NEWTON, Mass.--(BUSINESS WIRE)--Dear members of the ENB Board and Special Committees of EEP and EEQ:
On May 17, 2018 Enbridge Inc. (“ENB”) proposed to acquire Enbridge Energy Management, LLC (“EEQ”) and Enbridge Partners, LP (“EEP”) in exchange for ENB shares with no premium to severely depressed prior closing prices. This no-premium offer is highly unusual within the midstream space and we believe it dramatically undervalues the assets held at these entities. We believe each merits an exchange ratio of at least .37 ENB shares per unit or share. This is the minimum required to reflect fair value of these assets and to show a modicum of decency to the longsuffering holders of these securities. This would represent a 20% increase in consideration for EEP and a 28% increase for EEQ, but less than 2% dilution for ENB versus the current offer.
Fair value for EEP is at least 20-30% above ENB’s offer
Enbridge describes EEP on its investor relations web site as “a pure-play liquids pipeline MLP with premium low-risk assets, a strong financial position, conservative distribution coverage and visible growth.” Despite such laudatory language throughout its communications, ENB now proposes to acquire these assets at a steep discount to the valuation of every other large long-haul pipeline company. For comparison, the proposal would value EEP and EEQ at about 10X estimated forward EBITDA compared with a range of 11X to 15X for comparable long-haul pipeline MLPs. The offer would need to move up about 20% for EEP and 28% for EEQ just to reach the lower end of this range.
This is before considering several recent positive developments specific to EEP:
- 5% improvement in forward cash flow from FERC clarifications
- Substantial progress on the Line 3 replacement project
- Growing confidence in Bakken growth – note that most Bakken-levered midstream companies are up 20-45% YTD on a total return basis compared with negative 10% for EEP
After considering these fundamental improvements and substantial derisking of major projects, ENB’s offers imply a valuation of just 9.5X run-rate EBITDA. On its second quarter earnings call, management described its offers as “strong” and highlighted the increase in their value due to ENB’s share appreciation. We ask the Special Committees: is an offer that values EEP and EEQ far below comparable MLPs strong? Does appreciation in-line with the broader MLP space reflect the major fundamental improvements specifically experienced by EEP and EEQ since the offer announcement?
One share of EEQ = one share of EEP. Any exchange offer needs to be equivalent
EEQ was structured and sold as a tracking security for EEP that shields investors from EEP’s K-1 and associated tax complications. EEQ’s IPO prospectus makes clear that the economic value of EEQ’s holdings and its distributions will always be equivalent to that of EEP. Due to trading inefficiency, EEQ shares have traded at modest premiums or discounts to EEP units over time, but the intrinsic value is clear. A comparable transaction occurred in 2014 when Kinder Morgan Inc. bought in its MLP subsidiaries. Kinder did the right thing and offered i-unit holder KMR parity with the offer it made for common equity, despite its trading at a 4% discount at the time.
Though detailed legal analysis would be required to confirm, language in EEQ’s formation documents suggest that the offer as currently constructed might also constitute a breach of contract between EEP and EEQ. As EEQ’s initial public offering prospectus notes, EEP will not take any action that results in a “special event”, which includes among other things, “the merger of Enbridge Partners with another entity … unless in the transaction the only consideration that the owners of common units receive in exchange for their common units is a security that has in all material respects the same rights and privileges as the common units and/or cash.” Since ENB does not have the same rights and privileges as EEP common units, it appears an exchange of ENB shares for EEP units would constitute a special event. ENB has some ability to cause such a special event to occur, but according to the prospectus, “The purchase price for the shares in the event of a purchase by Enbridge Inc. upon the occurrence of a special event will be equal to the higher of the average market price of the shares and the Class A [EEP] common units as determined for a 10-trading day period ending on the trading day immediately prior to the date of the applicable event.”
In light of these facts, it is unimaginable that the EEQ conflicts committee would accept an offer less than what is approved by EEP.
ENB has consistently described EEP and EEQ as having premium assets, now they need to make an offer to match
Since its IPO in 1992, EEP has provided investors with a total return less than one quarter that of ENB. Over the past decade, EEP has missed one of the all-time great equity bull markets entirely, delivering a paltry 1% annual total return, compared with 7.5% for the MLP sector and 8.9% for ENB. Throughout this flagging performance and particularly during the 2016-2017 downturn, ENB management consistently described EEP as stable and unfairly punished by markets. Now ENB proposes to take these “premium low-risk assets” from investors at a price far below where it traded even during the dark days of $30 crude oil, and far below the valuation of its peers today.
We would like to ask Enbridge management which of the following is true: Are these premium assets as its investor relations website even now claims and therefore deserving of a premium valuation? Or are they the worst long-haul assets in North America by a wide margin as the current offer implies?
We agree with ENB that simplification of the Enbridge structure is in the best interest of all shareholders and unitholders, but this simplification must occur in a manner that at least approximates fair value. We hope that based on their own prior remarks that ENB management recognizes the severe undervaluation implied by its initial offer for these securities and merely intended the proposal to start a negotiation process. However, it is up to the Special Committees and unaffiliated investors to hold them to account and fight for fair value.
Matt Niblack, Portfolio Manager
HITE Hedge Asset Management LLC
One Gateway Center
300 Washington Street, Suite 308
Newton, MA 02458
Note: All prices and valuations based on closing prices on August 2, 2018 and HITE Hedge Asset Management estimates as of that date. This publication does not constitute investment advice.