Update: Energy Transfer wins court ruling in Williams Companies merger

A Delaware judge ruled on Friday that Energy Transfer Equity LP can escape a proposed merger with Williams Companies over tax fears. Williams had suggested the fears over an unexpected tax were illegitimate and was merely a ploy by Energy Transfer to duck out of the deal. The judge ruled that the tax fears were valid and opened a door to a potential cancellation of the merger.

The deal has encountered many twists and turns and the proposed takeover had peaked the interest of merger and acquisition professionals across the board as the process unfolded. Seeking to utilize tax treatments to negate the potential deal was a unique defense, and buyers remorse on such a grand scale was unusual. This deal now appears to be one of the largest deals undone by the depletion of oil prices.

“Williams has failed to demonstrate that the partnership has materially breached its contractual obligation,” the judge said in his ruling, adding that he had rejected Williams’ claim that lawyers withheld a tax opinion as a way of allowing Energy Transfer to back out of the deal. The law firm “in good faith determined that it cannot issue an opinion,” he said.

In actuality, the ruling means that Energy Transfer is entitled to back out of the merger following due diligence completed by the company with the assistance of advisors showing that a completed deal would not alleviate the tax liabilities for investors.

Election Deadline Today, Special Meeting of Stockholders is Monday

When The Williams Companies (ticker: WMB) + Energy Transfer Equity LP (ticker: ETE) proposed merger vote is finalized at June 27th’s special meeting of the Williams stockholders, the shareholders will have told the company, (a.) whether or not they want the merger to go forward, putting Williams into Energy Transfer Corp. subsidiary of Energy Transfer Equity, and (b.) whether they want to receive all cash, all shares of Energy Transfer Corp., or a mix of the two.

In a letter to Williams shareholders dated May 25, shareholders of WMB were asked to submit their election whether they wish to receive either 1.8716 of Energy Transfer Corp. (ETC) stock or $43.50 in cash, or a mix of $8.00 cash and 1.5274 of ETC stock. The election deadline for Williams stockholders to elect which form of consideration they wish to receive in approving the merger, subject to proration, is 5:00 p.m., Eastern Daylight Time, on June 24, 2016.

Time in Court

The proposed merger has not been without contention.

On Friday, May 13, The Williams Companies filed an action in the Delaware Court of Chancery seeking a Declaratory Judgment and Injunction preventing Energy Transfer Equity from terminating or otherwise avoiding its obligations under the merger agreement it entered into with Williams on September 28, 2015. Williams said it asked the Court to prohibit ETE from relying on either (i) any failure to close the transaction by the current “Outside Date” of June 28, 2016 or (ii) any failure to obtain a Section 721(a) tax opinion from Latham & Watkins LLP (ETE’s outside counsel), as a basis for ETE to avoid fulfilling its obligation to close the proposed transactions with Williams.

In a press release, Williams said it alleges that ETE has breached the Merger Agreement through a pattern of delay and obstruction designed to allow ETE to avoid its contractual commitments. Williams believes that the Merger Agreement prevents ETE from doing so.

“The Williams Board is unanimously committed to enforcing Williams’ rights under the Merger Agreement entered into with ETE on September 28, 2015 and to delivering the benefits of the Merger Agreement to Williams’ stockholders. This action was filed with that goal in mind. The Williams Board has not changed its recommendation “FOR” the Merger Agreement executed on September 28, 2015,” the Williams press release said.

Williams had earlier commenced separate litigation against ETE and its chairman and chief executive officer Kelcy Warren in response to the private offering of Series A Convertible Preferred Units that ETE disclosed on March 9, 2016. The litigation against ETE in the Delaware Court of Chancery seeks to unwind the private offering of Series A Convertible Preferred Units. The Delaware Court of Chancery has granted Williams’ motion to expedite the litigation. The litigation against Kelcy Warren in the district court of Dallas County, Texas, is for tortious, or wrongful, interference with the Merger Agreement executed on September 28, 2015 as a result of the private offering of Series A Convertible Preferred Units.

On May 15, Kelcy Warren, the chairman of ETE’s general partner, in response to Friday night’s announcement by the Williams Companies, Inc. issued a press release:

“ETE is disappointed that Williams, rather than seriously engaging in discussions regarding the existing transaction, has chosen to file a third separate lawsuit in the last six weeks regarding our pending merger. The filing of these lawsuits has contributed materially to the very delay in completing the Securities and Exchange Commission’s (“SEC”) review of the proxy statement/prospectus and proceeding towards a stockholder meeting that Williams complains about in its most recent suit.

“Before this suit was filed, we were making progress towards clearing all SEC comments and believe we were close to finalizing the proxy statement/prospectus for the Williams stockholder meeting to vote on the merger. We further believe that ETE’s good faith efforts were reinforced by our recent agreement with Williams to amend the merger agreement to provide for a reduction of the time periods necessary for certain administrative matters. This amendment essentially provided nearly an additional month for the parties to finalize and mail the proxy statement/prospectus than was contemplated in the original merger agreement.”

Amended Disclosure: Merger Expected to Deliver $126 Million Annual Synergies, not $2 Billion

On June 17, Williams said it was filing an amended disclosure to the proxy statement:

“The Williams Companies, Inc. (NYSE:WMB) (“Williams”) today announced that, in connection with settling litigation by a Williams stockholder, it has agreed to file an amended disclosure to its proxy statement in connection with the merger agreement with Energy Transfer Equity, L.P. (NYSE:ETE) (“ETE”).

