Last Thursday, the Energy Transfer organization reached another milestone: agreeing to transfer 100 percent ownership of ETP HoldCo ("Holdco") to Energy Transfer Partners. Holdco is an equity holding company, initially owned 60 percent by Energy Transfer Equity (ETE) and 40 percent by Energy Transfer Partners. It was created about mid-year 2012.
The purpose of today's article is to review Holdco assets and valuation, analyze the price paid by ETP to its sister company ETE on the proposed deal, and offer a brief summation as to what it may mean to investors.
The Energy Transfer Press Release
On March 21, Energy Transfer announced further simplification of their corporate structure via the consolidation of "Holdco," into ETP. Here is an excerpt from that press release:
Energy Transfer Partners, L.P. (NYSE:ETP) and Energy Transfer Equity, L.P. (NYSE:ETE), announced today that ETP will acquire from ETE its interest in ETP Holdco Corp. for $3.75 billion of cash and ETP common units. ETP Holdco is the entity formed by ETP and ETE in 2012 to own the equity interests in Southern Union Company and Sunoco, Inc. With this acquisition, ETP will own 100% of ETP Holdco. The deal is expected to close in the second quarter of 2013, subject to customary closing conditions.
What is "Holdco?"
Holdco was created as a temporary holding company for certain recently-acquired assets obtained by the Energy Transfer companies. A spate of M&A activity spawned the need for a corporate entity in which to place new businesses prior to drop-down simplification and for tax efficiency.
Holdco was created in June 2012. Equity ownership was split 60 / 40 between ETE and ETP.
What did Energy Transfer Equity Contribute?
Energy Transfer Equity submitted its Southern Union assets to Holdco. These assets included Panhandle Eastern, Trunkline and Sea Robin pipeline systems.
Citrus, another Southern Union company that holds an indirect 50 percent interest in the Florida Gas Transmission pipeline, was spun off to Energy Transfer Partners for $2 billion consideration. It was not placed in Holdco.
I valued the total ETE / Southern Union cash and equity deal at approximately $5.4 billion. I estimated this figure by adding the $3 billion cash with the approximate $2.3 billion in ETE units paid to Southern Union owners. (57 million ETE units I valued at about $42 each at the time of sale).
If one subtracts the Citrus spin-off from the total purchase, Energy Transfer Equity contributed assets worth about $3.4 billion to Holdco.
What Did Energy Transfer Partners Contribute?
Energy Transfer Partners contributed its ownership in Sunoco, less Sunoco cash at closing and subsidiary Sunoco Logistics Partners (NYSE:SXL). In exchange for keeping the cash and SXL out, Energy Transfer Partners added about 91 million "Class F" equity units to its Holdco contribution.
Energy Transfer Partners acquired Sunoco for $5.3 billion. Sunoco had about $2 billion in cash at closing that was transferred to ETP. The Class F equity units were substituted in consideration for that cash. I valued the Class F shares as discounted to the Sunoco cash withdrawn. Lastly, Sunoco Logistics Partners was excluded from Holdco. I placed a value of about $2.5 billion on this business. I arrived at this figure taking SXL's 2012 Free-Cash-Flow and applying a 12 percent perpetual discount rate.
If one subtracts the $2 billion cash received at closing and my estimate of $2.5 billion for the value of Sunoco Logistics Partners , then adds back $1.0 billion for the Class F shares, Energy Transfer Partners contributed assets worth about $2.3 billion to Holdco.
I admit I found valuing the Class F units and SXL a bit dicey. The 8-K filing and related amendments were difficult to handicap. My view is that Energy Transfer management and its board cannot commence an internal deal that disproportionately favors either ETP or ETE unitholders at the expense of the other. While one can easily debate the accuracy of my foregoing premises, I contend the result net/net should remain the same.
The Holdco 60 / 40 Split
I offer that Holdco represented net contributions of $3.4 billion and $2.3 billion by ETE and ETP, respectively. The total of $5.7 billion was therefore split 60 percent ETE and 40 percent ETP, as aligned with the contributions.
Energy Transfer Partners' Buy-Out of Holdco
At the time of formation as outlined above, I estimate ETE placed a net $3.4 billion into Holdco. ETP plans to pay a total of $3.75 billion in cash and equity for the assets.
What about the $350 million difference?
