What happened

Energy Transfer Partners LP (NYSE:ETP) rallied more than 11% by 11:15 a.m. EDT on Thursday after agreeing to merge with its general partner Energy Transfer Equity (NYSE:ETE).

So what

In a clearly telegraphed move, Energy Transfer Equity announced that it had finalized an agreement to merge with its master limited partnership (MLP) Energy Transfer Partners in a unit-for-unit exchange. Under the terms of the deal, investors in the MLP will receive 1.28 common units of Energy Transfer Equity for each unit they currently own in a transaction that should close in the fourth quarter.

A handshake over an energy facility.

Image source: Getty Images.

This deal does several things for the Energy Transfer franchise. First, it helps simplify the organizational structure by combining these two entities into one easier-to-understand company. Second, it will improve the combined company's cost of capital by eliminating the costly incentive distribution rights (IDRs) while preserving an investment-grade credit rating, which will make it less expensive for Energy Transfer to raise money for organic expansions and strategic acquisitions. And third, it will increase the amount of internally generated cash flow it retains, giving the company more money for growth projects.

Now what

This merger needed to happen because Energy Transfer Partners was paying an exorbitant cost of capital to fund its large slate of expansion projects, due in part to the hefty IDRs it was paying Energy Transfer Equity. By eliminating those fees and retaining more internally generated capital, the combined company can earn higher returns on future expansion projects. On top of that, the deal will improve the long-term sustainability of Energy Transfer Equity's high-yield payout, making it a much more appealing option for income-seeking investors.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.