What: Units of Midcoast Energy Partners (NYSE:MEP) were on fire last month, surging just over 17%. Fueling that rally was a number of related catalysts that had investors more enthusiastic about the company's prospects.
So what: Midcoast Energy Partners' rally was ignited by its first-quarter earnings report. The financial report itself wasn't all that thrilling given that the company's adjusted EBITDA, distributable cash flow, and coverage ratio were all just in line with expectations, with each continuing to be negatively impacted by challenging commodity prices. Instead, it was the company's commentary on how it plans to address these challenges that caught everyone's attention. In particular, Midcoast Energy Partners noted that it is working with its sponsor, Enbridge Energy Partners (NYSE:EEP), to address some of the challenges both companies are facing.
For starters, the companies are exploring a broad range of strategic alternatives for their jointly owned gas business Midcoast Operating. However, in addition to exploring options for that specific asset, Enbridge Energy Partners has indicated that it is also considering alternatives for its investment in Midcoast Energy Partners, which could include asset sales, mergers, joint ventures, or a reorganization.
The potential for a strategic transaction led Credit Suisse to upgrade Midcoast Energy Partners from underperform to neutral while also raising its price target from $5 to $6. Further, it contends that Enbridge Energy Partners should buy Midcoast Energy Partners. Such a transaction would enable Enbridge Energy Partners to reset its own distribution to a more sustainable long-term level as opposed to jettisoning assets at what could be the low point of the cycle just to maintain its payout.
Now what: With its business under pressure due to weak commodity prices, Midcoast Energy Partners and its sponsor are starting to evaluate their options. One option that seems to make a lot of sense is for Enbridge Energy Partners to bring Midcoast Energy Partners back into the fold given that the initial separation hasn't worked out as planned. That outcome is certainly something the market seems to be anticipating given how sharply units of Midcoast surged last month. That said, investors could be setting themselves up for a big disappointment if that's not the chosen strategy.