Image source: Getty Images.
Continue Reading Below
Shares of both Energy Transfer Partners (NYSE: ETP) and Sunoco Logistics Partners (NYSE: SXL) dropped as much as 10% following the news that the two companies will merge under the Sunoco Logistics Partners name. Coincidentally, shares of parent company Energy Transfer Equity (NYSE: ETE) were up as much as 15.6% on the news. Shares for both have tempered a bit. As of 1:00 p.m. EST, shares of Energy Transfer Partners and Sunoco Logistics Partners are down 8.2% and 7.4%, respectively.
Continue Reading Below
According to the press release from the company, Sunoco Logistics Partners will issue 1.50 shares per share of Energy Transfer Partners, which at the time amounted to a sale price of $39.30 per share, which was a premium to the past 30-day average but slightly below the market value at the close of the market on Friday.
While the company gave a lot of reasons why this deal was great for the two companies -- simplified structure of the Energy Transfer business as a whole, more geographic and assets diversity for Sunoco Logistics Partners, synergies, etc. -- probably the most telling one was this statement in the investor presentation as to why it was a good move for Energy Transfer Partners:
Without this transaction, ETP would need to consider a distribution reduction in the range of 15-25%, subject to a number of assumptions, in order to reduce leverage and increase distribution coverage to strengthen ETP's financial health and future cash distribution growth profile.
The one thing that Sunoco Logistics had going for it was the fact that its debt load was much more manageable than that of Energy Transfer Partners. Just one glance at their balance sheets would sniff that out.
|Company||Net Debt to EBITDA||EBITDA/ Interest Expense|
|Energy Transfer Partners||6.79x||3.01x|
|Sunoco Logistics Partners||5.4x||7.14|
Data source: S&P Global Market Intelligence.
So by Sunoco Logistics -- a much smaller entity than Energy Transfer Partners -- absorbing all of Energy Transfer Partners in an all-stock deal, the earnings power will help to bring the combined companies' debt metrics more in line with what investors want to see in a midstream master limited partnership. This will also help ensure that Energy Transfer Partners can lower its debt without having to slash its payout to investors to achieve the same goal.
For Energy Transfer Equity, it has the advantage of consolidating its two largest subsidiaries under one simpler structure, which will reduce the risk of Energy Transfer's debt risks. Since the company receives both distributions and incentive distribution rights from the two, anything to ensure a cut doesn't happen is a plus.
Management at Energy Transfer can try to spin it any way it can, but the truth of the matter is that Energy Transfer Partners was in trouble financially and this was the only way to preserve it without having to take more drastic measures that would have hurt investors. It's also discouraging for investors that management didn't price the deal at a premium to yesterday's closing price.
In the long run, perhaps this deal will help to solidify these two companies' balance sheets and provide some growth opportunities that may not have been present as two separate entities. It should be noted that the management team at Energy Transfer -- the one in financial trouble -- will take all of the major executive positions in the new company while the management team at Sunoco Logistics Partners will take smaller management roles. That isn't exactly the greatest sign of things to come.
10 stocks we like better than Energy Transfer Partners
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Energy Transfer Partners wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 7, 2016
The Motley Fool has no position in any of the stocks mentioned. 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.