Description

Both Williams (WMB) and Williams Partners (WPZ) are undervalued.

Lets start with WPZ, its midstream and pipline MLP, created recently by merging its pipleline assets and pipeline MLP and WMB-owned midstream assets into WPZ to create an MLP that rivals EPD and KMP in size and importance.  At the current $38 unit price, WPZ yields about 6.5%, in line with EPD and KMP.  However, closer inspection will reveal a far superior balance sheet and cash flow situation at WPZ:

1) balance sheet: like EPD and KMP, WPZ is investment grade and just issued over $3bn of bonds at absurdly low rates (just days before Obama's anti-prop trading rhetoric backed up spreads), but unlike those other two, WPZ's GP (100% owned by WMB) has no debt. (KMP's GP, as everyone knows, was taken private by GS and mgmt and is highly levered, and EPE has debt which can only be paid down with a sale of EPD shares; in both cases managements claim the benefits of a spread between borrowing costs and dividends received - which is true, until it isn't.)

2) cash flow: on p 78 and 79 of WMB's recent data book, it shows that WPZ will finance in 2010 and 2011 ALL its cash uses (dividends, IDRs, maintenance capex, interest AND growth capex) from EBITDA, except for a small amount in 2010 which will come from cash balances and the revolver ($250m used FYE10, out of $1.75bn available). This is rare in MLP-land, with only a few conservative MLPs like NS and MMP financing growth from internal cash sources; most rely on the serial issuance debt and equity securities.  What this suggests is that the WPZ yield is extremely secure and has substantial room for growth.

Valuation of WPZ could well reach $50/unit in 3yrs time.  If WPZ were a C-Corp, investors might look at it like this: $2.15bn EBITDA in 2011, 50% from pipelines (mostly Transco and NW Pipe which are critical must-have on infrastructre) which would get 12x in a strategic sale and 50% from best-in-class midstream assets which would get 8x in a strategic sale.  So 10x for WPZ = $21,500, less $6,500 debt, $15,000 divided into 590 WMB shares is $25/shr.  (I assume here that the GP ownerhsip offsets the 20% of WPZ owned by the public -- which is not precise, but works out to roughly the same result: 80% is $20 per WMB shr and the GP which earns $140m in IDRS capitalized at 12x is $3 per WMB shr -- so $23 per WMB shr of value for WPZ.  As an aside, $15,000 equity value for WPZ is $54 per WPZ share, versus $38 today.

Now to WMB: besides WPZ units and the WPZ GP, here's what they own of significance:

1) world class lower 48 onshore E&P assets, mostly conventional, mainly in the Rockies with some in the Marcellus and Barnett shales -- but key driver is Pieance, Rockies

2) key Canadian midstream assets serving Suncor and Fort McMurray heavy oil players, very valuable fee based business with long term contracts and with lots of profitable growth ahead

3) 25% Gulfstream Pipeline (will eventually be sold to WPZ, and Sempra's 50% ownership suggests $300m equity value for a 25% stake (WMB's doesnt break out #s)

4) Venezuela midstream (written down to 0)

5) majority control of Apco Oil - publicly traded Argentine oil company - tough to value, as Argentine oil canonly be sold at $40/bbl

6) $1.2bn of cash of which $750m is "excess" and will be used for growth projects in E&P over time

7) $2bn debt, well termed out

8) marketing and trading operation for gas and NGLs to market own products (salary plus bonus, not an Enron style hedge fund)

Basically, the cash and non E&P assets offset the debt, which means at the current WMB price of $21, with WPZ valued at $23 per WMB share, E&P is for free.  (Using WPZ's current price of $38 * 240 WPZ shrs owned by WMB = 9,120 divided by 590 WMB shrs = $15/shr plus $3/shr for the GP = $18/shr, in which case E&P is being valued at $3/shr, or $1.7bn.)

What's E&P worth: Bill Barrett (BBG) is the best pureplay comparable, based in exactly the same Piceance basin as WMB -- in fact, the current BBG mgmt sold their old company (Bill Barret Resources) to WMB for about $2.5bn (could be off by a few $100, as I am going off memory) as a white knight offer against a hostile offer from Shell, and those assets today produce nearly $2bn in cash flow!  BBG trades for > $2 per proved reserve.  Not much difference between PDPs and PUDS, as it's all derisked, there are no dry holes and it costs about $1 to get the PUDS to producing.  Williams has 4.5Ts of proved reserves, $9bn at $2/proved - or roughly $15 per WMB share.

Sum of the parts in E&P busineses are dangerous valuation methods because E&P can deteriorate quickly and clever E&P operators generally prefer the small company entrepreneurial environment to corporate bureaucracy (COP/Burlington is example #1, and there are already moans and groans coming out of XTO and XOM tries to lock down the good people).  El Paso is the perfect example of a crap E&P businesses, where some of the parts will lead to a value trap, unless they run an auction for their pipes in a frothy debt market.  That's basically why integrated E&Ps like Questar or Williams trade at discounts to pure play peers -- with Equitable and NFG being standouts whose E&P trades on substantial value for unbooked resources because of their hyped-up Marcellus positions.  But E&P at $0-$3 per WMB shr is ridiculously low, especially for a company seemingly on the way to a demerger of their E&P from midstream/pipes.  Since the company announced its MLP restructuring, WPZ has traded from $29 to $38 per unit, and WMB is flat.  Management must make this work for WMB too, and they will.

Catalyst

1) more Street focus on E&P assets by traditional E&P analsyst, as well as existing integrated and midstream analsyts

2) mgmt highlighting E&P value thorugh focused IR strategy, starting with upcoming NY analyst day

3) greater financial flexibility to make acquisitions and deploy growth capital in midstream, pipelines and E&P

4) recognition of the Rockies as a basin with oversupplied transportation infrastructure to serve 3 potential markets (CA/WA, Chicago and Nymex) vs just  1 for Marcellus (Nymex) and 1 for Haynesville (HHub)