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. As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Ms. Jennifer Neal, 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 percent 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 8,000,000 shares of our common stock at $57.65 per share, which was upsized from the previously announced offering of 7,000,000 shares. Barclays also has a 30 day option to purchase up to an additional 1,200,000 shares of common stock.
Targa expects to receive net proceeds of approximately $455,700,000 or approximately 524 $100,000 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 Web site 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 ks for the year ended December 31, 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 McDonoughty, EVP, Southern Field Gathering and Processing and Matt Molloy, 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. 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 3 outrigger entities with assets across some of the most prolific Permian Basin acreage in an acquisition that is highly complementary to our existing target footprint.
We are acquiring assets in the Delaware Basin and the Midland Basin for $565,000,000 of initial consideration. Based on the future realized performance of the existing contracts in place at about closing, Targa may make 2 additional payments to the owners of 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 Jim mentioned, this morning, we launched a 7,000,000 share bought deal offering of TRGP common stock. Based on demand, that deal was upsized to 8,000,000 shares.
This is a strong statement of the support that the market has for Targa. Now that offering, combined with cash in hand from operations and equity issued via our ATM program during the Q4 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 6 bullet points that we wanted to highlight related to the transaction. I know 6 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 6 bullet points in a little more detail.
Beginning with bullet point number 1. The $565,000,000 initial cash consideration represents a 9 times 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 2. These are attractive fee based natural gas gathering and processing and crude gathering assets in the Permian Basin backed by long term contracts.
Okay, 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 31 close of the acquisition of Chevron's 37% interest in Versado, so that we now own 100 percent of that system.
If you look at the map on Page 6, and I like maps, Page 6 of our investor presentation, the outrigger Delaware assets are very well positioned between our Versado system in the north and our Sand Hill 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. And with respect to that term long term contracts, the weighted average contract tenure is over 13 years of remaining life. Moving to bullet number 3.
The acquisition increases Targa's gross processing capacity to approximately 2,000,000,000 cubic feet per day across Permian Basin by year end 2017. And 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. And of course, outrigger assets and customers will now benefit soon benefit as soon as we connect them from being a part of a multi plant, multisystem network in the Permian Basin. Bullet number 4. 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 2,000,000 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 5. 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 $565,000,000 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 2016, Target 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 the structure that works well for Targa and the sellers. Lastly and very importantly, bullet number 6. This transaction is accretive to distributable cash flow in 2017 beyond. To reiterate what we mentioned earlier, with proceeds from our now upsized $8,000,000 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 discussed 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 6 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 2,000,000 acres dedicated to us in the most prolific basin in the world. And 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. And 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 Westex and SAOU.
And 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 7 for reference. 1st, 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 Basin E and P deals get announced recently in producer excitement over the rock quality and the high number of producing de risk 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 70,000,000 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, and we will be able to offload volumes into the Sand Hills system. Sand Hills is already connected to our SAAO U system to our Midland County pipeline and our SAO U and Westex systems are already connected. So 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.
And 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. But 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 and additional expansions will be planned to optimize the entire western part of our assets. Turning to Page 8 of the investor presentation, you can see that similarly in the Midland Basin, our rigor 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 10,000,000 cubic feet per day processing plant in Martin County. And 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 Target 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 relationship across the Permian Basin. With that, I think we've covered the high level asset points that I wanted to make.
So 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 ks, which included some preliminary 4th quarter and full year 2016 results. We announced that we expect to report that LPG export volumes for the Q4 of 2016 averaged approximately 205,000 barrels per day or approximately 6,300,000 barrels per month. We also expect that our 4th quarter performance is expected to result in dividend coverage that exceeds 1.2x. And for 2016, we expect annual dividend coverage to exceed 1.05 times.
Now I'd like to provide some brief color around our thinking related to the structure of the transaction, then 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 $565,000,000 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 2 additional earn out payments up to a cap where the total consideration of the initial payments and the earn out payment cannot exceed $1,500,000,000 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. So as Target 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 2 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 target 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 7,000,000 share offering that was upsized to 8,000,000 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 earnout 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 9 of the investor presentation. As we have said previously, the initial consideration is $565,000,000 Now turning to the earn out, let's walk through all the pieces. First, the timing. The potential earn out payments are structured for 2 12 month periods that end in 2018 2019. The 1st 12 month period ends at the end of February 2018 and the 2nd period ends at the end of February 2019.
