. It is really, really a good deal. It fits in the Targa glove like a hand or a couple of fingers of a hand. The fit is extraordinary. The opportunity to be in two of the best parts of the Permian Basin and to increase our presence there bolted onto our assets is awfully unique.
To be able to structure it in a way that makes sense for the seller and really, really works for us from a leverage standpoint and an accretion standpoint. If I found 10 of those, I'd do them all. Okay? We could figure out a way. It's just that good a deal.
Appreciate the color. That's it for me. Thanks.
Okay, thanks.
Thank you. Our next question comes from Danilo Juvane from BMO Capital. Your line is open.
Thank you. Congrats on the deal.
Thank you.
My question is with respect to the EBITDA split between the Midland and Delaware, as well as between the crude gathering and gas processing. If you can provide those, please.
We haven't provided details of where the operating margin comes from between businesses. We don't give that up in the Badlands either. We'll report it and aggregate it on a growth basis. I'd say both of those are material. They're both significant contributors to the operating margin. There's a split between Midland and Delaware, crude and gas, but all four of those pieces are meaningful.
Okay. Are there any MVCs associated with the contracts?
There are some negligible MVCs.
Not really material. Yeah.
Got it. I guess you seem to be very confident that this is a good deal. Would it be fair to say that you're pretty confident that you will be making those earn-out payments going forth? If so, how should we think about financing for those payments?
Yeah. I think we are pretty confident that this system is going to grow. The volumes are going to continue, the producers are going to continue to drill, and we will be making some earn-out payment. As I mentioned earlier, the bigger that payment is, the more cash flow there is and likely the better the accretion is for us. I think we're expecting to make some. At what level exactly, and how much in 2018 and 2019 will be remains to be seen, but I think we do expect to be making some of those payments. What's also about this is the payment is based off an LTM gross margin. We'll be forecasting this every month or even more frequently than that. We'll have good visibility into what we think that payment is going to be.
The earn-out amount is not going to sneak up on us. We'll be planning for this well in advance, we'll finance this earn-out payment like we would a capital project. We'd look at a mix of debt and equity, look at market conditions at the time, what our growth CapEx budget is going into that year, then just determine what makes the most sense, whether it's debt or equity. We would want to position ourselves, if we did want to do some equity, to be ahead of it so that we're not having to wait and play catch up at the last minute.
No, I appreciate the call. Last question from me, just going back to the CapEx questions that have been asked. On the maps that you guys have on page, I think, seven and eight. You are showing proposed pipelines being built. I wanted to make sure that comes with the existing contracts and system or whether this is something incremental that you are going to have to do to connect to the current footprint.
Yeah. If you look at the map on page seven, you'll see there's proposed pipe and existing pipe. Some of the existing pipe crosses over our system as well. We're going to be looking to expand south into Southern Delaware. We're now thinking about what size pipe we want to put in there, so we're having to make that determination. We'll be crossing over both on the northern side of the Delaware and on the southern side.
Okay. To be clear, this is incremental to what was within the Outrigger platform, not something that comes with this deal, correct?
Some of it is pipes in process, and some of it is pipes that they have planned to put in. It's all just part of what we expect the build-out to be.
Right.
Right. It's underpinned by existing agreements.
Right.
What's shown on this map. Certainly, there's other acreage in and around the system that is not currently contracted that we will be aggressively going after.
Okay. That's it for me. Thank you.
Okay. Thank you.
Thank you. Our next question comes from Sunil Sibal from Seaport Global Securities. Your line is open.
Hi. Good morning, guys. Congratulations on the transaction.
Thanks. Good morning.
Yeah. Most of my questions have been hit. I just had one clarification. For the immediate EBITDA multiple guidance that you've given, I was just curious, what kind of operating margins are assumed there? If there is a gross margin EBITDA at the outset of the transaction that you can provide.
Yeah. Well, that was the one time we actually gave you an actual EBITDA number or an operating margin number. The other earn-out multiples are based off gross margin and do not include a deduct for OpEx. We did estimate for 2017, we call it EBITDA because, again, there's no real allocated G&A to the system. That's really the operating margin. Our estimate of operating margin for 2017 would be nine divided by 565.
Oh, okay. What you're saying is that 9x multiple is really a gross margin multiple too?
No.
Is it approximation?
No. The 9x is an EBITDA multiple for 2017. It'd be 565 divided by nine, would be our estimate of operating margin or EBITDA for this system for 2017.
We didn't give you a gross margin for 2017.
We didn't give you a gross margin for 2017. The earn-out payments are gross margin, and we did not give or provide back into EBITDA from those.
Okay, got it. One clarification. I think you said a number of times that the deal is accretive on a distributable cash flow basis. Is that distributable cash flow per unit or just DCF?
Well, yeah. It'd be per unit. It'd be on a unit basis. Per share.
Oh.
Yeah, per share.
Per share. Okay. Got it. That's all I had.
I did unit, yeah.
I think the right answer is both.
Right.
Both on a per share.
A dollar. Yeah.
