WHY ENBRIDGE’S ROLL-UP DECISION COULDBE A GOOD THING FOR INVESTORS.
Tax advantage, transparency for investors
Enbridge Inc.’s decision on Thursday to absorb four of its subsidiaries is designed to mitigate the negative tax implications of a U.S. regulator changing its policy and to shore up investor confidence, analysts say, but it will do little to address the $60-billion debt elephant in the room.
Enbridge intends to swap $11.4 billion in common shares for the equity it does not already own in its four publicly traded master limited partnership (MLP) subsidiaries: Spectra Energy Partners LP, Enbridge Energy Partners LP, Enbridge Energy Management LLC and Enbridge Income Fund Holdings Inc.
The transaction, subject to shareholder approval and expected to close in the fourth quarter, comes on the heels of a proposal in March by the U.S. Federal Energy Regulatory Commission (FERC) to eliminate critical tax advantages for MLP structures.
David Galison, an analyst at Cannacord Genuity, said management has defended the corporate structure, even as depressed oil prices challenged the viability of the operating subsidiaries, but the FERC proposal effectively forced the company’s hand. He has a $52 price target on Enbridge, implying a 30-per-cent upside.
“That cheaper funding mechanism was broken, and now with the changes in the U.S. FERC policies, it’s permanently broken,” Galison said. “It’s actually to the point where they may not be viable entities on their own.”
Enbridge’s reputation for delivering steady growth and reliable distributions has taken a beating in recent years. Its stock is down nearly 40 per cent since early 2015, after the collapse in oil prices and a subsequent Us$28-billion mega-deal to acquire Houston-based Spectra Energy Inc.
Increased leverage and waning investor confidence — particularly as rising interest rates provide other high-yield alternatives — have forced Enbridge to backpedal on some of its forward-looking statements, which has led to “concern from a strategic direction standpoint,” Galison said.
Nevertheless, he believes Enbridge’s move to consolidate is a step in the right direction since it avoids tax obligations while providing investors with much-needed financial transparency.
“One of the overhangs that has been on the stock is the complicated nature of the Enbridge structure,” Galison said. “As an investor, you had to work much too hard to understand what earnings and cash flows you were truly entitled to. So by rolling everything back up, that eliminates that overhang in the stock, which over the long term should be positive.”
The company has left earnings and distribution guidance unchanged through 2020, Galison added, so there’s no real financial impact aside from reduced tax obligations.
The move to consolidate may, however, improve investor sentiment. Matthew Taylor at Tudor, Pickering, Holt & Co. said it should give investors confidence that management is beginning to execute on its plan, announced in December, to simplify the company’s structure and divest noncore assets to pay down debt.
Earlier this month, Enbridge announced a $3.2-billion sale of renewable-power facilities and natural-gas processing assets in North America, and the company has earmarked another $7 billion in divestitures as it aims to bring its debt down to five times EBITDA by the end of the year.
The newly consolidated structure will also enable the parent company to better retain cash and fund operations at a higher level, as unitholders in the subsidiaries are made to trade in their stock for lower-yielding shares of the parent company.
“It was a sense of, how will we fund these projects longer term,” Taylor said, “and Enbridge has taken the position that if we roll it up and finance these projects on the parent level, we’re at an advantage. And we tend to agree with that.”
Taylor’s firm has a price target of $46 on Enbridge, implying upside of about 15 per cent.