Tax ad­van­tage, trans­parency for in­vestors

National Post (National Edition) - - FINANCIAL POST - David dias

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.

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