It’s Time for Williams Cos. to Round Up Its Partners: Gadfly

The latest indignity heaped onto master limited partnerships, courtesy of the FERC, has revived the question of which companies may abandon the model altogether. The Williams Cos. is a prime candidate.

We know this because — in the dry dialect reserved for public communications with shareholders — Williams pretty much said so, in a press release following the Federal Energy Regulatory Commission’s tax ruling that sent MLPs reeling:

As we’ve often discussed, we are well-positioned to execute on corporate structure changes, which would restore the income tax allowance to the pipeline’s cost of service rates.

We also know it because doing so could offer a serious boost to Williams’s stock.

Williams consists of two entities. Williams Partners LP is the MLP that operates its various pipelines and plants, including its crown jewel, the Transco trunk pipeline delivering natural gas from the Gulf Coast and Appalachia to the huddled masses of the Northeast. Williams Cos., the parent, owns a 74 percent stake in Williams Partners. They are essentially two different ways of investing in the same asset; one a partnership and the other a regular C-corp.

Just over a year ago, I speculated here that Williams might decide to simply collapse the two entities into one, once corporate tax cuts had been passed. The tax cuts have not only been passed but also precipitated the FERC’s ruling, which affects interstate gas pipelines operated by MLPs, therefore leaving half of Transco’s revenue exposed to some sort of impact.

This might be the catalyst to finish what Williams already started. The parent’s majority stake results from a deal in early 2017 to get rid of its incentive distribution rights in Williams Partners (see this for an explanation of IDRs). It also cut distributions at the MLP.

While keeping the MLP around offers flexibility on financing options in theory, in practice the trend is toward more self-funding and less dilution to pay for growth projects (Williams has already pledged to avoid this). Plus, with only 26 percent of Williams Partners’ shares actually trading, it’s hardly likely to offer the most competitive funding anyway:

So, with the FERC’s ruling likely to take effect in the second half of this year — and little sign of a robust bounce-back in MLPs thus far — a buyout of the rest of the MLP could happen soon.

This would likely be done as an all-stock deal with a minimal premium, given the control Williams Cos. already exercises over its MLP. And assume the following:

Takeover premium of 15 percent, implying a takeout price for Williams Partners of $40.61 per unit ; Consensus Ebitda estimates for Williams Partners of $4.62 billion in 2018 and $4.96 billion in 2019; Maintenance capital expenditure of $500 million and expansion capex of $2.7 billion in 2018 and 2019; Williams Cos. and Williams Partners raise dividends/distributions at 7 percent and 15 percent per year, respectively, at the top end of guidance; Cash-flow shortfalls funded with debt costing 5.3 percent, with no new equity issuance; No cash taxes paid by Williams Cos., as per guidance; Deal modeled as if it occurred at the start of 2018.Under these terms, the minority unitholders of Williams Partners would get 1.55 Williams Cos. shares per unit, which is higher than the relationship has averaged in recent years. That might help offset some of the pain long-term MLP holders would suffer in terms of capital gains tax and the implied dividend cut (since Williams Cos. payouts are lower).

The potential gain, on the other hand, could be substantial for all involved.

Under my assumptions, consolidated net debt would rise from just under 4.5 times Ebitda in 2017 to a pro-forma level of just under 4.7 times in 2018, easing down a little in 2019. This is unlikely to spook the credit-rating firms or investors.

And the latter — facing a cleaner investment without the governance gremlins of MLPs and with a good growth story centered on rising U.S. gas production — may be willing to put a higher multiple on Williams Cos. stock.

When I first wrote about a potential combination in February 2017, Williams was trading at an enterprise value of about 11.5 times forward Ebitda. It’s now at about 10.5 times. Meanwhile, Oneok Inc., which took out its own MLP last year, has seen its multiple jump from less than 11 times to almost 14.5 times, which is now higher than the multiple for even best-in-class MLP Magellan Midstream Partners LP:

Williams currently trades at 9.8 times 2019 Ebitda, versus Oneok at 13.3 times, according to figures compiled by Bloomberg. Using the assumptions above, Williams’s stock could gain significantly from a similar re-rating:

There’s a lot of assumptions built in here, obviously, but the potential is hard to ignore altogether.

The kicker is that if Williams does pull the trigger this year, and investors reward the move, which other large MLPs might follow?

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