Tag Archives: SEP

What’s Behind Enbridge Offer for Spectra Energy Partners

Calgary-based energy infrastructure company Enbridge Inc. (NYSE: ENB) on Thursday made a nonbinding offer to acquire the approximately 17% of Spectra Energy Partners L.P. (NYSE: SEP) it does not already own in a deal that would pay unitholders of Spectra 1.0123 shares of Enbridge common stock for every common unit of Spectra they currently hold.

At last night’s closing price, that represents a premium of about 2% and a purchase price for the outstanding common units of around $2.56 billion.

In a letter to Spectra’s board of directors, Enbridge said:

We believe the proposed exchange ratio for SEP Common Units reflects a fair value to the stand-alone value of SEPs Common Units today. In particular, the value offered for all of SEP’s outstanding publicly-traded Common Units takes into account the difficulty of supporting SEP’s existing distribution levels from 2019 on, given the combined impact of the announcement of the Federal Energy Regulatory Commission’s income tax allowance policy change and U.S. tax reform on MLP market valuations and the resulting impact on MLPs’ access to capital at reasonable rates.

The Federal Energy Regulatory Commission (FERC) in March revised its prior policies and no longer allows master limited partnerships (MLPs) like Spectra to recover an income tax allowance in their cost of service. Under previous policy, MLPs were allowed to receive both an income tax allowance and a return on equity based on discounted cash flow, a policy the federalcircuit court in Washington, D.C., ruled gave MLPs double recovery of income tax costs and that the FERC was forced to roll back.

What was once a feature of MLPs is now a bug, and the convoluted corporate structures that characterize MLPs may no longer benefit the general partners or the limited partners to the degree that they once did. Weighed against a lower cost of capital for corporations that issue common stock, MLPs lose again.

Enbridge’s offer is really one of those that unitholders can’t refuse because there is no other option. Yesterday, Cheniere Energy paid a 1% premium toacquirea subsidiary’s shares that it didn’t already own. The subsidiary’s sole asset was a stake of about 49% in Cheniere Energy Partners, another MLP. Though different in details, the two transactions are reactions to the FERC’s March policy change.

Common units of Spectra traded down about 0.8% Friday morning, at $32.47 in a 52-week range of $31.16 to $46.47.

Enbridge shares traded down 1.6% at $32.47, in a 52-week range of $29.00 to $42.31. The stock’s 12-month consensus share price is $41.66.

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Merger Mania Sweeps Through the Energy Sector, Dramatically Altering the Landscape

Natural gas pipeline giant Williams Companies (NYSE:WMB) announced today that it agreed to acquire the rest of its master limited partnership (MLP) Williams Partners (NYSE:WPZ) that it didn’t already own in a $10.5 billion deal. Not to be outdone, Canadian energy infrastructure giant Enbridge (NYSE:ENB) made an offer to acquire its namesake MLP Enbridge Energy Partners (NYSE:EEP), along with the rest of its publicly traded entities, including Spectra Energy Partners (NYSE:SEP). These transactions have big implications not only for investors in these entities but for those who own other pipeline companies, too.

Details on the deals

Williams Companies agreed to acquire the 26% of Williams Partners that it doesn’t hold in a stock-for-unit transaction. Under the terms of the deal, investors in Williams Partners will receive 1.494 shares of Williams Companies for each unit they own, which represents a 6.4% premium to yesterday’s closing price. The transaction, which Williams hinted was in the works, will simplify its organizational structure, improve its credit profile, and increase dividend coverage, making the company’s 5%-yielding payout even more sustainable.

Two people shaking hands superimposed on an energy facility in the background.

Image source: Getty Images.

Enbridge, meanwhile, offered to buy all its sponsored vehicles, which include MLPs Enbridge Energy Partners and Spectra Energy Partners, as well as Enbridge Energy Management (NYSE:EEQ) and Enbridge Income Fund Holdings (TSX:ENF). Under the terms of thismegadeal, the company would swap its shares for the equity of these various entities at a ratio equivalent to yesterday’s closing price, implying no merger premium. Overall, Enbridge would issue 272 million new shares valued at 11.4 billion Canadian dollars ($8.9 billion). This proposed transaction would simplify Enbridge’s structure, improve its credit profile, and increase retained cash flow to fund growth. The deal would help support Enbridge’s strategic plan to grow its 6.4%-yielding dividend at a 10% annual rate through 2020.

What’s driving these mergers

While several factorsserved as catalysts for these deals, the main one is a policy change by the Federal Energy Regulatory Commission (FERC) that will have a significant impact on MLPs going forward. In March, FERC revised a long-standing ruling that allowed MLPs to collect income taxes on top of the rates they charged shippers on certain pipelines after a court ruling found that FERC “failed to demonstrate there was no double recovery of income tax costs.” That rule change hit MLPs operating these pipelines hard, including Enbridge Energy Partners, which expected a $125 million hit to its revenue this year. However, since both Enbridge and Williams are corporations, they can retain the income tax allowance on those pipelines by acquiring their MLPs.

Enbridge noted that the FERC ruling and subsequent “market reactions across the MLP landscape” had “challenged the stand-alone viability of Spectra Energy Partners, Enbridge Energy Partners, and Enbridge Energy Management as reliable and cost-effective sources of capital to support Enbridge’s growth.” Because of that, the company could no longer drop down assets into those entities and raise cash to finance growth. The company also noted that Enbridge Income Fund had “lost its cost of capital advantage and is no longer an effective funding vehicle.” Thus, it made sense to bring all these vehicles back in-house and create one stronger company.

A person in a hard hat walking by a pipeline with a blue sky on the other end.

Image source: Getty Images.

There are more deals in the pipeline

These transactions will likely spur others to follow suit. Energy Transfer Equityhas already made it clear that it will merge with its MLP Energy Transfer Partnersas soon as it gets the green light from credit rating agencies that the combined entity can maintain an investment-grade credit rating. Meanwhile, TransCanadawarned that its MLP, TC Pipelines, isn’t a viable funding vehicle in light of the FERC ruling. Because of that, TransCanada might follow Enbridge and Williams in rolling up its MLP.

However, given the distressed nature of these MLPs, it’s unlikely that investors will receive much, if any, merger premium. So there’s no sense in buying them in hopes of earning a quick return. Instead, investors need to take the long-term view and consider companies like Williams and Enbridge, which are becoming much stronger, more sustainable dividend-growth stories with the buyouts of their MLPs.