Deals

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.

I get it: Even with a $28 billion price tag appended to it, you find it hard to get excited about a pipeline merger. In thinking about Enbridge's acquisition of Spectra Energy, though, that actually makes sense. Being boring is a plus in pipelines these days.

The sector's had more than enough excitement already. Almost a year ago, another big deal was unveiled, Energy Transfer's $37 billion takeover of Williams Cos. That merger's descent into farce over the following nine months captured perfectly the unraveling of years of excess.

Enbridge's deal is, of course, huge and ambitious in its own way; this is still $28 billion we're talking about. But it also reflects the painful lessons learned in the past year.

The thing that really sunk the Energy Transfer-Williams deal was the $6 billion check that was to be paid to the latter's shareholders. At a time when the likes of Kinder Morgan were slashing dividends and Energy Transfer itself was preparing for a potential cut, it was clear that money was tight for pipeline companies. That $6 billion check just wasn't doable without potentially taking down the balance sheet of the resulting combined company. Looking at the dividend yield of the Alerian MLP Index, you can see how capital, previously handed to pipeline companies whenever they needed it, suddenly dried up:

Back From The Brink
The Alerian MLP Index's dividend yield spiked above 12 percent earlier this year
Source: Bloomberg

Average yields are back to where they were a year ago but remain higher than the sub-6 percent level at the sector's height in 2014. Almost half the Alerian's members still yield north of 8 percent, according to data compiled by Bloomberg. So while the capital markets are no longer completely frozen, the thaw isn't total, either.

Which is why it's a good thing that not a penny of cash will change hands in Enbridge's deal with Spectra. Making it an all-stock deal also gives Spectra's shareholders enough comfort to sell without missing out on further recovery; prior to Tuesday's news, the stock was still almost a fifth below its all-time high in 2014.

More importantly, putting these two together should entrench their advantage when it comes to raising money. Reassuring the capital markets is the number-one skill any pipeline executive requires in the aftermath of the crash.

Combining Enbridge and Spectra should do this on several fronts, starting with the $415 million annual cost synergies target, equivalent to less than 8 percent of their combined, trailing operating expenses.

Marrying Enbridge's liquids-focused infrastructure with Spectra's 88,000 miles of natural-gas pipelines also makes for a more diversified set of customers and markets, both in terms of the fuels being transported and geography. It helps also that, as the companies pointed out on Tuesday, 96 percent of combined cash flow will come from long-term contracts, with less than 5 percent of Ebitda directly exposed to movements in commodity prices. Those numbers are pointed firmly toward the many investors who bought pipeline stocks during the boom, under the impression they were insulated from the oil and gas markets, but then watched the sector do this:

Frenemies
Pipeline stocks suddenly started to march almost in lock-step with oil prices as the crash took hold
Source: Bloomberg
Note: Rolling 90-day correlation coefficient for the Alerian MLP Index and the generic 1st month Nymex crude oil futures contract. A score of 1.0 indicates perfect positive correlation.

It is almost laughable that Enbridge's presentation on Tuesday offered dividend growth guidance out to 2024. But this is where the pipeline industry finds itself. After the go-go years and subsequent crash, what investors want is long-term certainty around payouts and growth. Essentially, they want MLPs to revert back to being more like utilities.

Buying Spectra for stock will give Enbridge both exposure to a long-term growth story in the form of U.S. natural gas supply and a more reassuring profile for the investors who will help fund that growth. And, as Darren Horowitz of Raymond James points out, a combined suite of services and infrastructure spanning North American oil and gas should give the resulting company an edge when it comes to winning customers, too.

That edge in both funding costs and winning contracts means more big pipeline deals are likely. Williams, for example, has already had an approach from Enterprise Product Partners and is under fire from activists. Plains All American Pipeline, meanwhile, is collapsing its current structure and has been forced to cut its dividend. Perhaps it, too, could benefit from diversifying away from oil. With more MLPs having launched initial public offerings in the past five years than in the previous 10, there is plenty of scope for consolidation.

Piping Hot
An IPO boom has made the listed pipeline sector more crowded than ever
Source: Alerian
Note: Data show number of IPOs of master limited partnerships each year.

As deals get done, those not joining in risk getting left behind with higher capital costs and, quite possibly, shrinking market share. A year after Energy Transfer and Williams heralded the beginning of the end, Enbridge and Spectra have put everyone on notice that the cleanup has started in earnest. How's that for exciting?

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

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

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