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 Williams Cos. Inc. has some unfinished business. And President Donald Trump might help get it done.

Williams Cos. announced a plan last month to clean itself up. The biggest change involved getting rid of so-called incentive distribution rights in its subsidiary, Williams Partners LP. These are a common feature of master limited partnerships -- though becoming less so -- whereby they kick up extra payments to their general partner as dividends rise (for an explanation, see this). In exchange for forgoing these payments, Williams Cos. is getting an extra slug of common units in the MLP. It also bought another $2 billion of them, selling shares in itself to fund that purchase.

When the dust settles, Williams Cos. will be left owning about 74 percent of Williams Partners -- and will have become little more than a tracking stock for its MLP.

As investment propositions go, this is not terribly compelling. Sure, owning a regular stock is less complicated tax-wise than owning units in an MLP. So there may be investors or institutions that would prefer exposure to Williams Partners via Williams Cos. But being the non-tax-advantaged tracking stock of a tax-advantaged entity that actually owns the operating assets just isn't going to make for a great presentation at the next midstream conference.

So there's a good chance last month's move was just the precursor to a full takeover of Williams Partners, perhaps as soon as 2018 . Why then? Two reasons: debt and taxes.

While no one felt particularly warm and fuzzy about Williams Cos. cutting its dividend last year and then Williams Partners cutting its dividend last month, doing so was the first step in addressing a big problem: high leverage. Results released late on Wednesday showed consolidated net debt stood at 5.26 times Ebitda at the end of 2016.

Using consensus forecasts and assuming Williams Partners raises $2 billion from selling assets this year, that ratio should fall to about 4.7 times by the end of 2017, significantly below the 5.25 times Williams Cos. is targeting. By the end of 2018, it could be down to 4.3 times. And this assumes distributions and dividends grow by 7 percent a year at Williams Partners and 15 percent a year at the parent, at the top end of guidance given last month.

This would provide plenty of room for a full takeover. First, though, a layer cake of assumptions:

  • Williams Partners pays a distribution of $2.57 per unit in 2018 which, at the current yield, implies a price of about $43;
  • Williams Cos. trades as a pure tracking stock, with its 74 percent stake in the MLP implying a price for its own stock of just under $31;
  • Williams Cos. offers a 15 percent premium for the rest of Williams Partners, paying 90 percent in its own stock and 10 percent in cash;
  • Williams Cos. annual overhead of $30 million;
  • Capital expenditure on growth projects of $2.5 billion in 2017, $2 billion in 2018, and $1.5 billion in 2019.

Using these, Williams Partners' public investors would be offered just under $50 per unit -- not quite back to the all-time peak, but roughly where it traded in June 2015, just before it fell off a cliff.

Before The Fall
Williams Partners last traded at around $50 in mid-2015, just before it plummeted
Source: Bloomberg

More importantly, these terms would address one of the biggest concerns when an MLP's parent comes knocking to consolidate: namely, keeping distributions whole. Typically, these deals involve a stealth dividend cut, as the parent's shares given in payment offer lower payouts (see this).

In this case, though, Williams Partners's investors would receive 1.46 shares in Williams Cos. for each of their units. With Williams Cos. own dividend projected to be $1.38 in 2018, those investors would be paid $2.57 -- which just happens to be the projected payout for Williams Partners that year. Plus, they would be getting almost $5 in cash as partial payment for their Williams Partners units. So while they stood to get distributions totaling $5.32 across 2018 and 2019 on each Williams Partners unit, they would now get more than $10.

That would also help ameliorate another concern MLP investors have about these deals: the tax hit. When MLP units get sold, the taxes they've been spared on their distributions over the years fall due. A cash component helps to cover at least some of that.

It doesn't help with the other problem, which is that the MLP investor would now own paper in a taxable company.

However, this is where the president's desire to slash corporate tax rates could help. If the rate fell to 20 percent or less, taking shares in Williams Cos. would be a more palatable proposition for Williams Partners's selling investors.

Indeed, clarity on the tax rate is crucial to Williams Cos. pulling the trigger on this deal because it is critical to valuing the main currency to be used, its own shares. Along with current debt levels, uncertainty over taxation likely played a role in Williams Cos. taking a step toward a full takeover last month but not going all the way just yet.

Based on Gadfly's analysis, a combined Williams Cos. would end 2018 with net debt of just 4.4 times Ebitda, with the ratio dropping even further in 2019.

Moreover, a quirk specific to acquisitions of MLPs means Williams Cos. would be able to take the underlying assets in Williams Partners onto its own balance sheet at the new purchase price. Depreciating them from this higher level would cut Williams Cos. own taxable earnings, giving it a nice tax shield for years to come (this, by the way, is precisely why Kinder Morgan Inc. consolidated its own MLPs back in 2014).

Add it all up, and the end result should be a stock that trades on a higher multiple than today's relatively low one of about 13 times Ebitda (especially as Williams would be a cleaner takeover target itself). Say that got bumped up to 14 times on projected 2018 Ebitda of $4.9 billion. Netting out just under $22 billion of debt -- again, based on Gadfly's analysis -- implies a value for Williams Cos. shares of almost $40 -- 37 percent higher than today.

The clock's ticking.

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

  1. Williams Cos. actually attempted a buyout of Williams Partners in early 2015 but this was derailed by Energy Transfer Equity LP's takeover attempt on Williams later that year (which also failed). Never a dull moment when it comes to MLPs.

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