I recently had the opportunity to speak with management representatives from Energy Transfer Partners (ETP). We discussed the pending Sunoco (SUN) acquisition and the generous 7.8% distribution currently offered via this master limited partnership.
Energy Transfer Partners is a publicly traded partnership that owns and operates a diversified portfolio of energy assets. The company owns the largest intrastate pipeline system in Texas. ETP currently has natural gas operations that include approximately 24,000 miles of gathering and transportation pipelines, treating and processing assets, and three storage facilities located in Texas. ETP also holds a 70% interest in Lone Star NGL LLC, joint venture that owns and operates natural gas liquids storage, fractionation, and transportation assets.
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Our teleconference covered ETP's recent news release regarding the $5.3 billion Sunoco acquisition and my associated pro forma cash flow facts and assumptions.
The news release contained the following quote:
'This transaction, which will be immediately accretive, represents the next step in Energy Transfer Partners' transformation into a more diversified enterprise with an integrated and expanded footprint,' said Kelcy Warren, ETP's chief executive officer and chairman of the board of directors.
This comment caught my attention, as well as fellow Seeking Alpha contributor Ron Hiram's thoughtful article from July 3 that called into question how the Sunoco deal could be accretive. Working independently, Hiram and this writer questioned how the Sunoco acquisition was "immediately accretive." My initial pro forma model was closer to being cash positive than Hiram's table as published in the article, but it still was in the red.
So I placed a call to ETP. Energy Transfer Partners management and I discussed public documents related to the acquisition. No proprietary information was discussed. The discussion of public information with management offered a further understanding of the transaction. The accretive nature of the acquisition was reiterated.
Sunoco Acquisition Economics
The following is an overview of my latest opinion of the Energy Transfer/Sunoco pro forma economics. Facts and premises were determined through review of public documents, SEC filings, news releases, and transcripts.
Here's my obligatory disclaimer: The pro forma and cash flow conclusions are my own. Readers may come to different conclusions using the same information. This analysis is not intended to offer investment advice to buy or sell ETP units.
Now let's review the Sunoco deal in two parts. First, how will Energy Transfer Partners finance the deal? Second, what are the projected cash flows associated with the financing activities and new assets?
The total acquisition cost is reported to be $5.3 billion. Energy Transfer Partners stated it intends to finance the deal through a 50/50 blend of cash and equity.
Via its first-quarter unaudited 10-Q filing, Sunoco had $949 million net cash on its balance sheet. I subtracted cash and debt held by SXL to arrive at this figure. I premise that Sunoco net cash will become part of the cash used to complete the transaction. Let's assume there is $900 million net cash remaining upon the closing date. The closing is scheduled for sometime in the third or fourth quarter of this year.
As part of the April 30 ETP/SUN transcript conference call, the inventory and stock from the Sunoco Pennsylvania refinery will be monetized. The after-tax proceeds are estimated to be $200 million. If the Philadelphia refinery can avoid closure (which appears to be the case based upon the Carlyle announcement), an additional $100 million upside is anticipated. For purposes of my pro forma, I excluded the positive impact of this development. These aforementioned cash items total $1.1 billion.
On July 3, ETP announced the completion of a successful secondary offering of approximately 15.5 million new units at $44.57 each, thereby raising $690 million. Assuming another $1.96 billion of equity financing is required, ETP will need to issue an additional 43.6 million units at $45 each. I assumed a $45 per unit secondary offering was reasonable. The actual secondary price could be more or less. In any event, under these assumptions, such offerings will total an issuance of 58.8 million new units and provide the proposed $2.65 billion in equity financing.
To finance the remaining balance of notes totaling $1.55 billion would be required to complete the transaction. I assumed that ETP can place long-term notes at 5%. On June 18, S&P affirmed ETP's BBB credit rating and offered a stable outlook. This is the low end of investment-grade debt; 5% is in the ballpark.
Total -- $5.3 billion financed.