The earn out payments for 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 1st 12 month period is 9.75 times. The Midland Basin multiple for the 1st 12 months is 9.25 times.
For both systems, the multiple for the 2nd 12 month period is 8.75. Any earn out payments made in 2018 2019 are reduced by the initial consideration and by any previous earn out payments paid. And 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.
And as Targa adds new commercial contracts, accretion associated with the transaction is even higher. And again, there is a total cap such that combined, the initial consideration and potential earn out payments to the outrigger sellers cannot exceed 1,500,000,000 Strong performance from existing contracts above that contingent payment level only accrued 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. So with that, we would like to thank you all for your interest and open the call up to questions.
Thank And our first question comes from TJ Schultz from RBC Capital Markets. Your line is open.
Great. Thanks guys. Congratulations. Hey, guys. Just first, 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?
TJ, you sort of answered the question. Our immediate focus will be to connect the 2 systems. That's our advantage relative to a standalone owner, making it part of the existing target systems. At that point, capital benefits the outrigger system, our larger multi plant systems and then the multi systems that are part of the overall target 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.
And we'll be doing that to keep up with producer needs. There are no capital project transfers. I mean, we're going to continue doing the same good things that Outrigger was doing, but 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, but 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 target glove. We may, at our next earnings call, provide some 2,007 CapEx. But 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 and 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, but 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. But 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. So 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 bit 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? And I'll leave it there. Thanks.
Okay. We described it in the script as an 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 RS Permian and Jagged Peak, which I guess would be an example of private going to public.
Aside from that, that strong mix has proved their success at developing and exploiting oil in the Midland Basin and the Delaware Basin. And that's probably all I have to say about customers. You know our policy, TJ. 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.
Matt, can you is there any more color on the line items between EBITDA and gross margin here in terms of your 2016 and then 2018 or 2017 2018 multiples?
Yes, sure. It's the lion's share of that is going to be operating expense. It's really OpEx. We don't allocate G and A down to the business unit and I don't see much incremental G and A. So it's really just operating expenditures sorry, OpEx.
OpEx. In order of magnitude, how should we think about that relative to the gross margin?
Yes. We don't break out for you OpEx by system. I would say if you look out in this area, we have our Sand Hill system and our Versado system, which those are our older facilities that have higher OpEx. So 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 system. This will be new equipment, new facilities, which will have lower OpEx.
So 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. And just one more for you. The cash payments for the earn outs, are those due February 2018 2019 or before or after that?
They're due after that. So there's a window. It will likely happen in Q2. So 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. So we'll have a period of time there.
And Q2 would be the target for when that happens.
That preparation is not complicated, but it takes a little bit of time after the end of the period. Right. And it only applies to the existing contracts, those contracts that are in place at about close. So there obviously will be parts of operating margin that are not included in the calculation.
Understood. And then the last one for me. So it sounds like there's some fairly clear line of sight operating synergies here. And 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, so we will implement interconnect there almost immediately. And then again on the Midland system, we will integrate that into our Westech system and we'll do that pretty quickly also and so 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 announcements. Couple of questions for me. Can you just fit into the context how this transaction may help you further downstream in terms expansion specifically at the fracs? And if I'm correct, frac expansion, if I'm correct in 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.
So does that accelerate in your mind, Joe Bob, the potential frac expansions out there?
Directionally, yes.
Okay. And then other question for me, just as 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?
Well, the current business is a simple feed times volume, gathering crude to a point or points for our customers just as we do in the Bakken. And that is our initial focus in the Permian Basin. In fact, we've looked at trying to do crude business in the Permian 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. And 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 JPMorgan. Your line is open.
Good morning. Congratulations.
Thanks, Jeremy. Thanks, Jeremy.
I was just curious on the CapEx side, maybe coming out
a little bit of a different
angle. Recognizing that you're not going to parse it out anymore in the future, I was just curious as of right now with this deal, how much 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. And that additional capital is being deployed at an attractive rate of return.
Got you. Makes sense. And just when you think about M and A right now, are there other opportunities out there that you guys are still pursuing? Or you feel, I mean, this was a big deal right here, are you guys kind of all set for right now? I mean, we
look at deals all the time. And I think we've said that, 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. And 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 target glove like a hand or a couple of the fingers of the hand. The fit is extraordinary. The opportunity to be in 2 of the best parts of the Permian Basin and to increase our presence there bolted on to our assets is awfully unique.
