Midstream sector becomes the player in mergers

For anyone inclined to only think of Enbridge in the context of the Northern Gateway pipeline project, its $37-billion deal to acquire Spectra Energy should put those thoughts to rest.

Northern Gateway was, and still is, more important to Canada than to Enbridge from a corporate standpoint and should never have been seen as a company maker.

The Spectra deal fits that description by creating North America’s largest energy infrastructure player, with an enterprise value of $165 billion.

For the sake of comparison, the $37-billion deal is almost three times the size of TransCanada’s acquisition of Columbia Pipelines in March and marks the largest deal ever done in the Canadian energy space.

Rio Tinto’s acquisition of Alcan in 2007, with a price tag of $40.95 billion, remains the biggest deal ever done in corporate Canada. Suncor’s takeover of Petro-Canada in 2009, the last merger near this size, was valued at $19 billion.

Where the last oil market crash resulted in the creation of the super major category — ExxonMobil, BP Amoco and Chevron-Texaco, the midstream sector is now the big player in the game of mergers and acquisitions.

Not only have Enbridge and TransCanada made big moves, so too has MPLX, which bought MarkWest for US$17.4 billion, and Energy Transfer Partners, which snapped up Regency Energy Partners for $17 billion. Last month, Enbridge partnered with Marathon Petroleum in paying $1.5 billion to Energy Transfer Partners and Sunoco Logistics Partners for a minority stake in the Bakken Pipeline.

In hindsight, Enbridge has been setting the stage for this kind of a move for a while.

In late 2014, it undertook a restructuring through what’s known as a drop-down transaction, transferring $17 billion via a tax free rollover into the Enbridge Income Fund. The move effectively separated growth-oriented assets, which stayed within Enbridge, from the yield-oriented assets into the Enbridge Income Fund. At the time, it was seen as a way to position the company to become more active in the acquisition space.

Earlier this year, the company took advantage of favourable equity market conditions to raise $2.3 billion in a deal that was oversubscribed. In early May, it undertook an internal re-organization, presumably to position itself to integrate a transaction of size. Why now? It’s as much a function of a time in the cycle where the organic growth prospects are not as compelling in terms of timing and returns — much of it due to the regulatory issues — relative to acquisition opportunities.

There was a time, under the leadership of former Enbridge chief executive Pat Daniel, where organic opportunities brought growth.

Things are different today.

Deals like these — especially given the commodity price environment and regulatory challenges — are as much about scale and synergies as they are about access to capital and lowering a company’s cost of capital.

For midstream companies, diversifying the asset base as the Enbridge-Spectra transaction does, is critical. It makes sense for the two asset portfolios to be merged because it takes Spectra from being wholly exposed to the utility sector and natural gas transportation and decreases Enbridge’s dependence on transporting and storing oil.

Much like the TransCanada-Columbia deal, acquiring Spectra gives Enbridge exposure to infrastructure taking natural gas from the prolific Marcellus basin into the lucrative U.S. Northeast.

The challenge for bigger companies, of course, is that it’s harder to generate meaningful growth from a larger asset base. The value of projects either planned or underway for both companies adds up to $74 billion, which suggests the runway for continuing to generate meaningful returns for shareholders is even stronger as a merged entity.

Some might view the Enbridge deal as a signal no major Canadian infrastructure projects will be built, or that Enbridge is now an American company headquartered in Calgary, but it’s great news for Canada.

For too long, the direction of acquisitions has flowed from the south, with Canadian companies bought up by U.S. players. Dick Haskayne, in his 2007 memoir, Northern Tigers, lamented the fact too many Canadian companies were unwilling to take advantage of growth opportunities and become global players in their areas of expertise.

The point was recently made in a paper published by the C.D. Howe Institute that highlighted the need for Canadian companies to look for growth opportunities on a global scale. The new Enbridge has breadth, reach and capacity to do just that.

Another way to view this is that bigger companies are less likely to become acquisition targets. That was one factor behind the merger of PanCanadian Energy and Alberta Energy Company — to create a company big enough to deter a hostile takeover and ensure the legacy assets remained under Canadian ownership.

Enbridge and TransCanada both appear to be heeding Haskayne’s advice, and the same reasoning could be applied to merger talks taking place between Potash Corp. and Agrium. It makes sense for the world’s largest producer of the commodity to merge with a key fertilizer player that also brings with it an unbeatable North American retail network.

When it comes to the resource sector, size and scale do matter.

It’s a paradigm likely to increase in importance as operating models in the resource space are pressed to find ways to boost competitiveness and increase profitability.

Deals like these are as much about scale and synergies as … access to capital and lowering a company’s cost of capital.