Kelcy Warren, the billionaire running the third-largest U.S. natural gas pipeline company, says the days of deal making are returning.
Railroads and competing pipeline operators are taking market share, leaving networks with smaller regions and struggling to find business. To survive, companies need a geographically diverse portfolio of assets across an array of oil and gas products that can weather slowdowns in individual sectors or regions, Warren, chairman and chief executive officer of Energy Transfer Partners LP (ETP:US), said in an interview.
Mergers and acquisitions are the fastest way to grow now, according to Warren, who acknowledges getting a reputation as a deals-obsessed “cowboy” after leading a $13 billion buying spree in 2011 and 2012 to expand the reach of his company’s group of master limited partnerships, or MLPs.
“You’re going to see the resumption of some kind of M&A strategy that we deliberately shelved for quite a period now,” the 57-year-old Texan said Sept. 24 in his Dallas office. “I believe you’re going to see some MLPs look for a warm spot to go curl up as early as next year.”
Pipeline mergers and acquisitions fell this year to about half the $58.3 billion announced two years ago, the biggest spate since at least the start of 2001, according to data compiled by Bloomberg. Warren said he expects deals to pick up industrywide as more operators feel financial pressure, creating growth opportunities for larger operators like Energy Transfer Partners, which has a $24.8 billion market value.
Companies organized as MLPs don’t pay U.S. income taxes and distribute most of their free cash as taxable income to investors through partnership units, which trade like stock.
It’s certainly a seller’s market in the pipeline industry today, Ethan Bellamy, an analyst at Robert W. Baird, said in a phone interview. The larger MLPs that can weather a downturn are hungry for more assets to keep growing while the smaller players are struggling to keep up with the need to increase distributions to unitholders, he said.
“The competition for assets is intense,” Bellamy said. “If you have something that’s MLP-qualifying, whether it’s held privately, whether it’s a public corporation, there’s an MLP that is probably sniffing around.”
Warren isn’t limiting his growth plans to acquisitions. Pipeline construction and conversion projects are still on the drawing board, including its Trunkline crude project. The line is planned to have a capacity to carry 420,000 barrels a day from Illinois to the Gulf Coast.
Energy Transfer and partner Enbridge Inc. (ENB) extended the deadline to sign up customers for the pipeline to Sept. 30 after response was sluggish. If the project still fails to garner enough shipper interest and Enbridge decides against participating, Warren said he’ll consider shrinking the pipeline capacity by about half and moving ahead with the project alone.
“Nothing has changed about our perspective on the project,” Glen Whelan, a spokesman at Enbridge, said in an e-mail.
Warren also sees potential growth in Mexico, and said he is “aggressively” studying the possibility of a cross-border gas pipeline.
“We see a lot of opportunity to the south,” he said.
Oil companies are spurning some new pipeline projects as the geographic spread between crude prices narrows to the smallest in almost three years, underscoring the risk for shippers when committing to traditional 10-to-15-year contracts. The drop in crude spreads from near-record highs to multiyear lows means lower profits for shippers, who want to sell their product for the highest price in a destination market.
Meanwhile, growing rail transport is filling the gap while offering greater flexibility for North American producers and refiners, who can now ship their crude on trains connecting Alberta and North Dakota producers to East and West Coast refiners not served by pipelines.
Pipeline companies concentrated in one producing region will have less resilience to survive the competition, Warren said.
“They’re going to have their heyday and then they’re going to have their decline,” he said. “Unfortunately, I’m afraid we’re going to have to feel some more pain for there to be great consolidation.”
Energy Transfer’s planned return to the deals table may alarm some investors who are concerned that the level of debt and would prefer to see Warren concentrate on making the most of what he’s already got.
“They’ve bought enough assets at this point,” Darren Horowitz, an analyst at Raymond James, said in a phone interview. “What they need to figure out how to do is effectively integrate all these assets,” while paying down debt.
Energy Transfer Partners, the largest of four affiliated MLPs, carried $13.4 billion in net debt at the end of the second quarter, according to Baird analysis. That’s 3.9 times its earnings before interest, taxes, depreciation and amortization over the past 12 months. Energy Transfer Equity, the owner of the general partner overseeing ETP, meanwhile had debt that’s 3.4 times its distributed cash flow, according to Baird.
Energy Transfer Equity is up 43 percent this year, while Energy Transfer Partners has climbed about half that amount at 21 percent. The benchmark Cushing 30 MLP index rose 21 percent in the same period.
The industry has been good to investors. Tortoise Energy Infrastructure Corp., the best-performing energy fund this year with more than $100 million in assets, has pipeline and “midstream” partnerships among its largest holdings. The fund has gained 29 percent year-to-date, according to data compiled by Bloomberg.
Warren promises that any deals he does won’t hurt the group’s investment-grade credit ratings. He’s also determined to increase investors’ distribution payments, which will be boosted by 1 cent per unit in the third and fourth quarters, the partnership said last month.
He declined to discuss future growth of the distribution amount other than to say, “We will continue to please the market in that regard.”
Warren co-founded Energy Transfer Partners in 1995 with Ray C. Davis, who retired from Energy Transfer in 2007 and is now part-owner of the Texas Rangers professional baseball team. The company started with 200 miles of pipelines in East Texas, focused solely on moving the heating and power-plant fuel within the state boundaries.
As investors began to cool on the company late last decade, Warren said he realized Energy Transfer was too narrowly focused on one geographic area.
To broaden the business, he started a series of acquisitions in March 2011 with a $1.93 billion deal for LDH Energy Asset Holding LLC. Energy Transfer Equity (ETE:US) prevailed in a bidding war against rival Williams Cos. (WMB:US) to buy Southern Union Co. for $5.6 billion, while Energy Transfer Partners agreed to buy Sunoco Inc. for $5.3 billion last year.
“Ultimately he’s a guy that likes to buy stuff and be an empire builder,” said Bellamy, the Baird analyst.
Enterprise Products Partners LP (EPD:US) and Kinder Morgan Energy Partners LP (KMP:US) are the largest U.S. natural-gas pipeline operators based on market value. Energy Transfer Partners is third-largest.
Of the four publicly traded MLPs affiliated within the Energy Transfer group, Sunoco Logistics Partners LP (SXL:US) is the best positioned financially to make deals, Warren said.
Gas exports rank among potential investments Warren is studying. Energy Transfer, along with partner BG Group Plc (BG/), is planning to build a liquefied natural gas export terminal in Lake Charles, Louisiana. As the joint venture works on obtaining the final government permits that will allow it to proceed, Warren said he’s considering investing in other Gulf Coast LNG projects.
Because investors demand steady growth, acquisitions will remain an essential part of Energy Transfer’s strategy, though don’t expect deals the size of Sunoco or Southern Union, Warren said in the interview this week.
“You’re going to see a very deliberate, careful, well-thought-out open-mindedness to M&A,” he said.
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