According to a report by Reuters late last week, Williams Companies (NYSE:WMB) is now open to considering a new offer to amend the terms of its merger agreement with Energy Transfer Equity (NYSE:ET). That would represent a monumental change for a company that has steadfastly stood by its merger agreement amid months of speculation, drama, and legal disputes. However, in light of a recent countersuit brought by Energy Transfer Equity seeking a court ruling to terminate the merger, Williams Companies appears to finally be facing reality by agreeing with the general consensus that the merger just won't work under its current terms.
How we got here
Backed by a nearly ironclad merger agreement, Williams Companies has fought hard to close its proposed transaction with Energy Transfer Equity, which it views as being in the best interest of its shareholders. That's largely because the company held out until Energy Transfer Partners agreed to add a cash component to its offer, after Williams initially rejected overtures for an all-equity deal. It insisted on that cash to provide its investors with an immediate return, which under the current terms has Energy Transfer Equity paying Williams's investors $8 per share upon closing of the transaction.
However, that cash component, which Energy Transfer Equity planned to fund by taking on $6 billion of incremental debt, has become a huge sticking point leading to lawsuits and countersuits filed by both companies. At issue is the freezing of the credit markets due to the deep downturn in commodity prices. That credit crunch will likely make it very hard for Energy Transfer Equity to refinance its short-term acquisition financing at favorable terms, which will erode some of the expected cost of capital benefits of the transaction.
Because of those concerns this incremental debt has created a lot of controversy. According to reports, Energy Transfer Equity's former CFO said the debt was "mutually assured destruction," causing him to reportedly call Williams investors to convince them to vote against the deal, which ultimately led to his dismissal. To avoid that potentially destructive fate Energy Transfer Equity initiated a private offering of convertible preferred units, with those units deferring distribution payments to holders, enabling Energy Transfer Equity to retain cash to reduce debt.
What might happen now?
That private offering, however, is one of the legal disputes between these companies, with Williams suing not only Energy Transfer Equity, but its CEO Kelcy Warren, who received a large percentage of those units. That very lawsuit against Warren, and Williams's refusal to cooperate with Energy Transfer's efforts to finance the merger, are two of the main arguments Energy Transfer Equity is making in its breach-of-contract countersuit against Williams about why the transaction should be terminated. If the court does side with Energy Transfer and terminates the merger, it would trigger a $1.48 billion termination fee which Williams would be required to pay to Energy Transfer.
It's the risk of owing that termination fee, as well as the clear issues with the transaction's current form, that appears to be behind Williams's reported openness to renegotiate the deal. That said, such a restructuring would have to be "substantial," according to comments by Warren on Energy Transfer's last conference call, in order for the deal to work. More than likely it would include axing the cash payment in favor of additional shares in Energy Transfer Corp., which is the entity Energy Transfer Equity is using to acquire Williams. According to Reuters, the math would work out to increasing the equity portion from 1.5274 shares of Energy Transfer Corp. to 2.2 shares for every share of Williams Companies.
That's assuming the companies keep the same valuation as the prior terms. However, given the significant deterioration in the energy markets, Williams's credit profile, and its underlying operations, it's quite possible that it would need to agree to a lower valuation as well.
It appears that Williams Companies is finally facing the reality that it won't be able to close its merger with Energy Transfer Equity under the current terms. That said, while it is now open to renegotiating, that doesn't necessarily mean that a new deal will be struck. Investors need to brace themselves for the real possibility that Williams Companies will not only have to walk away from this deal, but also be on the hook for the $1.48 billion breakup fee. That's certainly not what investors expected would happen when the company initially rebuffed Energy Transfer's overtures last year in hopes of obtaining even more value.