Pro Forma Cash Flow
We'll now permit the rubber to hit the road. First, let's review the anticipated outgoing cash flows:
- The current cash distribution on ETP units is $3.575. Going with the assumed aggregate 58.8 million new units offered to finance the deal, the outgoing cash flow to maintain the distribution will be $210 million a year.
- The annual debt service interest payment for $1.55 billion at 5% should be about $78 million.
In order to maintain the retail marketing business, additional capex will be required. Sunoco indicated $70 million to $80 million a year is considered a routine run rate. I assume that ETP management will keep the capital toward the low end of the program: $70 million a year. My reasoning is that the retail business is not core to Energy Transfer Partners. While ETP management has stated that it is committed to the Sunoco retail marketing business, I premise this segment will ultimately be sold at the right time, at the right price. If correct, base run-and-maintain capex should be enough.
The Philadelphia refining business will not need any additional capital calls from Sunoco per the recent Carlyle announcement. In addition, please note that I am assuming that the ongoing refining business provides zero cash flow. Indeed, Sunoco has lost money on this business segment for years. However, the new refinery owners may be able to make changes that will reverse the losing trend. If successful, ETP will obtain some positive benefit. On the other hand, I do not see any further downside for ETP.
Total -- $358 million a year.
Now, the incoming cash flows:
- The Sunoco retail business is presumed to generate a flat $261 EBITDA going forward. This figure was taken from the 2011 SUN filings. I assumed a 20 percent tax rate for a net $209 million a year cash.
- Energy Transfer Partners assumed $70 million a year of operational synergies upon completion of the deal. I did not change this premise.
- Sunoco Logistics (largely the pipeline and distribution business segments) is set up as an MLP. Energy Transfer Partners expects to obtain about $97 million a year in pretax cash distributions from the SXL business. I made no assumption to increase the distribution or account for taxation.
Total -- $376 million a year.
The bottom line analysis comes to net positive cash flow of $18 million a year. This is barely breakeven.
However, Energy Transfer Equity (ETE), agreed to forgo IDR (Incentive Distribution Rights) of $70 million a year for three years as part of the Sunoco acquisition. When considering this factor, positive cash flow improves to $88 million a year for the three years succeeding the closing of the deal.
This analysis assumes no positive contribution from the refining business, nor any inventory uplift from the anticipated recently announced continued operations of the Philadelphia refinery. Furthermore, I included no increases in the retail business EBITDA or SXL cash distributions going forward. My view is that the likelihood of all these potential upside drivers failing to deliver any increased cash is a low probability.
Indeed, investors may also consider that for General Partner ETE to forgo IDRs for three years, the entity assumes that additional cash flows will enhance the transaction going forward. Otherwise, why do it?
Additional Commentary and Conclusion
Two overarching takeaways resulted from the interview with ETP management representatives:
- Management representatives maintained that the Sunoco deal would be "immediately accretive," and
- the current cash $3.575 distribution yield was safe.
After adjusting my original pro forma cash flow model as outlined in the foregoing, I can now arrive at a plausible methodology for concurrence that the ETP/SUN deal will be accretive.
Notably, the interview also touched on the disposition of the current cash distribution. ETP management representatives made a point to offer the payout was not in jeopardy. I countered that in late 2010, CEO Kelcy Warren had gone on record as stating that he expected the distribution to be raised not later than the third quarter of 2011. This did not happen, raising unit holder doubts about future payouts.
I received a response that when Warren made his initial statement about the distribution, it was before the company had embarked upon significant new business activity. This work included divesting its propane business, the Louis-Dryfus purchase, the Southern Union/Citrus drop-down deal, and the aforementioned Sunoco acquisition. Major pipeline construction and expansion projects were also ongoing. All this business development work altered the landscape of the company. There has been a lot of cash sloshing around, and it was prudent to maintain (but not increase) the distribution until the dust settled at bit.
My view is that while these deals have added both business complexity and a postponement of a cash distribution increase, there is a high likelihood investors will see a markedly stronger and more diversified company emerge. In the meantime, I suggest the current distribution is safe as a function of the business risks associated with an ongoing energy transportation enterprise.
Disclosure: I am long ETP.