Higher Bids Involving Stock and Cash May Be Less Attractive

question 94

Essay

Higher bids involving stock and cash may be less attractive than a lower all-cash bid due to the uncertain nature of the value of the acquirer’s stock.
Master limited partnerships represent an alternative means for financing a transaction in industries in which cash flows are relatively predictable.

Energy pipeline company Southern Union (Southern) offered significant synergistic opportunities for competitors Energy Transfer Equity (ETE) and The Williams Companies (Williams). Increasing interest in natural gas as a less polluting but still affordable alternative to coal and oil motivated both ETE and Williams to pursue Southern in mid-2011. Williams, already the nation’s largest pipeline company, accounting for about 12% of the nation’s natural gas distribution by volume, viewed the acquisition as a means of solidifying its premier position in the energy distribution industry. ETE saw Southern as a way of doubling its pipeline capacity and catapulting itself into the number-one position in the industry.

ETE is a publicly traded partnership and is the general partner and owns 100% of the incentive distribution rights of Energy Transfer Partners, L.P. ( ETP), consisting of approximately 50.2 million ETP limited partnership units. The firm also is the general partner and owns 100% of the distribution rights of Regency Energy Partners (REP), consisting of approximately 26.3 million REP limited partnership units. Williams manages most of its pipeline assets through its primary publicly traded master limited partnership known as Williams Partners. Southern owns and operates more than 20,000 miles of pipelines in the United States (Southeast, Midwest, and Great lakes regions as well as Texas and New Mexico). It also owns local gas distribution companies that serve more than half a million end users in Missouri and Massachusetts.

While both ETE and Williams were attracted to Southern because the firm’s shares were believed to be undervalued, the potential synergies also are significant. ETE would transform the firm by expanding its business into the Midwest and Florida and offers a very good complement to ETE’s existing Texas-focused operations. For Williams, it would create the dominant natural gas pipeline system for the Midwest and Northeast and give it ownership interests in two pipelines running into Florida.

Despite the transition of exploration and production companies to liquids for distribution, Southern continued to trade, largely as an annuity offering a steady, predictable financial return. During the six-month period prior to the start of the bidding war, Southern’s stock was caught in a trading range between $27 and $30 per share. That changed in mid-June, when a $33-per-share bid from ETE, consisting of both cash and stock valued by Southern at $4.2 billion, put Southern in “play.” The initial ETE offer was immediately followed by a series of four offers and counteroffers, resulting in an all-cash counteroffer of $44 per share from The Williams Companies, valuing Southern at $5.5 billion. This bid was later topped with an ETE offer of $44.25 per Southern share, boosting Southern’s valuation to approximately $5.6 billion.

Williams’s $44 all-cash offer did not include a financing contingency, but it did include a “hell or high water” clause that would commit the company to taking all necessary steps to obtain regulatory approval; later ETE added a similar provision to their proposal. The clause is meant to assuage Southern shareholder concerns that a deal with Williams or ETE could lead to antitrust lawsuits in states like Florida. The bidding boosted Southern’s shares from a prebid share price of $28 to a final purchase price of $44.25 per share.

Williams argued, to no avail, that its bid was superior to ETE’s, in that its value was certain, in contrast to ETE’s, which gave Southern’s shareholders a choice to receive $40 per share or 0.903 ETE common units whose value was subject to fluctuations in the demand for energy. ETE pointed out not only that their bid was higher than Williams’ but also that shareholders could choose to make their payout tax free if they are paid in stock. The final ETE bid quickly received the backing of Southern’s two biggest shareholders, the firm’s founder and chairman, George Lindemann, and its president, Eric D. Herschmann.

ETE removed any concerns about the firm’s ability to finance the cash portion of the transaction when it announced on August 5, 2011, that it had received financing commitments for $3.7 billion from a syndicate consisting of 11 U.S. and foreign banks. The firm also announced that it had received regulatory approval from the Federal Trade Commission to complete the transaction.

As part of the agreement with ETE, Southern contributed its 50% interest in Citrus Corporation to Energy Transfer Partners for $2 billion. The cash proceeds from the transfer will be used to repay a portion of the acquisition financing and to repay existing Southern Union debt in order for Southern to maintain its investment-grade credit rating. Following completion of the deal, ETE moved Southern’s pipeline assets into Energy Transfer Partners and Regency Energy Partners, eliminating their being subject to double taxation. These actions helped to offset a portion of the purchase price paid to acquire Southern Union.

In retrospect, ETE may have invited the Williams bid because of the confusing nature of its initial bid. According to the firm’s first bid, Southern shareholders would receive Series B units that would yield at least 8.25%. However, depending on the outcome of a series of subsequent events, they could end up getting a combination of cash, ETE common, and Energy Transfer Partners’ common or continuing to hold those Series B units. Some of the possible outcomes would be tax free to Southern shareholders and some taxable. In contrast, The Williams bid is a straightforward all-cash bid whose value is unambiguous and represented an 18% premium for Southern shareholders. The disadvantage of the Williams bid is that it would be taxable; furthermore, it was contingent on Williams’ completing full due diligence.
-What do you believe are the key assumptions underlying either the Energy Transfer Equity or the Williams valuations of Southern Union?

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Definitions:

Value

The importance, worth, or usefulness of something, often influencing decisions and behavior.

Work Outcomes

The results or consequences of work performance, including productivity, job satisfaction, and turnover rates among employees.

Flexible Working Hours

An arrangement that allows employees to vary their start and finish times, often to accommodate personal needs or preferences.

Sense of Purpose

A personal belief or aim that gives someone motivation and direction in life.