Already one of the largest midstream and energy logistics firms in North America, Energy Transfer Equity, L.P. (ETE) and its master limited partnership Energy Transfer Partners, L.P. (ETP) are about to get that much bigger.
In one of the largest midstream deals in history, Energy Transfer agreed to buy large rival Williams (WMB). That combo would create the largest midstream firm on the planet and the fifth-largest energy firm overall.
And yet, despite becoming the midstream firm, no seemed to like the deal. When it was officially announced, ETE stock fell nearly 13%.
So what gives — Is ETE stock now a tantalizing value? Let’s explore it with three pros and three cons to holding stock in Energy Transfer.
Energy Transfer Pros
Mega-Sized Midstream: After Energy Transfer completes the deal to buy WMB, the resulting energy logistics firm is going to be huge. Like, “biggest midstream firm in North America” huge. Combined, the new ETE will own/control a network of more than 104,000 miles of natural gas, NGLs, crude oil and refined product pipelines. That network will transport roughly 15% of the nation’s crude oil and 35% of its natural gas production each day. More importantly, ETE will now have a massive presence in natural gas’s hot bed — the Marcellus shale. Aside from pipelines, the combined deal will give Energy Transfer numerous processing plants, storage facilities and other pieces of energy logistics infrastructure. ETE will now have 11 billion cubic feet per day of natural gas processing capacity and boast America’s third-largest natural gas liquids business. ETE will also have a large percentage of the nation’s already approved LNG export capacity. All in all, the deal allows ETE to fire on all cylinders and compliments its already owned holdings well.
An IDR Machine: The beauty for ETE is that it’s the general partner of the Energy Transfer network. And as the GP, ETE is running the show and is entitled to receive fees and extra bonuses for managing the MLP. These are called incentive distribution rights, or IDRs. Additionally, GPs will be the majority owner of the LP units that are publicly traded. What that means is as Energy Transfer’s underlying MLPs grow and kick out more cash, ETE is entitled to a bigger share of that cash. After the merger, ETE will hold the IDRs and majority of units in previously mentioned ETP, Sunoco Logistics Partners (SXL), Sunoco LP (SUN), non-publicly traded Energy Transfer LNG and now Williams Partners (WPZ). All of these partnerships throw off major cash flows and the addition of WPZ will help ETE keep growing its dividend for its shareholders at a rapid pace. Already ETE yields 4.53%.
A New Tax-Deferred Account Entity: Under the terms of the deal, Energy Transfer will create a new stock called Energy Transfer Corp (ETC). ETC is designed to closely track the performance of ETE — which is structured as an MLP. However, ETC will be a C corporation and hold nothing but ETE units. The beauty is that the new ETC shares will allow to institutional investors, pension funds, endowments and foreign investors access to Energy Transfer. Many are prohibited from holding MLPs. That makes it easier for ETE to use equity for future transactions. That will help Energy Transfer reduce costs and not require it take more debt to pay for expansions. Additionally, ETC will allow retail investors using a retirement account or other tax-deferred vehicle to own Energy Transfer.
Energy Transfer Cons
A Really Complex Deal: MLPs have many moving parts. So when you are combining two of the largest MLPs and midstream firms, it’s going to be complex. And the Energy Transfer-Williams combo is going to be especially complex. Just look at this flow chart of the deal. And that doesn’t even include the next tier down with all of ETE’s current MLP subsidiaries. Understanding who gets what distributions and cash flows, how much is owned by current WMB shareholders, etc. is very confusing. Adding to that confusion are the various three scenarios that WMB shareholder must pick as to when the deal goes through. All have different benefits and potential ownership outcomes. ETE claims that “from complication comes value.” Over the long haul, that may not be so true.
Here Comes That C-Corp: Part of the appeal of investing with ETE is that it is structured as an MLP. And as one, its kicks out much of its cash flows — which consist of the IDRs and fees — back to unit holders. Still, the issuance of ETC shares could mean that down the road, ETE may abandon the MLP structure and convert fully to a C-corp. That’s something Kinder Morgan (KMI) did a year or so ago. That was all great for KMI shareholders. However, KMP unit holders saw their income basically cut in half when Kinder swallowed its MLPs. Given how big Energy Transfer is now getting, it may actually fit into the “too big for an MLP” camp. That means, investors buying ETE for its hefty, growing dividend may be in for a shock down the road.
Lower Natural Gas Production: While ETE and WMB aren’t producers of natural gas or crude oil, the downturn in prices is affecting them. That’s because lower prices have caused many energy firms to abandon drilling projects, reduce capex spending and ultimately cut supplies. This includes some of their major customers — like Chesapeake Energy (CHK). This means less natural gas and oil following through those pipeline and processing equipment. And since ETE/WMB get paid on volumes, any dip over the longer haul could seriously impact ETE’s cash flows and its ability to pay a growing dividend. That might make it harder for Energy Transfer to fund growth organically and it could be right back to the merger/buyout well for another round of mega-deals.
The Bottom Line
Given the positives and negatives, the pros outweigh any issues for longer-term investors. Energy Transfer is still looking like a major buy. The WMB buyout really does make ETE the midstream firm.
If the deal is successful and goes through without a hitch, the combined entity will be a tour de force in the midstream and energy logistics sector. And ETE will be a huge dividend machine.
The IDRs and cash flows it receives from its multiple MLPs will continue to help it raise its already juicy dividend further into the future. The new ETC share class will allow it to expand and fund growth at cheaper rates.
While already midstream royalty, the new Energy Transfer is quickly becoming the king. And as such, ETE should trade a premium with regards to the entire midstream sector. Investors looking to cash in on moving crude oil and natural gas around, ETE has to be on your list.
As of this writing, Aaron Levitt was long KMI.