The simplification transaction announced by Enbridge (ENB) on Thursday, May 17, is a massive one, a nearly $10 billion deal in what will be all-stock consideration. It is also turning out to be a harsh lesson for shareholders of the company’s sponsored vehicles: Enbridge Energy Partners (EEP), Enbridge Energy Management (EEQ), Enbridge Income Fund (OTC:EBGUF), and Spectra Energy Partners (SEP). Such simplification transactions are getting more commonplace within the master limited partnership (MLP) space recently, and some parts of this deal were widely expected to occur over the next several years.
What was not expected was just how harsh the deal terms are for shareholders and the highly aggressive language taken toward its daughter firms. The reasons for the deal rationale represent a complete turn from statements made just a few months prior. While this deal certainly benefits Enbridge, it cripples any good will with shareholders of daughter firms. I suspect there are going to be some very irate shareholders sitting on large tax bills and shareholder lawsuits are probably inevitable. For those of us that avoided the firm, the proposal unfortunately might drive investor capital away from the subsector when it needs it most.
Management’s Take on Simplification
For Enbridge, management touted the transaction’s ability to simplify the corporate and capital structure, allowing Enbridge to have full ownership of core strategic assets. That’s a true statement. However, the tone toward its daughter firms was incredibly negative and is a complete turnaround from statements made recently. For perspective, within its presentation of deal economics, Enbridge stated it should see its own credit profile enhanced by “eliminating sponsored vehicle public distributions” (I’m sure Seeking Alpha income investors love that part) and that “sponsored vehicles are ineffective and unreliable standalone financing vehicles.”
The blame for this has been pinned on a weak market for public valuations of midstream firms, the change in FERC policy on cost recovery, and lasting impact from U.S. tax reform. This broad blanket statement on the MLP structure is an ignorant one in my opinion. There are more than a few MLPs out there – correctly run – that have very low costs of capital, even in this environment: MPLX (MPLX), Shell Midstream (SHLX), and Phillips 66 Partners (PSXP) are all examples. Instead of taking responsibility for its own poor decisions in building out the capital structure and getting itself into this mess in the first place, management has decided to shirk responsibility and cast blame elsewhere.
Source: Enbridge Partners Simplification Transaction, Slide 6
Some Seeking Alpha readers often chide me (or other contributors for that matter) for not listening to management guidance or taking statements made on conference calls as gospel. In other words, “management knows best.” For every company I research, I form my own opinion before reading or listening to a single sentence on a conference call. This Enbridge saga is yet another opportunity to show why shareholders need to do their own due diligence and come to their conclusions. Let us wind back the clock and see what Chief Financial Officer of Enbridge John Whelen had to say just two months ago on the Q4 conference call (paywall):
With respect to our sponsored vehicles, the good news is that the legislation maintained the competitive tax advantages of our MLPs relative to corporate structures through at least 2025.
This was followed by a statement, picked up by other Seeking Alpha contributors, that the losses faced at Enbridge Energy Partners would be balanced out by gains for Enbridge Income Fund. In other words, neutral to earnings across the firms.
Looking forward, on balance, the Fund Group will actually benefit modestly from tax reform. As I noted earlier, EEP’s FSM tolls will be reduced as a result of the reduction in U.S. tax rates. To the extent the EEP tolls go down, ENF will see a corresponding uptick in its Canadian Mainline toll revenue under the existing International Joint Tolling framework.
Just two months ago, the competitive tax advantage of MLPs had been maintained and the FERC policy change would have no real change on dollars flowing to the Enbridge family due to the Joint Tolling Framework. Compare those statements with the ones made as part of this deal announcement. It is startling. Make no mistake, nothing has materially changed in the past two months. Was the tone on the Q1 conference call a little more negative? Sure, but management was just one week out from dropping this bombshell on investors. In short, management was happy to assuage investor concerns before pulling the rug out from under them.
Premium? What Premium?
If a company is going to roll up assets that are not being valued correctly in the public market, the least most of these firms do is throw a bone to shareholders. Slap a 10, 15, or 20% premium on the deal and the acquirer is still getting a steal on the assets versus replacement cost. Further, this placates shareholders a bit who have undergone quite a bit of pain and helps aid the transaction in getting past the conflicts committee. As a result, hopefully the general partner avoids getting sued in the process. What did Enbridge offer shareholders?
- SEP unitholders will receive 1.0123 common shares of Enbridge per SEP unit, representing a value of US$33.10 per SEP unit based on the closing price of Enbridge common shares on the NYSE on May 16, 2018 – equivalent to the closing price of SEP’s common units on the NYSE on such date.
- EEP unitholders will receive 0.3083 common shares of Enbridge per EEP unit, representing a value of US$10.08 per EEP unit based on the closing price of Enbridge common shares on the NYSE on May 16, 2018 – equivalent to the closing price of EEP’s common units on the NYSE on such date.
- EEQ shareholders will receive 0.2887 common shares of Enbridge per EEQ share, representing a value of US$9.44 per EEQ share based on the closing price of Enbridge common shares on the NYSE on May 16, 2018 – equivalent to the closing price of EEQ’s common shares on the NYSE on such date.
Investors won’t find that here. Not even a dollar. And that whole “EEQ shares are equivalent to EEP shares” thesis? The 10-K might say that they are equivalent, but management has certainly taken the stance that 1:1 does not mean 1:1. For all their trouble of forming an investor base for Enbridge to fund dropdowns, these investors will be locking in a massive loss, eating a major tax bill made worse by return of capital lowering their basis, and are being rewarded with Enbridge common stock and not cash.
While I’m sure some will try to spin this positively, even as a non-shareholder and someone who recommended against buying any of these companies in the past, it just leaves a sour taste in my mouth. Enbridge is a massive entity and the actions it takes have broad implications across the entire MLP space. Management teams that would never dream of trying to pull off a transaction like this due some sense of fiduciary duty will unfortunately have to deal with the consequences of an impaired investor base that might never invest a dollar in these types of assets again.
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Disclosure: I am/we are long MPLS, SHLX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.