Description

WMB is trading at a $3+ discount to the cash/stock deal value of its merger with ETE, representing an opportunity to make 27%+ (unannualized) if the deal closes on terms, which I deem likely in the next 2 – 5 months.  Based mostly on the strength of the merger agreement, but also the deal logic, I view the spread as grossly mispriced.

***  WMB shareholders will receive stock in ETC, a newly created C-corp version of ETE.  Although ETC broadens the potential investor base and will be liquid, it’s reasonable to assume ETC trades at a discount to ETE due to extra C-corp tax, despite some equalization provisions.  I express the spread in terms of ETE parity for ease of reference, but you should make your own an assumption about any ETC discount.  FWIW, I pencil in an unscientific 10% discount, which would reduce the spread by ~60c based on ETE’s $4.05 closing price.

Merger Consideration

The deal is an election of either $43.50 cash or 1.8716 shares of ETC.  Cash is clearly the superior election, and assuming everybody elects it, WMB shareholders will receive $8.00 cash and 1.5274 shares of ETC.  Non-electors will receive the stock election (ouch!). 

WMB and ETE are entitled to continue paying distributions.  If both pay, WMB arbs pick up an extra 20c net per quarter.  ETE is already ex- their Q1 distribution, with WMB yet to declare (previously paid 64c).  WMB will also pay a 10c special dividend at the closing.  Assuming WMB pays a 64c Q1 distribution, the spread closed last night at $3.76 (before any ETC discount), or 34% of WMB’s closing stock price.

Merger Agreement

-          No requirement for ETE unitholder vote

-          Majority vote required for WMB; date not set yet.

-          FERC approval received

-          FTC antitrust approval required.  “Hell or high water” provision in merger agreement. 

o   Possible sale of Gulfstar asset necessary (not a big deal).

o   Signed timing agreement w/ FTC not to close before March 18.

-          Material Adverse Effect (“MAE”) carves out:

§  changes in economy,

§  changes in gathering/processing/treating/transport/storage and marketing industries,

§  changes in oil/natural gas/refined products/NGLs/NGL fractionation product prices, 

·         Changes in the above 3 pts may be considered in an MAE determination only to the extent they have a disproportionate impact on WMB relative to other participants in the same industry

§  changes in financial condition of customers / commercial counterparties

·         (i.e. CHK)

-          Receipt of tax opinions, including from ETE’s counsel

-          $1.5B break fee for someone to buy WMB (18% of WMB mkt cap at today’s price)

-          Both parties agree to specific performance and that monetary damages are not adequate remedies.  DE law.

-          Novel third party beneficiary language that adds certainty to quantifying damages in the event of an ETE breach by calculating them based on damages incurred by WMB shareholders (vs. potential legal theory that “no 3^rd party beneficiaries” merger contract language may confine damages to corporate deal expenses)

Link to latest proxy, with merger agreement:  http://www.sec.gov/Archives/edgar/data/1648098/000119312516428028/d80568ds4a.htm

WTI is down 36% from the September deal date and the nat gas strip is down 15%, but there are no operating or financial thresholds as a condition to the deal (for an example of what one looks like, see the EBIDTA requirement in RAD / WBA).  ETE unitholders cannot vote the deal down.  ETE cannot pay a fee and walk away.  As might be expected for a merger agreement resulting from negotiations between a highly motivated strategic buyer and a reluctant seller, it is a strong contract.

It is worth noting that DE courts have yet to determine that an MAE has occurred and litigation has set a high bar:  ““for the purpose of determining whether an MAE has occurred, changes in corporate fortune must be examined in the context in which the parties were transacting.  In the absence of evidence to the contrary, a corporate acquirer may be assumed to be purchasing the target as part of a long-term strategy. … A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close … [for] such a decline to constitute a material adverse effect, poor earnings must be expected to persist significantly into the future.” – Hexion vs. Huntsman, 2008

For specific performance, where the courts can order one side to perform under the contract (i.e. close the deal) IBP/Tyson (DE chancellor applying NY law) in 2001 is the latest example in the merger context.  It was also a cash/stock deal.

Deal Highlights

ETE aggressively pursued WMB and broke up the announced merger of WMB and WPZ.  On the 09/28 conf call, ETE touted $2B+ of commercial synergies by 2020 on $5B of capital spend.  $300 – 400mm of operating synergies at WPZ by 2017.

ETE has in place a committed 2-year $6.05B bridge financing at 5.5% to fund the $8.00 cash payment to WMB shares.

WMB’s value is basically tied to WPZ; see the recent VIC write-up and thread on WPZ for more detail there.

The spread has been volatile, driven by speculation around ETE’s desire/intentions to re-cut the deal.  ETE’s CFO had been telling WMB holders that the deal on current terms would be “mutually assured destruction”, and otherwise talking it down.  He was replaced in a late Friday 8-k last week, which has spooked the spread today, although he is still on the board.  This coincided with an article about imminent CHK BK fears related to restructuring counsel.  CHK refuted their intention to file for BK in a statement, and I believe they will not file until well after their March maturity (see the VIC CHK bond idea and thread -- I agree with the analysis and the comments on the March bonds).

I think two scenarios comprise the bulk of probable outcomes:

1.       1.  Deal closes on terms; ETE cuts the distribution massively to de-lever.

2.       2.  WMB agrees to a very modest cut, like not declaring its next 1-2 quarterly distributions, in return for ETE letting WMB shop the company with no break fee.  The $1.5B break fee was customary on WMB’s market cap with the stock ~$55 after the sale process, but is now comically large.  Meanwhile, it’s conceivable that a strategic buyer could be interested in paying a big premium to today’s price and would have skipped the previous process at astronomical prices.  I.E. would XOM be interested at $20 all cash?

I can imagine three ways the deal breaks, or at least becomes an even bumpier ride:

1.      1.  CHK doesn’t pay their March maturity and files BK, and ETE somehow litigates successfully that this constitutes an MAE (would require an assumption of WPZ contracts re-setting much lower, among other things).

2.      2.  ETE finds a way to defeat the tax opinion contingency.  Latham & Watkins, ETE’s counsel, must deliver a tax opinion that the deal qualifies as a 721(a) exchange.  I have never seen a deal break on tax opinion contingency, but it’s certainly imaginable given the complicated corporate structures here.  I do not think Latham & Watkins would participate in a nefarious scheme to somehow not deliver the tax opinion – they get paid for the opinion and don’t get paid to take that sort of legal risk (ETE prohibited from taking actions to frustrate this condition).  But, it’s imaginable.

3.       3. ETE simply throws their hands up, breaches, and takes their chances on specific performance / damages calculation in court.  Lawyers will do their best to come up with something (see DOW/ROH deal where DOW simply refused to close on a similarly strong merger agreement.. the all-cash deal closed on terms after trading at a massive spread)

I am 75%+ the deal closes on terms and would consider a modest cash cut in exchange for a free shop period to be a positive outcome.

In the event the deal closes, I think WMB downside is ~ $10 as any future distribution cuts likely come after a merger with WPZ, in order to shield WMB holders from their IDR high-splits hurting them when/if WPZ distributions need to shrink.

If the deal breaks, I expect ETE would probably rally.  Given the stock at multi-year lows, a light hedge should be a consideration.  WMB on no hedge is basically creating ETE at $2.16 per share.  VIC comments on ETE are welcome! 

Catalyst

Deal closes on terms

Deal re-cut - WMB suspends distributions in return for a free shop period?

Deal breaks