The Strategist

Cost Of Capital Driving Midstream Mergers And Acquisitions

05/28/2015 - 07:39

Of late, mergers and acquisitions have been taking place to rein in issues regarding cost of capital and company efficiency. Certain companies have gone on to acquire their own subsidiaries or MLPs to inspire stability within the company and also reliability for investors. The effects these moves might bring to the midstream space are now to be seen.

New York – 27 May 2015 – According to Bussiness Wire, an efficient business method is to find a synergy between the two companies vying to go through mergers or acquisitions. While the parent companies continues to acquire its own subsidiaries like companies that are valued at less than their own company, there is a need for exhaustive research and calculations before such a venture is set in motion. The success of a merger or an acquisition cannot be justified by just a sense of procurement rather it should be judged by how the value of the parent company increases after said merger or acquisition.
Fitch Ratings, being the erstwhile specialists of these fields have a major role to play on how the newly formed alliances are viewed among the industry watchers. In Fitch Ratings’ words:
Mergers and acquisitions will likely continue as the cost of capital, project backlogs, and rising interest rates remain issues for master limited partnerships (MLPs)”.
The Williams Companies Inc.'s (WMB) recently acquired its MLP, Williams Partners L.P. (WPZ). The said company’s projected venture will create a stronger credit profile for the combined WMB/WPZ entity. Fitch Ratings placed WMB's ratings on Rating Watch Positive, in aftermath whereby it is observed that one of the biggest driving forces of the planned merger is the cost of capital at WPZ, which has become a wider concern for issuers in the midstream space.
Cost of capital is a very important yardstick for measuring a company’s standing in the market as it either inspires or demeans its value and reliability in an investors’ eye. Other recent transactions that occurred to improve the cost of capital include Energy Transfer Partner, L.P.'s acquisition of its affiliate MLP, Regency Energy Partners L.P. in April 2014 and Kinder Morgan Inc.'s acquisition of its MLP's in November 2014.
The recent Williams transaction, where Williams Companies acquired Williams Partners, sheds light on this matter wherein incentive distribution rights (IDR) paid to the general partner can have on equity cost of capital for mature MLPs that have been around for a long time. However, this is not to be viewed as a renunciation of the MLP structure as capital markets remain open to it, despite the tricky commodity price environment.
Fitch Ratings initially thought that mergers could lead to mitigate IDR burdens and MLP conversions would be confined to Kinder Morgan (KMI; BBB-/Stable Rating Outlook) since it had a relatively distinctive situation. Kinder went ahead and acquired its own two MLP subsidiaries namely Kinder Morgan Energy Partners, LP (KMP) and El Paso Pipeline Partners, LP (KMP) effectively pulling its subsidiaries in and setting a goal towards more traditional tax structure.
Kinder’s main reason to put in motion such a move was of course the wish to decrease the cost of capital involved for these entities in order to encourage competitive efficiency and inspire the company to grow at a speedier rate.  However, the success and positive equity response that the KMI and the WMB/WPZ transactions have experienced could now inspire other MLP issuers following the trend.
Deductions from exploration and production capital spending over the past several months, succeeding the decline in prices of commodity in November 2014, are also intimidating midstream institutions. In the long run, if production volumes are lessened, it could result in slower growth and cause pain to volume-sensitive issuers or lead to notable declines and/or delays in planned growth projects in the future.