It’s been described as a merger of equals: Crestwood and Inergy announced a definitive agreement to consolidate their respective general partners (GPs) and underlying master limited partnerships (MLPs) in early May. Inergy LP’s MLP—Inergy Midstream—is purchasing Crestwood’s MLP, Crestwood Midstream, via a complicated series of financial transactions mostly at the GP level.

The surviving entities will be two MLPs: Inergy LP, which will own the GP interests of both Crestwood Midstream and Inergy Midstream, and Inergy Midstream, which will be headed by the chief executive of Crestwood Midstream, Robert Phillips. Crestwood’s sponsor, First Reserve, will be the sponsor of the combined entity.

The pro-forma Inergy entity, with an enterprise value of about $7.3 billion, up from $4.6 billion, will be a vertically integrated midstream partnership comprised of Crestwood’s supply-oriented, natural gas and natural gas liquids (NGL) gathering and processing assets and Inergy’s demand-focused gas, NGL, crude oil storage and transportation assets. The new entity will be in the top three or four for gathering and processing with services in virtually all the premier shale plays in North America.

The complementary services offered by Crestwood and Inergy are expected to create synergies of $15-$20 million within the next two years. Management further estimates approximately $2 billion in greenfield development and bolt-on acquisition opportunities for the combined entity.

Crestwood’s view

From Crestwood’s perspective, the advantages of the deal are clear. Management had expressed interest in acquiring assets downstream of its gathering and processing footprint, and this transaction accomplishes that objective. In addition to a broader midstream footprint, Crestwood’s stable, fee-based operations will now have an enhanced-growth profile with access to Inergy Midstream’s fiscal 2013 growth capital budget of $80- $100 million, which includes the continued build out of the COLT crude oil hub in the Bakken and further storage and pipeline development in the Marcellus shale.

Additionally, assets currently housed at the GP level of Inergy LP could be sold to Inergy Midstream as the former transitions itself to a pure-play holding company (though management noted that near-term focus on the integration will defer asset drop downs to a later period).

Finally, the combined entity will have a lower cost of capital, providing it with a stronger platform from which to pursue organic investments and acquisitions.

From Inergy’s perspective, the benefits of the merger fall disproportionately to Inergy LP over Inergy Midstream. Management indicated that the deal is immediately accretive by 10% to Inergy LP versus only about 5% to Inergy Midstream. The deal accelerates Inergy LP’s migration to a pure-play GP with more favorable incentive distribution rights and a better valuation.

But what about Inergy Midstream?

The partnership, which had suffered from concerns about its long-term growth prospects, will benefit from greater scale and diversity (in terms of both the types of assets and their locations) and capital strength to improve its forward-looking growth outlook. But the deal comes at a steep purchase price—Morgan Stanley estimates that Inergy Midstream paid approximately 12x 2013 EBITDA for Crestwood Midstream—reflecting the increasingly competitive environment for midstream operators.

From an operations perspective, robust shale production supports demand for more energy infrastructure investment in the U.S. However, the sheer number of MLPs has risen dramatically as upstream companies carve out qualifying assets to capitalize on the tax advantages of the MLP structure.

The MLP shift

From a capital markets perspective, the proliferation of MLPs has shifted the way the asset class is valued. The market now places greater premiums on the visibility of long-term distribution growth than on the sustainability of current yields, even if attractive. JP Morgan estimates that the new Inergy Midstream may be able to achieve 8%-10% distribution growth in the future, though this is overshadowed by Inergy LP’s estimated 20% growth.

Given the high valuations of MLPs, midstream growth via acquisition is expensive. It is also, as the Crestwood purchase shows, highly complicated, often involving several layers. Accordingly, traditional acquisitions as a means to enhance payouts have been deemphasized by the investment community.

While organic growth around existing asset footprints is preferable, such growth is harder to achieve and requires distinct competitive edges that not all partnerships enjoy. In addition to having existing strategic assets—the right assets in the right basins—and extensive customer relationships, vertical-integration synergies are extremely important. Interconnected midstream services are more easily bundled and expanded and, moreover, brownfield infrastructure projects offer materially better returns than pure greenfield projects.

From this lens, the purchase of Crestwood, a relatively lower-growth entity, in the pursuit of growth, makes some sense. The vertical integration and improved credit metrics of the combined entity enhances Inergy Midstream’s long-term yield outlook, but the high cost and complexity of the deal underscore the increasingly competitive nature of the midstream landscape in the near-term.