Pipeline prey may now be too pricey for Williams

July 6, 2011

By Christopher Swann and Lisa Lee
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Investors don’t expect American energy group Williams Companies to give up the chase for rival Southern Union. But trumping the latest $5 billion offer by Energy Transfer Equity will destroy value for its own shareholders. With Southern Union starting to look an expensive catch, Williams may be better off leaving the overpaying to its rival.

Shareholders of Southern Union have good reason to thank Williams. Its $4.86 billion cash bid last month broke up a cozy arrangement with Energy Transfer that lavished goodies on Southern Union executives while short-changing other investors. Still, Williams now faces a tough choice. Energy Transfer’s sweetened bid for Southern already looks like a full price. At nine times next year’s EBITDA, it is in line with similar deals done over the past decade, according to Barclays Capital.

Moreover, to clinch a deal Williams needs to climb added hurdles. Southern Union’s share price suggests investors expect a $42 bid. On top of that, Energy Transfer’s latest deal with management doubled the initial breakup fee to $212.5 million, or an extra cost to Williams of around $1.70 per Southern Union share.

Add these fees to the pipeline company’s existing debt, and a $42 a share offer would cost Williams around $9.4 billion in total. Based on Southern Union’s forecast operating profit, that would bring the deal’s post-tax return on investment to below 5.5 percent. That’s below Williams’ 7 percent weighted average cost of capital.

And even this calculation is generous, as it assumes Williams can achieve $100 million of cost cuts and revenue gains that Energy Transfer has promised. In its spoiler bid Williams had only estimated around $50 million of such synergies.

Furthermore, there’s no certainty that a $42 bid would work. Winning over Southern Union’s top managers — who own about 14 percent — might be even harder. Williams’ all-cash offer would leave them paying capital gains taxes. To clinch its prey without issuing equity might require Williams to pay as much as $45 a share.

Williams chief Alan Armstrong has already done enough favors for Southern Union shareholders — and forced a rival to scramble to pay 20 percent more for assets it coveted. Now he can best serve his own investors by walking away from a costly bidding war.

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