What’s Behind Enbridge Offer for Spectra Energy Partners

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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 SEP’s 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 federal circuit 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 to acquire a 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.