Williiams (WMB); market cap (as of 02/10/15): $27.63bn
Energy Transfer Equity (ETE); market cap (as of 02/10/15): $21.96bn

 

Introduction

On Monday September 28, Energy Transfer Equity (ETE) announced to acquire its rival The Williams Company Inc. (WMB) for c. $37.7bn (assuming $4.6bn of Williams’ debt). This transaction happened in a context of a consolidating Oil Sector.

 

About Williams

The Williams Inc., headquartered in Oklahoma is a pipeline infrastructure provider dealing primarily with North American natural gas supplies. The Williams Inc. already controls 60% of Williams Partners which gathers and transports natural gas to olefins for processing.

About Energy Transfer Equity

Energy Transfer Equity is a Master Limited Partnership (MLP) Midstream Company, which wholly owns Energy Transfer Partners and Sunoco. ETE group operates c. 115 thousand kilometres of gas and crude oil pipeline. The company sells natural gas to electric utilities, power plants and local distribution companies.

 

Market Reaction

ETE fell 7.5% to $18.77 at the close in New York Tuesday after dropping 13% Monday. Williams fell 4.5% to $34.93 after losing 12%. This market reaction is odd and should be carefully analysed. What could have caused this plummeting?

A Question of Timing

In June of this year, Energy Transfer offered Williams $64 a share in an unsolicited all-share merger bid. This offer was however reneged by Williams at the time. This week however, Williams has agreed to a renewed offer at the lower price of $43.50 per share, with $6bn in cash and the rest in shares. The oil industry condition is most likely the reason why Williams accepted the offer this time around.

Although the offer prompted Williams to begin looking into other strategic alternatives, the original June offer was refused because the board believed it undervalued the company’s existing assets, even at $48bn. This transaction represents therefore $11bn of opportunity costs. Despite the market pressures acting on Williams, it is hard to understand what prompted such a change of heart.

 

Deal Structure

This deal creating the second largest crude and logistic MLP appears more complex then it originally seems. Under the term of the transaction, it is Energy Transfer Corp (ETC), a subsidiary of ETE created especially for the operation, which acquired Williams at $43.5 a share. Williams’ shareholders have the right to choose between exchanging their share against 1.8716 ETC’s units (equivalent of shares in the MLP legal structure), or cash. However, only an amount of $6.05bn is available in cash. The transaction is expected to be tax-free for Williams’ shareholders, except for the cash received.

The acquisition will be funded through $26.8bn of ETC shares, $6bn of debt issued, $4.2bn of Williams’ debt and $634m of ETE Revolver Draw. It would be used to purchase WMB Equity valued at $32.868bn, terminate WMB Revolver of $434m, pay for the transaction expenses of $200m and WMB’s debt of $4.2bn.

This deal also terminates a previous one still in process: the merger agreement between The Williams Inc. and Williams Partner that was announced in May 2015 for $13.8bn. Breaking this contract will cost The Williams Inc. $418m of fees.

 

A Complicated Deal

The complexity of the deal could also have had an impact on analysts’ reaction. ETE structured the transaction this way.

ETE

First, Energy Transfer Corp GP LLC and Energy Transfer Corp LP (“ETC”) are formed; ETC elects to be taxed as a corporation for federal tax purposes (1).

Then, ETC issues shares and cash to WMB stockholder in exchange for all outstanding shares of WMB. WMB and ETC merge (2).

ETE issues ETE Class E units to ETC in an amount equal to the number of shares issued in the transaction. In exchange of the Class E units, ETC contributes WMBS’s assets to ETE, which becomes a co-obligor of WMB’s outstanding debt. ETC will benefit from a dividend equalization agreement through 2018: ETE ensure that ETC shareholders receive the same dividend per ETC share as the cash received from ETE units (3).

Post closing, it is expected that ETE unit holders will have the option to exchange ETE units for ETC shares during a selected exchange period each year (4).

 

Rationale

Energy Transfer appears to take a major step to expand across the USA. From a geographical perspective, this deal offers ETE a presence in all of the US. With its 115,000km of pipelines plus Williams’ 33,000km, ETE in now in the position to compete in size with juggernauts such as Kinder Morgan or Spectra.

This acquisition would increase operational efficiencies with $2bn of synergies by 2020 (thanks to $400m of costs savings), which represents 20% of the pro-forma EBITDA. This transaction would allow pipeline producers to reduce their cost in an environment where low barrel price push oil driller to so reduce and even stop production. The prolonged rut in global oil prices has forced investment and profitability of North American producers to drop significantly. Especially in the large shale gas industry the choices have become narrow: sell yourself to avoid bankruptcy or build in size and weather the storm.  Although the drop in oil and gas prices should not theoretically affect the profitability of infrastructure and pipeline providers such as Williams, their customers are suffering and the reduced demand has continued “downstream” to the providers.

Part of the new strategy will be to build and expand pipelines in such a fashion to allow the movement of cheaply produced gas from the Marcellus field and Texan sources across the country to more profitable destinations such as New York, the Midwest, Canada and the Gulf Coast.

According to the Chief Financial Officer Jamie Welch during an analyst conference call: “We can basically take you from anywhere to anywhere and everywhere in between, that’s a pretty unique value proposition”

This strategy of providing a “one-stop” solution to gas transport is a bet that by cutting margins, and compensating with increased volumes, the newly consolidated company will be able to push out competitors. In an industry where economies of scale play a large role, this seems like a safe bet.

This deal therefore appears as a strategic response to Kinder Morgan future expansion. The diversification of its assets will also help ETE’s operations.

 

Conclusion

Energy Transfer and Williams however are not the only midstream producers to suffer over the last several months. The largest competitor, Kinder Morgan lost approximately 25% of its stock price over the last 3 months in a sign that the major market trends have been the dominant driver of shareholder angst as of late.

In light of the circumstances, three other important consolidations were reported in a little more than one year: Kinder Morgan Inc. and Kinder Morgan Energy Partners, Kinder Morgan Management and El Paso Pipeline ($76bn), Halliburton and Baker Huge ($35bn), Shell and BG Group (£47) and finally Schlumberger and Cameron ($15bn).

 

Advisors

While Williamsons has been advised by Barclays and Lazard, ETE hired Goldman Sachs, BoAML, Citigroup, Deutsche Bank, UBS, Credit Suisse, Morgan Stanley, JP Morgan and RBC.

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