I will grant you this: “Simplification Thursday” does not have quite the same alliterative appeal as “Merger Monday.” But this Thursday is one for the history books if you follow that niche of the energy sector called master limited partnerships.
On the same morning, Williams Cos. Inc. announced an all-stock buyout of the roughly 27 percent stake it didn’t already own in Williams Partners LP, while Enbridge Inc. announced all-stock deals to consolidate Enbridge Energy Partners LP, Enbridge Energy Management LLC, Enbridge Income Fund Holdings Inc., and Spectra Energy Partners LP. Well done if you made it through that sentence in one go.
It really isn’t every day that companies representing 10.3 percent of an index – the Alerian MLP Index, in this case – get taken out. With Tallgrass Energy Partners LP also due to shuffle off (that deal was announced in March), the index’s ranks will soon drop to 38, down from 50 at the end of 2014, when times were good.
Apart from teeing up some mercifully cleaner organization charts, there’s a simple reason for Williams and Enbridge to take out their MLPs: They’ve gone from being a honeypot for investors to a deterrent.
Enbridge CEO Al Monaco said bluntly on Thursday’s call that “holding our assets in MLP structures is no longer advantageous.” But I think Williams CEO Alan Armstrong captured it better when he described difficulties courting institutional investors, who apparently reacted to the company’s MLP the way vampires react to crucifixes.
The MLP structure took a big hit in March, when the Federal Energy Regulatory Commission abruptly took away a long-standing tax benefit for operators of certain interstate pipelines (see this for an explanation). Both Williams and Enbridge cited this is as one reason to do their deals.
But the FERC’s blow was more coup de grâce than opening salvo. Tax reform, cutting the headline rate for regular companies and allowing immediate expensing of capital expenditure, had already eroded the tax advantage MLPs held over C-corps.
More broadly, the MLP moniker had been tarnished by a combination of weak corporate governance (see this); incentives skewed ridiculously toward insiders (try this); and a funding model that was, for some, fundamentally broken (and this.) The Williams deal, in particular, has looked likely for a long time (see this column laying out the rationale from early 2017).
One clue that this is a structural issue is investors’ indifference to MLPs, despite the apparent tailwinds of rising energy prices and U.S. production of oil and gas. There’s also the listlessness of Kinder Morgan Inc.’s stock – in part, I think, because it still talks the language of MLPs despite ditching them years ago. Turnover in the ownership of dedicated MLP-focused funds also illustrates a shift in the underlying shareholder base.
Earlier this month, Miller/Howard Investments Inc. wrote an open letter to MLP management teams calling on them to clean house and capture new investors now that so many on the retail side have abandoned them:
Many of you have voiced displeasure with your “high” yields, stating it’s difficult to raise equity to fund capital projects. The markets have been telling you something, but you’ve not listened. Compared to investors in utilities, a similar business, MLP investors require more than twice the yield to invest capital in your businesses … Be aware of who your future investors are and what they want.
What they want is exposure to steady cash flows and sustainable growth from energy infrastructure, backed by good governance and sound balance sheets. Williams, for example, should see its net debt to Ebitda ease from a pro-forma 4.64 times at the end of 2018 to below 4.6 times in 2019, despite raising its expansion capital expenditure budget and dividend growth of around 15 percent.
As I wrote here, and Miller/Howard’s letter mentions in that excerpt, this model sounds a bit more like that of utilities. A simpler story, combined with a simpler structure and financial metrics, should garner a friendlier reception from those “future” institutional investors when Williams and others show up for pitches. Expect even more of this.
My only request is future deals get announced over a weekend; “Simplification Sunday” just has a nicer ring to it.
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