Interestingly, I suggest that the difference may be captured in a subsection of the buyout agreement as noted in the same March 21 press release (bold type my emphasis):
In exchange for the interest in ETP Holdco, ETE will receive $2.35 billion of newly issued ETP common units and $1.40 billion in cash. ETE, which owns the general partner and incentive distribution rights (IDR) of ETP, has agreed to forego all of the IDR payments on the newly issued ETP units for each of the first eight consecutive quarters beginning with the quarter in which the closing of the transaction occurs, and fifty percent of the IDR payments on the newly issued ETP units for the following eight consecutive quarters.
By foregoing its full IDRs for some two years, ETE takes extra cash upfront and is effectively paying it back to ETP over a period of time. The differential appears to favor ETE by some $50 million, more or less. However, on the whole, Energy Transfer Partners has obtained full control of a solid set of assets that offer expense efficiencies and improved cash flows.
Speaking of Asset Rationalization.....
Energy Transfer owners should be well-aware of two other related developments.
First, Energy Transfer sold two non-core gas transmission companies to the Laclede Group for about $1 billion. Here's an excerpt from that December 17, 2012 press release found on the Energy Transfer website:
Energy Transfer Equity, L.P. ("ETE") and Energy Transfer Partners, L.P. ("ETP") today announced that two newly formed subsidiaries of Laclede have entered into definitive purchase and sale agreements with Southern Union Company ("Southern Union"), an affiliate of ETE and ETP, pursuant to which Laclede will acquire the assets of Southern Union's Missouri Gas Energy ("MGE") and New England Gas Company ("NEG") divisions (collectively, the "Utilities"). The value of the transaction is $1.035 billion.
Second, Energy Transfer sold an affiliate of Southern Union to Regency Energy Partners LP for $1.5 billion. Southern Union Gathering Company (SUGS) was another non-core business to the Energy Transfer companies. Here's a short take on the press release on that transaction:
Energy Transfer Partners, L.P. (NYSE:ETP) and Energy Transfer Equity, L.P. (NYSE:ETE) announced today that their affiliate, Southern Union Company (Southern Union), has agreed to contribute Southern Union Gathering Company, LLC, the owner of Southern Union Gas Services, Ltd. (SUGS), to Regency Energy Partners LP (NYSE: RGP) in exchange for $1.5 billion.
Therefore, of the $5.4 billion Energy Transfer paid for the Southern Union acquisition, a total of $2.5 billion is under agreement to be recouped. Of the $2.9 billion estimated basis remaining, $2 billion of value has been retained by Energy Transfer Partners via the Citrus transfer.
However, leftovers include remaining Panhandle Eastern assets, Trunkline, and Sea Robin. As noted in my earlier article, I believe one of the most exciting ETP forward developments include converting the Trunkline natural gas system into a crude oil pipeline.
It may appear that events are shaping up such that Energy Transfer has come out the better for the Southern Union deal.
The Bottom Line
Within a year, Energy Transfer has purchased major assets that diversified a regional natural gas transmission company into a national, mid-stream / downstream energy transportation and marketing company.
The formation of Holdco has served its purpose, and is now being consolidated into the ETP structure.
The ETP / ETE Holdco formation and subsequent transfers appear to have been mutually beneficial. In addition, the current situation has bound the two companies closer together through unit exchange.
Recent asset rationalization and related consideration planned for certain Southern Union assets indicates the creation of unitholder value when compared with the acquisition price.
Furthermore, I believe more asset rationalization may follow along. For instance, it is still not completely clear to me how the Sunoco retail marketing business is core to the Energy Transfer family. In the meantime, that business tends to be a cash cow. Management sees no need to sell, if ever, unless the right buyer at the right price comes along.
In addition, I suggest that a bit more internal restructuring will occur. Eventually, I see consolidated operating businesses ending up with Energy Transfer Partners, and MLP General Partnerships under the Energy Transfer Equity umbrella.
For Energy Transfer equity owners, I continue to see slow, steady progress towards unlocking value. The negative of corporate complexity is being overturned by simplification and value creation.
The market's first reaction has been favorable: since the announcement of the Holdco consolidation, both ETP and ETE have seen a small price pop.
A boost in the ETP distribution, stagnant since 2008, would further evidence management confidence in the future for the Energy Transfer companies and ETP investors.
Risks include, but are not limited to, management's inability to extract ratable cash from the assets, poor asset integration, weak energy markets and prices, and sloppy expense / project controls.