What Happened In June: Save The MLPs!

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Includes: CHK, DCP, EPD, ETE, HES, KMI, PAA, WMB, WPZ
by: Alerian

By Maria Halmo

After college, a small group of us made a point of attending girls' weekends at least once or twice a year. Like every movie ever, we would all fly in, open some wine, laugh until our sides hurt, and gossip late into the night. Then Larissa announced she had met someone, and Kelly, who rarely (and correctly) approved of anyone's significant other, said she liked him, too. I figured all bets were off-Larissa was getting married and no matter how great Chris was, this was the end of our girls' weekends.

Thank goodness I didn't bail out early. Larissa and Chris have been married for years and we still have girls' weekends [1]. If anything, these weekends are so much more precious to us now that we have serious relationships. It's our time to ask for advice, let our hair down, confess our private fears, and cement friendships that have lasted long past that time Kelly spilled red wine all over Larissa's wedding dress.

That's what I think of every time I hear someone bemoaning the coming end of the MLP structure just because Kinder Morgan (NYSE:KMI) announced it was buying in its MLP subsidiaries last August. Some investors might be bailing out, having absorbed all the losses they can stand and fearing more. But in the biggest news of the month, two large players are doubling down on the MLP structure.

Energy Transfer Equity (NYSE:ETE) made a hostile takeover bid [2] for Williams Companies (NYSE:WMB), but they made that offer contingent on WMB not eliminating its MLP. ETE is only interested [3] if Williams Partners (NYSE:WPZ) continues to trade.

To summarize everything we've said about M&A activity in the past year: everyone is expecting it, but sellers want valuations based on commodity prices from early last year, and buyers want valuations based on current commodity prices, and the gap is just too wide. ETE may have offered WMB a 30% premium to its current stock price, but it's only an 8% premium over last year's high.

Back in May, WPZ experienced a one-day pop of 22.7% on the news that WMB would acquire it at a 14.5% premium, but has already dropped back down to pre-announcement levels [4]. WMB, on the other hand, rose 6.2% when it announced that it would buy WPZ, and then another 25.9% on the day investors found out that ETE was willing to pay a 30% premium for the stock. Absent any transaction, ETE helped WMB return to early 2014 valuations.

What ETE wants in this transaction is not WMB per se, but what WMB has: namely, control over WPZ's assets. In the Northeast alone, the combined company could be a powerhouse, owning long-haul natural gas pipelines, gathering and processing and fractionation facilities, NGL takeaway and export capacity, as well as all the incremental projects that would come with being the dominant player in the region.

If WMB finds that it cannot create the largest shareholder value as a standalone family of companies, who else could it partner with? Plains All American Pipeline (NYSE:PAA) has had a $1 billion revolver outstanding for the past six months, just waiting to buy something. But WMB is a $43 billion company. KMI's very acquisitive, but they'd likely run into anti-trust issues [5]. So, the only other MLP white knight candidate would be Enterprise Products Partners (NYSE:EPD). The company has done large transactions in the past, and certainly could make a bid, but ever since buying in its general partner [6] in 2010, part of management's pitch to investors has been that that Enterprise only has one publicly traded security. So it's unlikely they would consider competing with ETE's offer of a C corporation currency. Additionally, EPD only needs a couple of billion dollars of growth capex per year to maintain its distribution growth profile. EPD knows who it is: a mega-cap diversified energy MLP with a healthy balance sheet, excess distribution coverage, and 5%-6% distribution growth. It is not going to pay big bucks for a massive company just to bump its growth profile a couple of percent in the short and medium term only to be on a treadmill of chasing deals afterwards. In short, EPD could be a white knight, but it doesn't have a savior complex.

As issue we've discussed briefly before is that a large energy company with midstream (or MLP-able) assets that is not getting the premium valuations these assets bring in a separate structure will be needled by shareholders to do so. (The family tree history of DCP Midstream Partners (DPM) is an excellent example of this.)

Hess Corportion (NYSE:HES) announced a joint venture with Global Infrastructure Partners (GIP) where HES sold half of its Bakken midstream assets to GIP and will now pursue an IPO of Hess Midstream Partners (future ticker: HESM). Proceeds will go toward supporting HES upstream operations. If this sounds familiar, it should. During the last commodity price freefall in 2009, Chesapeake Energy (NYSE:CHK) announced a JV with GIP where CHK contributed natural gas gathering, compression, dehydrating, and treating assets to an entity of which GIP would buy a 50% interest. That entity [7] filed an S-1 five months later and went public five months after that. This time around, Hess already filed the S-1 last year, so it probably won't take 10 months for HES and GIP to take HESM public. Last time, GIP paid less than 4x for its interest in CHK's midstream assets; but here, it's paying north of 18x EBITDA. So it's probably reasonable to conclude that GIP at least believes in a long-term recovery [8] in the Bakken. Again, for a deal of this size [9], only a few MLPs [10] could have been potential buyers anyway.

It hasn't been an easy time these past couple of years with MLPs trading up and down. The next six months might get better, but the market could continue to be fickle. M&A might shake things up or down, but just as solid friendships survive marriages and job transitions, the long-term growth trajectory of the energy infrastructure sector remains intact.

Footnotes:

[1] This past May, we rented a house in New Orleans. We drank wine, walked around Bourbon Street, went to yoga, slept in, and got powdered sugar from the beignets all over ourselves from laughing too hard.

[2] If you’re interested in what one Alerian team member called “truly beautiful hostile takeover writing,” definitely check out the link to ETE’s press release.

[3] A caveat: part of the reason ETE doesn’t want to buy a consolidated WMB is because it would be more expensive to do so with more WMB shares outstanding. Presumably ETE CEO Kelcy Warren is less concerned with not creating a taxable event—one of the principal criticisms of the Kinder deal—for WPZ unitholders, except as it relates to convincing them that his offer is better.

[4] Notably, WPZ units fell 7.6% on the ETE/WMB news.

[5] KMI was able to overcome anti-trust issues in its acquisition of El Paso Corporation (former ticker: EP), but the concerns about market power in the interstate natural gas pipeline business would be far greater this time around.

[6] Enterprise GP Holdings (former ticker: EPE).

[7] Originally, Chesapeake Midstream Partners (former ticker: CHKM), which became Access Midstream Partners (former ticker: ACMP), which acquired WPZ and adopted its name and ticker. The world comes full circle.

[8] GIP is a private equity firm, and PE firms typically have investment horizons of at least five to seven years.

[9] GIP paid $2.675 billion in cash.

[10] PAA again comes to mind, as they already have a sizeable position in the Bakken. But PAA management has historically been conservative on acquisition multiples.

Disclosure: © Alerian 2015. All rights reserved. This material is reproduced with the prior consent of Alerian. It is provided as general information only and should not be taken as investment advice. Employees of Alerian are prohibited from owning individual MLPs. For more information on Alerian and to see our full disclaimer, visit http://www.alerian.com/disclaimers.

Maria Halmo is the Director of Research at Alerian, which equips investors to make informed decisions about Master Limited Partnerships (MLPs) and energy infrastructure. Ms. Halmo leads the firm's research efforts, which include examining MLP regulatory filings, monitoring legislative activity, and investigating industry developments. She also oversees Alerian's public communications strategy through investor and media outreach. Ms. Halmo is a former Associate at SteelPath Capital Management LLC, a Dallas-based MLP investment manager, where she conducted valuation analyses of petroleum transportation partnerships and researched macro-level energy issues. Ms. Halmo graduated with a Bachelor of Arts in Astrophysics from Barnard College at Columbia University. She is also a contributing author to Midstream Business, a monthly publication addressing the need for business market intelligence on North American energy infrastructure.