And then 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 Juveen from BMO Capital. Your line is open.
Thank you. Congrats on the deal. 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 and aggregate it on a growth basis. I'd say there's both of those are material. They're both significant contributors to the operating margin.
So it's 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 contract?
There are some negligible MVCs. I would it's not really material, yes.
Got it. And 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 forward? And if so, how should we think about financing for those payments?
Yes. 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.
So I think we're expecting to make some at what level exactly and how much in 2018 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 of an LTM gross margin. So we'll have visible we'll be forecasting this every month or even more frequently than that. So we'll have good visibility into what we think that payment is going to be. So the earn out amount is not going to sneak up on us.
We'll be planning for this well in advance and we'll finance this earn out payment like we would a capital project. We 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 and then just determine what makes the most sense, whether it's debt or equity. But we would want to position ourselves if we did want to do some equity be ahead of it, so that we're not having to wait and play catch up at the last minute.
No, I appreciate the color. Last question for me, just going back to the CapEx questions that have been asked. So on the maps that you guys have on Page, I think, 78, you are showing proposed pipelines being built. I want to make sure that 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?
Yes. If you look at the map on page 7, you'll see there's proposed pipe and existing pipe. Some of the existing pipe crosses over our system as well. So 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. But we'll be crossing over both on the northern side of the Delaware and on the southern side.
So to be clear, this is incremental to what was sort of 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. So it's all just part of what we expect the build out to be.
Right, right. And it's underpinned by existing agreements, which shown on this map. But 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 and congratulations on the transaction.
Thanks. Good morning.
Yes, most of my questions have been hit. I just had one clarification. So for the immediate EBITDA multiple guidance that you've given, I was just curious what kind of operating margins are assumed there? So if there is a gross margin EBITDA at outside of the transaction that you can provide?
Yes. 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 DDoS for OpEx. We did estimate for 2017, we call it EBITDA because there's again, there's no real allocated G and A to the system. So that's really the operating margin.
Our estimate of operating margin for 2017 would be 9 divided by 5.65.
Okay. So what you're saying is that 9x multiple is really a gross margin multiple too or is it approximately?
No. So the 9 times is an EBITDA multiple for 2017. So it would be 5.65 divided by 9 would be our estimate of operating margin or EBITDA for this system for 2017.
And EARN didn't give you a gross margin
for 2017. We didn't give you a gross margin for 2017. And then the earn out payments are gross margin and we did not give or provide and backed into EBITDA from those.
Okay, got it. And then one clarification, I think you said a number of times that deal is accretive on a distributable cash flow basis. So is that distributable cash flow per unit or just DCF?
Well, yes, it would be per unit. It would be on a unit basis per share. Yes, per share.
Per
share. Okay. Got it. That's all I had. Yes.
I think the right answer is both.
Right. Both on a per share and dollar. And dollar.
Thank you. Our next question comes from Craig Shere from Tuohy Brothers. Your line is open.
Good morning and congratulations.
Thanks. Good morning.
So with all the fee based contracting that this brings to the table And would you be considering adjusting down the targeted dividend coverage required over time? And 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 1 is adding fee based margin, yes, is an overall positive and an overall positive to our performance since we said it was accretive. Part number 2, we do like the fee based margin as part of a Permian presence, and 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. But 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.
And I think that's sort of indicative across the broad Permian. New spaces may be fee pays, old spaces that have a long tradition of POP, where Target just keeps adding fees to those POP are more likely to continue in that flavor. But 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, and that's not what we're about.
Understood. And I just want 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 and that this will grow dovetailed with producer growth similar to what you've already been doing every time you announce a $200,000,000 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.
And many of our producers are really good at communicating where they're going to be and when. And that's what it will be determined by. You both asked and answered the question better than I do.
And I would say one other thing is first, we'll get the benefit, the efficiency benefit of utilizing our unutilized capacity. So we have some room to grow without expending capital that will be beneficial to us. And then your answer is then absolutely on spot that we will grow with them.
Excellent. I appreciate that. My last question I want
to add on 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. Then we figured that out knit together with our system. So we've got a real good idea of what capital might look like and pacing all of that, I hope we have more of that, looks good for us.
Great. I really appreciate the color. And 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? And maybe some color around potential timing for when this can really grow?
