More Mergers in MLP Land: When Simplification Continues to Make Sense

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The term “simplification transaction” may fly under the radar of many investors who look for mergers and acquisitions. This strategy has been working in the realm of oil and gas when it comes to master limited partnerships (MLPs). Some of the “simplifications” have been bad for the equity unitholders, but it may be a win-win for the likes of Energy Transfer.

Energy Transfer Equity L.P. (NYSE: ETE) and Energy Transfer Partners L.P. (NYSE: ETP) have entered into a definitive merger agreement for ETP to become a wholly owned subsidiary of ETE. The deal is being conducted in a unit-for-unit exchange, meaning it is a cashless merger transaction. According to the release, this transaction will act to both streamline Energy Transfer’s organizational structure and also eliminate the incentive distribution rights (IDRs) burden. ETE’s IDRs in ETP will be canceled under the transaction.

ETP unitholders (other than ETE and its subsidiaries) will receive 1.28 common units of ETE for each common unit of ETP they own. The simplification transaction also, according to the companies, is expected to strengthen the balance sheet of the combined organization as it can use the cash distribution savings to reduce the entity’s debt and will be used to fund a portion of ETP’s growth capital expenditure program. Energy Transfer noted the path of future distributions:

The completion of major capital projects currently in progress is expected to continue to generate strong distributable cash flow growth for the combined partnership following the transaction. The partnerships expect to maintain investment grade credit ratings for the combined partnership.

The transaction has been approved by the boards of directors and conflicts committees of both partnerships. The merger is expected to close during the fourth quarter of 2018 and is subject to the approval by a majority of the unaffiliated unitholders of ETP and other customary closing conditions. ETE currently owns the general partner of ETP.

Merrill Lynch previously had a Buy rating and a $21 price objective on ETP. That has now moved to No Rating, and the price objective has been removed as the firm noted that fundamentals no longer apply.

Moody’s already opined on the deal. The ratings agency maintained its investment grade rating of Baa3 on Energy Transfer Partners (with a negative outlook) and is reviewing the Energy Transfer Equity rating for an upgrade. Moody’s said of the transaction:

This simplification transaction, which, with the projected elimination of ETE’s Incentive Distribution Rights (IDRs), will relieve ETP of the growing IDR burden on its cost of capital, while enabling it to retain a significantly greater amount of cash flow with which to fund its future growth. The combined entities’ extremely large and diversified midstream asset base, generating largely fee-based cash flows should enable the company to manage its financial leverage to a modestly lower level while sustaining high levels of distribution coverage.

Energy Transfer Equity and Energy Transfer Partners generally rank among the largest publicly traded midstream MLPs. On top of the large market values, there is also the geographic reach and the operational diversification of its businesses.

The equity units of Energy Transfer Equity were last seen up just three cents to $18.46, with a $19.9 billion market cap. Its 52-week trading range is $12.80 to $19.34, and the consensus target price from Thomson Reuters is roughly $20.20. Its distribution is closer to 7% on a yield-equivalent basis.

The units of Energy Transfer Partners were up $2.31 (10.9%) to $23.52. It has a $27.4 billion market cap and a 52-week range of $15.05 to $24.00. The distribution’s yield equivalent is above 10% here, and the consensus target price from Thomson Reuters is $24.05.

Unfortunately for unitholders, both ETE and ETP units are valued at roughly half of their peak a few years ago.