Thank you. Our next question comes from Craig Shere from Tuohy Brothers. Your line is open.
Good morning, and congratulations.
Thanks. Good morning.
With all the fee-based contracting that this brings to the table, would you be considering adjusting down the targeted dividend coverage required over time? Does the fact that this is predominantly fee-based suggest that you might have an increasing interest over time in organically restructuring some of the legacy POP exposure?
Part number one is adding fee-based margin, yes, is an overall positive, an overall positive to our performance since we said it was accretive. Part number two, we do like the fee-based margin as part of a Permian presence, that's fairly new. It's fairly new because of this brand-new development in the heart of our system. We do not see that to suggest opportunities of restructuring our legacy POP contracts elsewhere in the Permian. We do believe that as we grow in and around these newly acquired pipes, those contracts are likely to be dominated by fee-based because of the precedent that has been set by them. I think that's sort of indicative across the broad Permian. New spaces may be fee-based.
Old spaces that have a long tradition of POP, where you know Targa just keeps adding fees to those POP, are more likely to continue in that flavor. It's an evolution, not a revolution. If we try to do a revolution and turn over those legacy contracts, we probably don't do that to our value advantage, that's not what we're about.
Understood. I just wanted to clarify, there's many questions around CapEx. It sounds like other than some nominal incremental build-out on existing contracts and dovetailing the systems with your legacy Permian operations, there's really no material built in CapEx commitments, that this will grow dovetailed with producer growth, similar to what you've already been doing every time you announce a $200 million a day plant.
You know what? I wish we could type in that answer. That's very well-described. That's how we're going to approach it. The additional capital investments will be dovetailed with the producer growth and paced by that producer growth. We're pretty darn good at not making our producers wait. Many of our producers are really good at communicating where they're going to be and when. That's what it will be determined by. You both asked and answered the question better than I did.
I would say one other thing is first, we'll get the benefit, the efficiency benefit of utilizing our unutilized capacity. We have some room to grow without expending capital that will be beneficial to us. Your answer is then absolutely on spot, that we will grow with them.
Excellent. I appreciate that.
Let me add one, because we've had some time to study this, fortunately and unfortunately. We started with what it looked like as a standalone entity and what capital might be required under various forecasts of producer activity. We figured that out knit together with our system. We've got a real good idea of what capital might look like and pacing the capital might look like depending on the level of producer activity and ultimate oil production. All of that, I hope we have more of that, looks good for us.
Great. I really appreciate the color. My last question, kind of picking up on Gabe's question around crude gathering. Can you all provide some more color around the opportunity set you see there? Do you see a lot more just organic off the systems you've already acquired? Are there more bolt-on opportunities? How are you thinking about this? Maybe some color around potential timing for when this can really grow.
I don't have a whole lot more clarity there. The color to it is, of course, first we would like to work on additional business, both from the existing contracts and new contracts in and around the assets we just acquired. That helps by putting us in business in the Permian. Is it, can we extend those assets to get additional oil gathering contracts? By being in business, do we find other opportunities, either with our existing customers or with new customers to grow that business? Heck, we've looked for oil opportunities for quite a while in the Permian, this is just our starter. We'll be focused on it, and we'll be focused on trying to meet our customer and future customer needs.
Great. Thank you, and congratulations again.
Thank you.
Thanks.
Thank you. Our next question comes from John Edwards from Credit Suisse. Your line is open.
Yeah, good morning, everybody, and congrats on this.
Thanks.
I just want to clarify. The existing build-out Outrigger, that's completely independent of the earn-out payments, correct?
I don't know that I'm following that exactly. The contracts that are going to be in place, the acreage dedications that are in place from the producers, both from the Midland and Delaware, it's under those acreage dedications, the volumes associated with those, the fees associated with the dedicated acres, that's what's going to be the gross margin test for the earn-out payment. We're going to have to build some pipes, and Joe talked about we'll put in capacity and offloads, all these things to handle the volumes. It has to do with the contracts underlying the
The volume growth out there.
If assets were theoretically put in place just for the existing contracts, they would also benefit additional contracts.
Right
in the area. You could look at it vice versa. I'm not sure what the independence is.
What I was thinking about was, there's no any additional deduct or anything like that because, as you laid it out.
There's no CapEx. We're wearing the CapEx risk, and we're wearing the OpEx risk.
We have taken that into consideration.
In the multiples.
Yeah, right. We understand it in the multiples.
Okay.
We understand it under various forecasts, and it is included in our statement that says that this is accretive in 2017.
Right
going forward, under a multiplicity of forecasts.
Okay. That's helpful. I thought I heard you say that the total consideration is capped.
Yes
seeing as how you feel pretty confident in this transaction, I'm assuming then. I realize you're not ultimately guiding on EBITDA, but it seems to make sense here that the ultimate realized EBITDA is going to be significantly less than the 9x here that associated with the initial consideration.
Yeah.
Is that fair to say?
I'd say we certainly hope you are correct, we're going to do everything we can to work with producers, add additional acreage, get new producers, to get the EBITDA gross margin EBITDA as high as we can to make that statement true.