Yes. 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. Then is it can we extend those assets to get additional oil gathering contracts?
And then 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 and this is just our starter. But we will be focused on it. We'll be focused on trying to meet our customer and future customer needs.
Great. Thank you. Thank you and congratulations again.
Thank you. Thanks.
Thank you. Our next question comes from John Edwards from Credit Suisse. Your line is open.
Yes. Good morning, everybody, and congrats on this. Good morning, John. I just want to clarify. So the existing build out without rigor, that's completely independent of the earn out payments, correct?
I don't know that I'm following that exactly. So the contracts that are going to be in place, the acreage dedications that are in place from the producers both in 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. Now we're going to have to build some pipe. And Joe talked about we'll put in capacity and offload the only things to handle the volumes, but it has to do with the contracts underlying the volume growth out there.
So if assets were theoretically put in place just for the existing contracts, they would also benefit additional contracts in the area or you could look at it vice versa. I'm not sure what the independence is.
Well, I just what I was thinking about was there's no any additional deduct or anything like that because as you laid it out. Yes.
There's no CapEx, Deed. We're wearing the CapEx risk and we're wearing the OpEx risk.
But we have taken that to consideration.
In the multiples. Yes, right.
We understand it in the multiples. We understand it under various forecasts. And it is included in our statement that says that this is accretive in 2017 and going forward under a multiplicity of forecasts.
Okay. And that's helpful. And then just so I thought I heard you say that the total consideration is capped. And seeing as how you feel pretty confident in this transaction, I'm assuming then it's and I realize you're not ultimately guiding on EBITDA, but it would it seems to make sense here that the ultimate realized EBITDA is going to be significantly less than the 9 times here that associated with the initial consideration.
Is that fair
to say?
Yes. I'd say we certainly hope you are correct and 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. And then, you mentioned that the first thing that you're going to set out to do is connect the Outrigger system to the existing Targa system. And you indicated it looks like it's a pretty short timeline there. I mean, any idea how long you think that will take? And 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.
Go ahead.
Tell us.
Yes, there are 2, 1 in the Midland and 1 in the Delaware and there will be actually 2 in the Delaware eventually. But yes, the first one will take 3 to 4 weeks to be honest at almost no capital because the lines cross each other already and we have the capability of pulling off of their system low pressure. Our system, I guess I should say, not their system anymore.
Yes, they won't we won't be connecting probably until we close. Yes, that's fair.
But no, actually that interconnect we will make immediately. And then 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. And then in 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. So it sounds like the whole 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. 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.
Just a couple of quick ones. First of all, can you say what the current capacity utilization is on the systems?
We haven't given run rate, crude volumes or gas volumes. There is capacity both on crude and on gas both in Midland and in the Delaware. But as Joe Bob and Pat have talked about, we're looking at doing these offloads putting in additional infrastructure because we see going past those capacity limits here relatively quickly. So we're already looking at the best ways to expand.
All right. And then several times you've called out the new deals offload you. Can you just talk about how long before you actually start seeing new deals or your expectations for that? I mean, should we look for that to be by the end 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. So it will just it's just work that we do, not only here, but all over the Permian Basin. So all of our assets, all over Oklahoma.
So it'll just be a continued commercial effort to try and add customers. So there's no time frame for when we add them. We hope to be adding them continuously.
There are some advantages to this being a part of the Target 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.
And 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 Brobee 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 you've sort of where your pro form a fee business is today and if you can give us a sense where you think that's going to head this year and next?
Well, 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. So all things equal, we should be getting more fee based with this transaction as it grows over the next couple of years. But 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. So 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. So that should be trending up. But if commodity prices move more, it will have an offset to that.
Great. And then one question here, which I'm not sure if you'll give me the answer to, but it seems like you overfunded the equity portion of this. Can you give us an estimate of how much you think you've prefunded 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 kind of right out of the gates. We're at it's about, I think, 3.8 times debt to EBITDA was our last reported in Q3. It's within our 3 to 4 times target. But we are going to have growth CapEx with this acquisition and growth CapEx this year. So 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 house 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 Calucci with Morgan Stanley. Your line is open.
Hi. My question was answered, but thank you.
Okay. Thanks.
Thanks, Mark.
Thank you. And 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. Very disciplined crowd as we come up on the hour. I do appreciate your interest. I hope you share enthusiasm for this transaction. Now 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 derisked 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 don'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. You may now disconnect.