Williams Companies: A Smart Split

Includes: CHK, WMB, WPZ
by: Mike Maher

Shares of Williams Companies (NYSE:WMB) are surging today on reports of a breakup of the company into two separate parts: the Exploration and Production (E&P) and the Pipeline division, which includes the General Partner of WPZ, a 73% ownership of Williams Partners LP (NYSE:WPZ), as well as Canadian Midstream business. The split up is intended to unlock value in the companies, and both companies look positioned well to take advantage of the current market conditions.

E&P Business: The newly independent E&P business will have an IPO of 20% later this year, with the rest of the company spun out to WMB shareholders in 2012. The company will have 4.5 Tcfe of Proved reserves, 15.9 Tcfe of proved, probable and possible reserves, and is producing 1,190 MMcfe/d. The company is guiding that 2011 earnings will be between $200 and $550 million, and 2012 earnings of between $250 and $900 million. This business is obviously very tied to natural gas prices, much more so then the Pipeline segment. That said the most recent data I could find at costs per Mcf puts that number at $3.50, according to a December 2010 presentation at the Wells Fargo Energy Symposium. That places Williams E&P in the top tier of low cost producers, inside the top 25% in the US when it comes to costs. The company is also active in the Bakken and Marcellus Shales, two high growth areas of the U.S. Assuming a midpoint range for 2011 earnings of $375 million, and attaching an 18 multiple ( I'll explain this below) gives you an estimated value for the business of $6.75 billion.

Pipelines: This segment will control 100% of the WPZ General Partner (GP), which is entitled to 2% interest in WPZ and certain preferred distribution rights from WPZ, a 73% stake in WPZ, the Canadian Midstream Gathering Assets, the US olefins business, and a 25% stake in the Gulfstream Pipeline already marked for a dropdown to WPZ. Based on WPZ's market cap of $14 billion dollars, that stake is worth $10.2 billion. Based on a recent sale by Spectra Energy, the stake in Gulfstream is worth about $330 million. Prices for the Canadian Midstream, US olefins business and GP are harder to determine because there is no easily comparable data. Therefore set a base value of this company at $10.53 billion, knowing that the GP Canadian, and olefins assets are all left out of this summation.

Adding up the E&P and Pipelines values gets us to$ 17.28 billion, plus the assets that have not been valued. Not so surprisingly, with WMB trading at $29.90 as I am typing this, the market cap of the company is $17.5 billion. That implies that those assets we left out are worth a mere $220 million. My guess is that WPZ will attempt to buy out the GP from the new Pipelines Company, as Enterprise Products (NYSE:EPD) and Inergy (NRGY) both purchased their GP's late last year. This will simplify the structure and allow, in time, for WPZ to increase distributions at a faster rate. Also, the 18 multiple I applied to the E&P business is based on a slight discount to Chesapeake Energy's (NYSE:CHK) multiple, being because CHK is a lower cost producer. However, a ramp up in production by Williams E&P may drive costs down, or the relatively low costs and smallish market cap may add a takeover premium, so That 18 was really a quick estimate based on an industry peer, and could easily increase.

In my opinion William Companies is fairly priced right here, with little downside but room for longer term improvement. Management has shown that it is determined to bring out value for shareholders, and their track record should be seen as a positive. The large stake in such a solid MLP like WPZ, with its 5.6% yield, add further credibility to the companies and should provide a floor in the stock till the separation is complete. Upon completion, the price of natural gas will be the biggest driver in determining where the E&P business should trade, so anyone following WMB should keep an eye on natural gas, with $3.50 being the breakeven point for the E&P.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Disclosure: Sold out of WPZ calls on 2/11, no positions currently.