MLPs: Energy Transfer Partners LP Forks Over $18 Billion to Bulk Up

By Markets Fool.com

Energy Transfer Partners LP announced today that it was acquiring affiliate Regency Energy Partners LP in an $18 billion deal, which includes the assumption of $6.8 billion of debt. By rolling up its fellow MLP Energy Transfer Partners will become the second largest MLP in America. Here's a breakdown of the deal and what it means for investors.

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Details on the deal
Energy Transfer Partners is merging with Regency Energy Partners in a unit-for-unit exchange. Under the terms of the deal Regency unitholders will receive 0.4066 of Energy Transfer's common units for each one of its units. In addition to that, Regency unitholders will also receive $0.32 in cash for each unit they own. This implies a price of $26.89 per unit, which is a 13% premium to Regency's closing price last Friday.

To help the deal along,Energy Transfer Equity LP , which is the general partner of both MLPs, is reducing the incentive distribution rights, or IDRs, it receives from Energy Transfer Partners. It's chopping its cut by $320 million over a five year period. Because of the reduction in IDRs the deal will be breakeven to Energy Transfer Partners distributable cash flow this year and accretive thereafter. Said another way, without the reduction in IDRs, the deal wouldn't have made as much economic sense. That said, there are other reasons outside of economics that are driving this deal.

Why they're combining
Combining these two affiliated MLPs really creates greater scale at a time when MLPs are finding that scale matters. The combined entity creates one of the strongest and most diversified energy midstream companies in the U.S. Further, the deal is viewed as a credit positive event for Regency, which is important because credit is likely going to tighten for energy-related companies due to the downturn in oil prices. There's a grave concern that high-yield energy bonds could be hit with a massive default wave in the next year if oil prices don't improve. So, by creating a stronger investment grade entity, Regency and Energy Transfer Partners will be able to keep their cost of capital advantage over smaller rivals.

This was noted by Regency's CEO Mike Bradley in the press release announcing the deal as he said:

In light of the current volatility in commodity prices and the changes in the capital markets, it became apparent over the last several months that Regency needed more scale and diversification, along with an investment grade balance sheet, to continue its growth. As a result, the combination with Energy Transfer Partners became a logical transaction, as we believe that this merger will create significant immediate and long-term value for our unitholders. The merger will also allow Regency and Energy Transfer Partners to consolidate our complementary midstream operations in the Permian andWest Texasareas. The ability to bring those operations together under one roof is expected to create tremendous value for the unitholders of the combined partnerships.

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As he notes, the downturn in oil prices really brought to light the importance of having greater scale. Not only is it important from a credit standpoint, but it will enable the companies to reduce costs, obtain capital efficiencies, and strengthen the growth platform of the combined companies. This is why we've seen a number of affiliated MLPs combine over the past year as Kinder Morganrolled up its MLPs into its C-Corp, while Williams Companiesis combining its two affiliated MLPs into one stronger entity. It's a trend that will only grow stronger as commodity prices remain weak.

Investor takeaway
Energy Transfer Partners is creating the second largest MLP in America, but empire building isn't what's driving this deal. This deal is about growing its scale, which is becoming vitally important as it helps to keep its cost of capital low so that it can pursue growth. This is why it's quite likely that this isn't Energy Transfer Partners' last acquisition as it does have another affiliate that could be rolled up. Meanwhile, there's a number of smaller MLPs that could become targets should credit begin to tighten. It's a deal that makes a lot of sense for investors as the combined entity should thrive from a scale that will enable it to take advantage of the weakness of smaller rivals.

The article MLPs: Energy Transfer Partners LP Forks Over $18 Billion to Bulk Up originally appeared on Fool.com.

Matt DiLallo has the following options: short January 2016 $32.5 puts on Kinder Morgan and long January 2016 $32.5 calls on Kinder Morgan. He also thinks a huge M&A wave is about to hit the energy sector and is looking for potential takeout targets. The Motley Fool recommends Kinder Morgan. The Motley Fool owns shares of Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.