After winning a crucial court battle last week, Energy Transfer Equity (NYSE:ET) was free to terminate its troubled merger with Williams Companies (NYSE:WMB). While Energy Partners could have tried to renegotiate a deal that has been troubled from the start, it instead decided just to walk away.
Because of that, both companies are now going their separate ways. Here are the paths each is likely to take from here.
Energy Transfer Equity is going to keep simplifying
When Energy Transfer Equity initially clinched a deal to buy Williams Companies, it believed that the transaction would create substantial value for both companies that neither could achieve on its own. However, as oil prices crashed, and credit deteriorated in the energy market, the value-creation potential quickly evaporated. Instead, the deal was seen as a potential catastrophic value destroyer because of the incremental debt that Energy Transfer Equity would need to issue to close the transaction.
With the deal now in the rearview mirror, Energy Transfer Equity can go back to business as usual. For the company, that means continuing to simplify the corporate structure of its sprawling energy empire. The company embarked upon this path in 2014 as it transitioned toward a pure-play general partner. It did so by shifting assets among its three affiliated MLPs, Energy Transfer Partners (NYSE:ETP), Sunoco Logistics (NYSE: SXL), and Sunoco LP (NYSE:SUN), to streamline each company's strategic focus.
There is more simplification yet to be done. For example, Energy Transfer Partners currently owns the general partner and 100% of the incentive distribution rights (IDRs) of Sunoco Logistics, which are assets that would be better off in the hands of Energy Transfer Equity. Meanwhile, Energy Transfer Partners owns a substantial stake in Sunoco LP, which would be better off in the hands of its parent, or sold off entirely. By completing the simplification process, each entity will be able to devote its entire focus on growing within its strategic realm of expertise.
In addition to the continued streamlining, expect Energy Transfer Equity to work with its MLPs to fund their growth. This collaboration could include purchasing common units to provide its MLPs with capital to fund acquisitions and growth projects, or agreeing to subsidize IDRs to free up additional cash flow to enable its MLPs to fund growth internally. This path is the path that Energy Transfer Equity used to build its empire, and it's likely the route it will take to grow it in the future.
Williams Companies needs to find a sustainable path
For Williams Companies, on the other hand, it likely will not continue down its prior pathway. After two failed mergers in the span of a year, this company needs to reconsider its future direction.
The first step will undoubtedly involve cutting its dividend by a material amount. It has already warned that this would be the outcome if it failed to close its merger with Energy Transfer Equity, so investors can expect it to happen sooner rather than later. It is also entirely possible that its affiliated MLP Williams Partners (NYSE: WPZ) will also reduce its payout, given that both companies have rather embarrassingly unsustainable payout ratios.
Aside from the weak payout ratio, another reason why Williams Companies will likely need to reduce the cash outflows of Williams Partners is that it needs the money to fund growth projects. The company already had to cut its CapEx budget by $1 billion this year because it could not access the capital markets at a reasonable rate due to the energy market downturn, and concerns with its credit quality.
Further, even after making that cut, Williams Partners had planned to sell upwards of $1 billion in assets to fund CapEx, which is not a sustainable business practice. Instead, it likely will need to start using retained cash flow to support growth going forward, which means the distribution needs to drop.
In other words, Williams' needs to build its go-forward plan on funding its growth CapEx sustainably. Its present course of paying out nearly all its cash flow, and relying on the capital markets or asset sales to fund growth, just will not work anymore.
The failed merger will lead to two entirely different outcomes. Given its relatively stronger position, Energy Transfer Equity can go back to business as usual. However, that's not an option for Williams Companies. It's in a much-tighter financial position, which means significant changes are likely on the horizon.