Energy Transfer (ETE) is buying Williams Companies (WMB) for $32.6 Billion, $15.4 Billion less than was offered in June. Article
That is an astonishing 32% decrease in value in just 3 months. What is more amazing is that William is a midstream company with little direct price risk. It owns one of the industry’ most valuable assets: the Transco system, and has other pipes serving growing natural gas markets on both coasts.
One would think that Energy Transfer would be rewarded by Mr. Market for such a shrewd deal. Not so. On the day the deal was announced ETE dropped 13%, a further $13.7 Billion erosion in value. Read More
This $29.1 Billion loss in value is for a combined company that will have on the order $47 Billion in market value. What gives? Has the oil price contagion spread that far, that fast and that deep that even Steady Eddie pipelines are hurt? There is more to the story. Williams adds significant market reach to ETE extending to all three coastal end use markets and spanning some of the most productive producing regions on the continent.
Moreover, ETE was built on acquisitions (along with a few de novo development projects and has been a highly valued company since its founding in 1995. The senior management focuses on big picture strategy, shared services, building scale economies and financing growth. Project planning, development and market specific strategy are delegated to the operating entities. This is a sensible business process design that has paid off handsomely for ETE and the subsidiaries and, most importantly, for customers and shareholders. ETE has returned 21% annually to shareholders over the past 5 years and is judged to have a wide economic moat: that is competitive advantage. Similarly, WMB has returned 21% and it too has a wide moat.
Morningstar estimates the combined Fair Value at $115 Billion. Fair Value is the estimated net present value of cash flow to shareholders. While it is an estimate based upon assumptions, it has the benefit of being rational. That is it is not driven by emotion that determines Market Value. These estimates are probably pretty accurate since most midstream companies take little to no risk from declining prices or declining volume (the chance that falling throughput will reduce revenue). Most contracts are for Firm Transportation Service (FTS) that provides for a fixed revenue in the form of a reservation charge, paid regardless of through put. In short, they have most revenue risk of covered.
What can we make of all this? The drama in the wake of the oil and price collapse has left Mr. Market and his two sidekicks, Supply and Demand in a rather grumpy mood. It has also been a bit schizophrenic as some hedge funds have rushed in to scoop up what they perceived to be undervalued assets. For Hedge Funds Can't-Miss Trade Goes Bust.
My take on all this is that there are those that see a mean reversion scenario and some see a new normal. Mean reversionists believe Oil (and natural gas) prices will rebound, E&P companies will recover lost value and all will be right with the world. I think this is wishful thinking.
The rest of us see that the Shale phenomenon has become a disruptive technology that has forever and permanently changed the shape of energy markets. The resource base is vast and new supplies can be brought to market much faster and cheaper than in the past. As low prices stimulate consumption, supply and demand will regain some degree of equilibrium, but at a price that reflects the cost to bring those supplies to market. Producers have learned how to bring new supply to market through capital deployment efficiencies. I believe this improving business process still has legs and will continue, not forever, but improving efficiency has been shown to be longer lived than initially expected. All across their value chains, upstream companies are looking for ways to reduce costs.
All three pillars of business: people, strategy and process are under intense scrutiny for cost reductions. Unlike past downturns, it appears companies are playing it much smarter when it comes to their human capital. Among the better managed companies, layoffs are selective, intentional and deliberate. They are keeping and encouraging their high performers. Strategies are under careful review, evaluating basins and plays that closely match capabilities. Business processes, particularly capital allocation and deployment are being revised and honed to make players better stewards of capital.
While Mr. Market continues in his energy funk, there are upstream companies that are shaping up to be the winners of the future. At the same time, there are undervalued companies in the midstream that are doing just fine and represent great investment opportunities now.