Okay. You mentioned that the first thing that you were going to set out to do is connect the Outrigger system to the existing Targa system, you indicated it looks like it's a pretty short timeline there. Any idea how long you think that'll take? It sounds like you're talking about not a significant amount of I know you're not talking about CapEx, but it sounds like it's a fairly low CapEx expenditure you're expecting there.
Yeah.
Go ahead. Tell him there's two. There are two. One in the Midland and one in the Delaware, there will be actually two in the Delaware eventually. The first one will take three to four weeks, to be honest, at almost no capital, because the lines cross each other already, we have the capability of pulling off of their system low pressure. Our system, I guess I should say, not their system anymore.
No, we won't be connecting probably until we close.
Yeah. That's fair. No, actually, that interconnect we will make immediately. The second interconnect is just a piece of pipe, and it won't take long either. Got to buy a little right away and lay a little pipe. In the Midland Basin, it's the same scenario. It won't take a long time, and it's laying a little bit of pipe and interconnecting the two systems.
Okay. It sounds like you expect the whole thing to be done within a month or so.
No. To be fair, the longer-lay pipes, we will wait till close. The initial interconnect we will immediately do.
Good.
Okay, great. All right. Thank you. That's it for me.
Okay, thanks.
Thanks, John.
Thank you. Our next question comes from Selman Akyol from Stifel. Your line is open.
Thank you. Just a couple quick ones. First of all, can you say what the current capacity utilization is on the systems?
We haven't given run rates, crude volumes, or gas volumes. There is capacity both on crude and on gas, both in Midland and in the Delaware. As Joe Bob and Pat have talked about, we're looking at doing these offloads and putting in additional infrastructure because we see going past those capacity limits here relatively quickly. We're already looking at the best ways to expand.
All right. Several times you've called out the new deals offload to you. Can you just talk about how long before you actually start seeing new deals or your expectations for that? Should we look for that to be by the end of 2017, or is it going to be something that manifests itself more in 2018?
No, that's a good question. We're going to be working with producers out there. We're going to be calling our customers and doing everything we can to add as soon as possible. It's just work that we do, not only here, but all over the Permian Basin, so all of our assets, all over Oklahoma. It'll just be a continued commercial effort to try and add customers. There's no timeframe for when we add them. We hope to be adding them continuously.
All right.
There are some advantages to this being a part of the Targa system. We've got access to all of those customers. A customer thinking about what to connect to gets the benefit of, very, very shortly, multi-plant, multi-system network. That's better than relying on a single standalone plant. We'll be marketing that. Part of it has to do with when do the producers need those connections and how close they are to us, and we'll keep working that.
All right. Thank you.
Thank you. Our next question comes from Gregg Brody from Bank of America. Your line is open.
Hey, guys. Congrats on the deal.
Thanks.
Hey, Gregg.
Just to add one in here. I don't know if sort of where your pro forma fee businesses today and if you can give us a sense where you think that's going to head this year and next.
I'd say with this business, the volumes out here we would expect to grow relative to our overall gathering at a higher growth rate. All things equal, we should be getting more fee base with this transaction as it grows over the next couple of years. Commodity prices have also moved up. We still have significant POP exposure on some of our existing contracts, not only in the Permian but elsewhere. It's going to be dependent on commodity prices. I'd say we're adding fees, we're adding fee-based businesses. Those businesses are growing, that should be trending up. If commodity prices move more, it'll have an offset to that.
Great. One question here, which I'm not sure if you'll give me the answer to. It seems like you overfunded the equity portion of this.
Yeah.
Can you give us an estimate of how much you think you've pre-funded in terms of earn-out and growth CapEx?
Really the way we looked at this is we wanted to do a transaction that actually helped our balance sheet right out of the gates. It's about 3.8 times debt to EBITDA was our last reported in Q3. It's within our three to four times target. We are going to have growth CapEx with this acquisition and growth CapEx this year. We wanted to stay ahead of this acquisition and that capital budget and position ourselves with a stronger balance sheet, already somewhat preparing for a potential earn-out payment in 12 months so that our balance sheet is strong and that we have flexibility when that occurs.
I appreciate the time. Thank you.
Thanks.
Thank you. Our next question comes from Mark Carlucci with Morgan Stanley. Your line is open.
Hi. My question was answered. Thank you.
Okay, thanks.
Thanks, Mark.
Thank you. I'm showing no further questions from our phone lines. I would now like to turn the conference back over to Joe Bob Perkins for any closing remarks.
Thank you all for being on the call with us. A very disciplined crowd as we come up on the hour. I do appreciate your interest. I hope you share our enthusiasm for this transaction. We are acquiring systems in very attractive acreage, the Permian and the Delaware. Assets that perfectly fit our existing asset base in a deal that has been de-risked through the earn-out structure, and where we have kept the balance sheet in a strong position for the future and for future capital needs. It really just doesn't get much better than that, and we thank you for your attention. If you have any other questions, give us a call.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect.