- The company has to decide if there is an avenue to overturn the $410 million judgement.
- Far more important was how management tried to eliminate downside risk to key insiders.
- Williams was concerned that new shareholders could take actions that would decrease the value of their holdings post-merger.
- Management recently agreed to purchase common units at a price not available to the public.
- There are plenty of other issues facing Energy Transfer and its subsidiaries.
- This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Learn More »
Energy Transfer (NYSE:ET) recently lost a court case. As a result, they have a more than $410 million debt to pay (the judgement plus attorneys' fees minus a sanction). Now management has to decide what are the best actions in this case and whether or not there is a reasonable pathway to overturning this court decision. But in the meantime, some very interesting facts came out to show whose side management aligns with.
"Of particular concern to Williams was the possibility that Warren, a significant ETE common unitholder who would control both ETE and ETC after the merger, could take actions that benefitted ETE unitholders at the expense of ETC. That is precisely what the Preferred Offering achieved. The Preferred Offering guaranteed participants a cash distribution preference of 11 cents, plus an additional 17½ cents in accrual credits, regardless of whether any distributions were made to common unitholders."
"This had the effect of eliminating downside risk for participants in the event of a distribution cut, which ETE had anticipated since January 2016"
Source: The Williams Companies, Inc. v. Energy Transfer LP, et al. December 2021, Court Decision Pages 66 and 67.
One of the things assumed by most shareholders is that a major shareholder of company units or common stock is aligned with the goals and objectives of other shareholders. But this experience demonstrates that a determined management can try to come out ahead of common shareholders.
This management tried to unsuccessfully eliminate the downside risk associated with the merger at the time. That should be a warning to the common shareholders that this management will benefit itself at the expense of common shareholders if given the chance. The judge is pretty much telling you as a shareholder that is what is happening.
Management's reasoning to the court was that this action was allowed under the agreement. Clearly the court disagreed. To the public, management argued that there never was a distribution cut. Therefore, managements record of returns during the period could be duplicated by the public in the common units.
Williams took action to contest this (as the court put it) material change in the capital structure that was not part of the merger agreement. The judge also noted that the issuance of the preferred violated the limited partnership agreement as well. This tells you the lengths that management was willing to go to make sure that financially they did not suffer the same consequences as everyone else in this failed merger.
Management (recently) currently agreed to purchase some units that were to be sold to the public at a price that really was not available to the public. The sales price to the public was $7.65 while management paid $7.42. Therefore, the attitude about being a top manager has privileges persists to the current time. As a shareholder, you need to realize that this management will always be one step ahead of you. That is an extremely important investment consideration.
Another Fine And More
FERC has now proposed a $40 million fine to Rover Pipeline LLC, another Energy Transfer subsidiary for yet another case of multiple violations. This proposal is will now head to a "discussion period" and is not final. But it does appear that management has a bunch of issues to plow through that are holding the stock back.
Keep in mind that management has mentioned in every report that these issues are not expected to be material and management intends to vigorously defend the company. So, the final outcome of this and other issues could vary materially from the current headlines.
The one thing that is certain has got to be the lawyers' fees for all of this and that has to be material at this point even for a company of the size of Energy Transfer. Management has lawyers' teams in multiple states and those legal fees are probably at least in the millions for each team.
Management must also defend the company (and its relevant subsidiaries) against 48 criminal charges filed by the attorney general in Pennsylvania. Now these charges most likely will result in the payment of a fine. But that is still more money that is not available to simplify the capital structure or repay debt.
Distributions and Buybacks
In the meantime, management has announced that they will increase the distributions and buybacks in fiscal year 2022 in an attempt to return more money to shareholders.
The company is certainly large enough to do exactly what management announced. However, if the issues confronting the company and its subsidiaries continue to mount, then the market will have concerns about sustaining a distribution increase or a buyback program.
In the meantime, the Army Corps of Engineers has extended the deadline for the EIS that they are currently doing until September 2022. The uncertainty surrounding this case will likely continue at least through 2022.
Management continues to "plow ahead" by noting that even with the issues ahead, they expect to meet the latest deadlines. The Mariner East completion is scheduled for early in fiscal year 2022. Hopefully that will cause the legal issues in Pennsylvania to decline. This would remove some uncertainty from the stock price.
The real issue that appears to be holding the stock back is the final outcome of the issues facing management. Only some of these were discussed above. The company is very large and can therefore afford (at least up to this point) the legal issues that are confronting management.
But the market has doubts about the final cost of all of these challenges to the company and its subsidiaries. Therefore, any investment at the current time is a gamble that the cost of all the legal challenges (and other issues) will not be a material cost to a company the size of Energy Transfer.
From a debt perspective, this is an investment grade company. But between the debt claim to cash flow and the common shareholders are these issues and preferred stock. That makes the common riskier than one would normally expect for a company with investment grade debt.
The last issue was the finding by the court that the issuance of preferred stock created a situation that eliminated the downside risk of the transaction. That put management in a better positioned to potentially benefit at the expense of common unit holders. That kind of finding is unlikely to be reversed in any appeals process.
When combined with the recent common unit purchases, it is very clear that this management believes it can treat itself better than common unit holders. That is something that every potential investor needs to review before they invest in the company. This management has demonstrated that when the "chips are down" it could well seek in the future to benefit itself by eliminating risk at the expense of other investors. To me, that is a huge red flag.
I analyze oil and gas companies and related companies like Energy Transfer in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies -- the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.
This article was written by
Long Player believes oil and gas is a boom-bust, cyclical industry. It takes patience, and it certainly helps to have experience. He has been focusing on this industry for years. He is a retired CPA, and holds an MBA and MA.He leads the investing group Oil & Gas Value Research. He looks for under-followed oil companies and out-of-favor midstream companies that offer compelling opportunities. The group includes an active chat room in which Oil & Gas investors discuss recent information and share ideas. Learn more.
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