Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The good news for Energy Transfer Equity's investors is that their units are no longer the playthings of the oil market nor, perhaps, are they bound to hook up with Williams Cos. On the other hand, beyond cashing out altogether, they remain tied to Energy Transfer's Chairman, Kelcy Warren.

Dissociation
Energy Transfer's rolling 60-day correlation with oil has dropped sharply from January's peak
Source: Bloomberg

The plot twists of Energy Transfer's proposed, and now much regretted, takeover of Williams are so numerous at this point that a recap is in order. Having struck the deal less than seven months ago, it has surely dawned on Energy Transfer that it overpaid and the $6 billion cash element would trash its credit rating. So it has since:

On Monday, Energy Transfer threw a bit more napalm on this particular patch of earth with an updated merger filing. It disclosed that lawyers at Latham & Watkins had voiced reservations about issuing a favorable opinion on the tax-free nature of the deal, a condition of closing. Energy Transfer's units shot up in price immediately, as this looked to many like a deal-killer. Williams fell, meanwhile, and the spread between its price and the implied offer blew out.

Williams, It Was Really Something
Williams' discount to the Energy Transfer offer has widened beyond 30 percent again
Source: Bloomberg

It is hard to know exactly what might cause Energy Transfer's lawyers to potentially stymie a deal their client regrets agreeing to. One possible rationale could be that the $6 billion cash element, having jumped from roughly 16 percent of the transaction value to almost 30 percent, might cause issues with this being treated as a tax-free contribution of property to a partnership for some sellers. But this is a complex deal involving multiple companies and partnerships, so there are several possible reasons that could be given.

In any case, while merger arbs hurriedly shifting tack likely explains most of the violent moves in the various stocks involved this week, investors should be careful about simply jumping back into Energy Transfer. For one thing, Williams disputes the tax-law concern is actually a deal breaker.

Beyond this, though, there are bigger issues of governance to consider.

In the same filing, Energy Transfer also trashed profit guidance for the merged business, echoing its earlier synergies strike. Ebitda in 2017, for example, is now expected to be almost a quarter less than what Energy Transfer was projecting previously. The business environment hasn't deteriorated anything like that; oil prices have risen in the past month. As Timm Schneider at Evercore ISI put it in a research report published Tuesday:

For valuation purposes, we are solely using our OWN estimates (see body) and basically ignoring any guidance figures provided by the filing.

The guidance also confirmed what was long suspected: Energy Transfer foresees making savage dividend cuts if the deal goes through. 

It is tempting for investors surveying this soap opera to conclude that, assuming the threat of this deal is removed, normal service will be resumed at Energy Transfer -- don't forget, the same company that has been taking a flamethrower to guidance was, only two months ago, touting its "resiliency" on the quarterly earnings call.

Moreover, investors in master limited partnerships have long agreed, tacitly or otherwise, to be essentially along for the ride. MLPs typically lack usual protections, like a majority of independent directors or the ability to elect the board. After all, who needs those when everyone involved are partners, right?

Partnerships imply that interests are aligned, though, and Energy Transfer's earlier issuance of dividend-cut insurance to its Chairman was a stark rebuttal of that notion. And why did Energy Transfer resort to this? To cope with the potential damage from a $37 billion merger -- the biggest in a string of roll-ups -- that was announced in the fall but was starting to look dreadful already by midwinter. Limited partners should ask themselves: Even if they think their interests somehow remain aligned with Energy Transfer's management, is that the sort of leadership they really want to be aligned with?

Should the deal collapse, Energy Transfer may yet rise in value, but, at the very least, a hefty risk premium would be warranted.

As so often, when a cyclical boom ends, companies can distinguish themselves, or not, by how well they protect their investors from the fallout. There is no rule saying that MLPs have to be governed in this way. Companies such as Magellan Midstream Partners, for example, choose to have stronger, independent board oversight. It is unlikely to be pure coincidence that Magellan's balance sheet is among the strongest in the sector and that its units yield less than 5 percent, versus a sector average of 8 percent and Energy Transfer's 11 percent.

If the MLP sector's trial by fire ends up having a silver lining, it will only be if investors consequently wised up to exactly who they have partnered with.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net