Energy Transfer's Warren Has a Formula for Patient Investors

  • Company forecasts $2 billion extra annual profit from 2020
  • Market shuns the shares after deal pending for months

Energy Transfer Equity LP’s $38 billion acquisition of Williams Cos. fits with CEO Kelcy Warren’s long-standing formula for building an energy empire: Buy companies that connect the dots in the industry to leapfrog competitors.

So while the market’s initial reaction to his purchase was less than enthusiastic -- shares of both companies fell more than 12 percent -- many long-time Warren watchers are feeling more bullish. Once the immediate selloff fades, they say investors will refocus on the fact that Warren has pieced together a massive network of pipelines and processing stations that give him the size and flexibility to provide new services and gain more business.

The combined company would be the largest transporter of natural gas in the U.S., moving more than 15 percent of U.S. crude and on track for approval to build the country’s second-largest gas export terminal at a time when domestic production remains near record levels.

“The merger builds economies of scale in an industry where size
matters,” Erik Gordon, a clinical assistant professor at the University of Michigan’s Ross School of Business, said in an e-mail. “All that natural
gas has to move to markets, and pipelines will get more valuable.”

‘Unwarranted’ Reaction

ETE fell 7.5 percent to $18.77 at the close in New York Tuesday after dropping 13 percent Monday. Williams fell 4.5 percent to $34.93 after losing 12 percent.

“Market reaction was unwarranted, not justified by underlying economics,” Tudor Pickering Holt & Co. analyst Brandon Blossman wrote Tuesday in a note to clients. Consolidation gives Energy Transfer “plenty of room” to add capacity and volumes, he said.

Energy Transfer said the deal will generate $2 billion in higher profit annually by 2020 as the combined company pursues as many as 20 new projects ranging from gas pipelines to New England and oil lines carrying crude from the most-profitable basins to refineries along the Gulf Coast.

Large Numbers

“Those numbers are quite a lot larger than anticipated,” said John R. Cusick, who helps manage $6.3 billion of assets at Miller Miller Howard Investment Inc. in Woodstock, New York, including large stakes in Energy Transfer and Williams. “You’ve got to wait for it, but they are still nice numbers.”

On the size question, Energy Transfer’s investor presentation showed its enterprise value at $149 billion, vaulting it into the company of the major international oil companies, according to Bloomberg data. It will be bigger than BP, Total or Petrobras and the third-largest in the U.S. after Exxon Mobil Corp. and Chevron Corp.

Energy Transfer wants to offer one-stop shipping for producers, offering to trim costs in exchange for customers using more of its businesses, said Michael Kay, an analyst for Bloomberg Intelligence. The takeover gives the company a beach head in the Marcellus Shale formation in Pennsylvania, now the largest and most prolific U.S. gas field.

It expects to build and expand pipelines -- including Williams’ giant Transco line, which runs from Texas past the Marcellus to New York -- to get cheaper gas to pricey markets. The merged companies will deliver Marcellus gas in all directions, to the Midwest and Canada, and to the Gulf Coast, where it will satisfy new petrochemical demand and LNG exports, Energy Transfer said.

Going Everywhere

“We can basically take you from anywhere to anywhere and everywhere in between,” Chief Financial Officer Jamie Welch told analysts on a Monday conference call. “That’s a pretty unique value proposition.”

Given the initial negative market reaction, the complexity of the multi-level transaction and ownership structure may prove daunting to investors. Williams shareholders will get stock in Energy Transfer Corp. LP, an entity that will exist to own a majority stake and control Energy Transfer Equity LP, which itself controls three other publicly traded partnerships. There would be six related stocks; perhaps a seventh should Energy Transfer take public next year a LNG export terminal it wants to build on the Gulf Coast.

“The structure has become a little more difficult, with a whole new company and Williams Partners still out there,” Cusick said. Williams fell 12 percent to $36.56, its lowest close in 20 months and $1.41 below the value of the offer price as of Monday’s close. Energy Transfer Equity LP was down 13 percent to $20.29.

Facing Challenges

Energy Transfer and Williams are among midstream-energy and pipeline stocks bid down by investors over the past four months on concern that low fuel prices will curb production making it harder for pipeline builders to meet their growth targets.

Investors will watch to see how Warren navigates regulatory hurdles for pipelines to the Northeast. The Constitution Pipeline proposed by Williams to get gas to New England has been delayed by state regulatory approval in New York. “It’s densely populated, tends to be an area that’s environmentally conscious and hasn’t seen a lot of energy infrastructure development in recent years,” Don Santa, chief executive officer of the Interstate Natural Gas Association of America, said in a Sept. 25 phone interview. “That makes it challenging. 

The transaction ranks among the largest in the North American pipeline industry, which last year saw Kinder Morgan Inc. consolidate its partnership assets into one company through transactions with an enterprise value of more than $40 billion, according to data compiled by Bloomberg. Kinder Morgan’s market value is now about $60 billion, with an enterprise value of $108.5 billion.

Energy Transfer controls three other partnerships: pipeline owner Energy Transfer Partners LP, fuel distributor and retailer Sunoco LP, and Sunoco Logistics Partners LP, an owner of pipelines carrying crude oil and refined products.

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