The amended disclosure states the following: ETE’s original due diligence-based projection, which was presented to Williams, of over $2 billion in annual synergies by year 2020 as a result of the proposed merger, which was published by Williams and ETE in a Sept. 28, 2015, joint press release and web links, and in the companies’ SEC filings, should not be relied on. As a result of the joint integration planning process in early 2016 by Williams and ETE, a new synergies estimate was built from the ground up, and the parties now estimate merger-related synergies of only $126 million annually by 2020 (a difference of $1.874 billion or 94%), and have further estimated that even if market conditions return to their July 2015 levels, merger-related synergies would be $543 million, not $2 billion.”

Issuing a Special Dividend to Shareholders who Hold their Shares Until the Moment of Closing the Merger

On June 17, the Williams board of directors declared a special cash dividend:

“The Williams Companies, Inc. (NYSE:WMB) (“Williams”) today announced that its Board of Directors has declared a special dividend in the amount of $0.10 per share of Williams common stock. The dividend is contingent on the consummation of the merger, payable to Williams holders of record at the close of business on the last business day prior to the closing of the merger. To receive the special dividend, holders of record on the last business day prior to the closing of the merger must hold their shares of Williams common stock up until the moment of closing of the merger.

Explaining How Glass Lewis got it Wrong

In a press release it issued on June 20, urging stockholders to vote in favor of the merger, Williams presented the case that three of four leading proxy advisory firms recommended in favor of the proposed merger.

In its release, Williams outlined its observations regarding how the dissenting advisor, Glass Lewis, reached “the wrong conclusion” in recommending against the proposed merger:

“Williams also today noted that it believes Glass, Lewis & Co. (“Glass Lewis”) reached the wrong conclusion in recommending against the proposed transaction. While Williams appreciates that Glass Lewis expects that the “greater scale and asset diversification provided by the proposed transaction could potentially position the Company to better manage the current challenging commodity price environment, including by providing more diversified cash flows and a wide range of potential strategic opportunities,” the Glass Lewis recommendation fails to reflect the potential upside in the transaction, the value certainty provided by the cash component and the risks associated with a standalone Williams.

“Other key observations regarding Glass Lewis’ recommendation include:

  • In failing to assess the value of consideration being offered to Williams stockholders in the transaction, Glass Lewis ignores the significant acquisition premium being offered to those stockholders. If Williams stockholders were to reinvest the cash consideration of $8.10 per share in ETE stock at the current ETE share price (as of June 17, 2016), Williams stockholders would own 74% of the combined company, significantly in excess of Williams’ proportionate value contribution.
  • Glass Lewis mistakenly cites a revised aggregate pre-tax annual corporate synergy total of $126 million in the base case. While the expected commercial synergies have been revised to $126 million in the base case and more than $500 million in the upside case, Glass Lewis’ analysis omitted the fact that there are also additional significant material cost synergies that the companies expect to realize through the transaction. The base case of commercial synergies is consistent with the range of potential synergies considered by the Williams Board in approving the merger and by Williams’ financial advisors when performing the analyses and arriving at their opinions.
  • Glass Lewis also improperly assumes that Williams’ dividend will continue at or near the current rate in its flawed analysis of the cash to be received by Williams stockholders in the two scenarios.
    • Williams stockholders have a guaranteed $8.10 per share in cash in the transaction. While dividends at both ETE and standalone Williams are expected to be eliminated or significantly reduced, even at Williams’ historical dividend rate (without the expected elimination or significant reduction) it would take more than 12 quarters of dividends to equal the upfront cash in the transaction. With the expected elimination or significant reduction of the Williams dividend, the time frame elongates substantially.
  • While Glass Lewis recognizes that the combined company will have greater cash flow diversification, expanded options to manage debt and other benefits over a standalone Williams, its recommendation appears solely focused on higher initial leverage metrics at ETE. The analysis is flawed and should incorporate other factors when evaluating relative credit profiles:
    • While Williams is focused on continuing to improve its credit profile, current leverage metrics are higher than its targeted level, and there is risk for a credit rating downgrade if the merger is not completed. Williams’ consolidated current debt / 2016E EBITDA is ~6x.
    • Williams would also continue to face significant customer concentration risk. Notably, Chesapeake accounted for 18% of Williams’ 2015 revenues.
    • In addition to an expected elimination or significant reduction of the Williams dividend, Williams may also need to supplement debt reduction plans as needed by asset sales, potential IDR waivers and equity issuances.
    • ETE indicated in the S-4 that it expects that the combined company will have the ability to manage HoldCo leverage levels to approximately 3.7x by 2018. In addition, anticipated consolidated EBITDA is projected to increase by approximately $3 billion, or 29% between 2016 and 2018.”

Risk Abounds

The 600+/- page book that was sent to Williams shareholders regarding its proposed merger with ETE includes 48 pages of risk factors.

The first risk section outlines risks related to the merger including tax risks, termination risk, share price changes, unknown final market value, lack of a liquid market between election deadline and consummation of the merger, not receiving the form of consideration you elect, appearance of a competing proposal at a lower price than otherwise might be, ETC shares issued will have different rights from WMB shares, adverse affect on the businesses from pendency of the merger, ETC may fail to realize many of the anticipated benefits of the merger, integration costs, transaction costs, risks from actions of ratings organizations and securities analysts, possible substantial costs from litigation brought by WMB against ETE, board member interests that differ from shareholder interests, among others.

Other items in the risk factors include: a trading market for ETC common shares that will provide shareholders with adequate liquidity may not develop, limited voting rights, not having the ability to remove ETC’s general partner or its directors, issuance of securities senior to ETC common shares without shareholder approval, ETC shareholders may not have limited liability, ETC shareholders may have to repay distributions that were wrongfully distributed, transfer of ETC GP to a third party without shareholder consent, ETC GP’s affiliates may compete with ETC, a call right that may require ETC shareholders to sell their shares, the usual midstream business risks including negative effects of  commodities price volatility, customer supply dependency and other risks common to the energy industry.

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