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Monty Hall Has Nothing on These Guys

By Roger Conrad on May 4, 2012

CEO pay is always a hot-button issue, in large part because there are so many abuses.

But it’s equally clear no company runs itself. Without an adept man or woman at the top, the most impressive business is at risk of floundering.

Even the savviest can miscalculate, and best-laid plans often fail, to the ruin of all.

Nothing, however, gets built without direction. That’s why first-rate CEOs basically write their own ticket and why gauging their performance is critical for investors.

Most energy-related master limited partnerships (MLP) have scored solid total returns the past several years, as they’ve built assets with cheap capital and ratcheted up dividends.

Two MLP chiefs, however, have stood out for their achievement in building businesses: The late Dan Duncan of Enterprise Products Partners LP (NYSE: EPD) and Richard Kinder, founder and still CEO of Kinder Morgan Inc (NYSE: KMI) and Kinder Morgan Energy Partners LP (NYSE: KMP).

Given the favorable conditions in their industry, it’s quite possible these MLPs would have prospered without their enigmatic leaders. But it’s undeniable what these companies look like to today–from corporate culture to the assets they run–has been shaped by these men.

And their dealmaking continues to enrich investors today.

It’s too soon to tell if Kelcy Warren, CEO of Energy Transfer Partners LP (NYSE: ETP) and Energy Transfer Equity LP (NYSE: ETE), will wind up as revered as Messrs. Duncan and Kinder. But given the energy midstream MLP’s frenetic deal making the past 15 months certainly promises to give them a run for their money.

This week Mr. Warren announced his most audacious deal yet, a $5.3 billion cash and stock offer for Sunoco Inc (NYSE: SUN), an energy refining, marketing and logistics company that also operates 4,900 retail fueling stations in North America. The deal also conveys the general partner interest as well as 32.4 percent of the limited partner units in the immensely successful MLP Sunoco Logistics LP (NYSE: SXL).

The Sunoco purchase follows the $2 billion purchase of a 50 percent interest in the Florida Gas Transmission Pipeline. That was an asset “drop down” from general partner (GP) Energy Transfer Equity, following its completed takeover of the former Southern Union Group. The GP is currently integrating the rest of Southern Union’s assets, and more drop downs are likely.

Earlier this year Energy Transfer Partners sold what had been one of its cornerstone assets for more than a decade–the Heritage Propane distribution business–to AmeriGas Partners LP (NYSE: APU). That deal gave the company $1.46 billion in cash, as well as more than a one-third interest in AmeriGas and its hefty distribution.

Meanwhile, Energy Transfer’s Lone Star venture with affiliated MLP Regency Energy Partners LP (NYSE: RGP) continues to develop infrastructure to serve the natural gas liquids business in the Eagle Ford Shale region. The MLP currently has some $3 billion in projects in development through Lone Star as well as independently, which will add fee-based income under long-term contracts.

This frenetic pace of dealmaking has already transformed Energy Transfer Partners from a mid-sized MLP with a profitable but dispersed asset base to one of North America’s largest owners of pipelines and related assets.

The question is will its moving and shaking benefit unitholders or simply create an unwieldy enterprise that eventually, painfully, breaks itself up.

On the plus side, mergers between energy infrastructure companies–as with electric utilities–have a long record of success. That’s partly because of similar corporate cultures, on both the management and operating level.

But it’s also because these are at their core scale businesses. Owning more pipelines means being able to spread costs more effectively, earn better procurement terms, raise capital more easily, deal with regulation better and weather the blow from an underperforming asset.

Of the literally thousands of power utility mergers over the past 100 years plus, not one has broken apart or failed to eventually create a more powerful company. The same is true of pipeline and energy infrastructure companies.

There have, however, been some major stumbles along the way. In the 1990s, for example, the former Columbia Energy was forced into bankruptcy when sector deregulation suddenly made a whole slew of contracts uneconomic. The company still survives today, but only as part of Indiana-based power and gas utility NiSource (NYSE: NI).

Given Energy Transfer Partners’ recent results and the health of the Sunoco assets–today’s announcement of a seasonal first-quarter loss notwithstanding–makes it unlikely it will suffer the same fate.

In fact there’s every indication the MLP will continue to build cash flows from construction and that the Sunoco assets will live up to management’s pledge of immediate accretion.

For one thing, the purchase price is a relative bargain at a premium of a little more than 20 percent. And roughly half the offer is in equity, limiting additional debt needs.

As with any big deal, however, the burden of proof will be on management, and mainly Mr. Warren, to prove its words in the months ahead. Unlike many successful MLPs, Energy Transfer Partners hasn’t raised its distribution since 2008, instead investing all available capital to grow its business.

This fact is likely to make a good many investors impatient for results, particularly as management has routinely promised a return to growth.

One of the key benefits touted by management for buying Sunoco is it will add fee-generating assets tied to “heavier hydrocarbons,” meaning oil and natural gas liquids (NGLs). Natural gas prices have recovered a bit from their lows in the past couple weeks. But anxiety is running high that the entire industry–drillers, producers, pipelines–is headed for a sharp slowdown.

Adding Sunoco assets will offset the effect of that on overall Energy Transfer profits, with management projecting 30 percent from such operations by 2013. And it gives the MLP an immediate huge presence in the liquids-rich Marcellus Shale, with stakes in several huge projects. But there are no guarantees that business will grow enough to offset the weakness in the gas side of the operation, should things get as bad as some fear.

Finally there’s the question of debt. You’ve got to spend money to make money. But the more aggressive a company gets the greater its exposure to adverse events. Just ask Aubrey McClendon, the embattled CEO of Chesapeake Energy Corp (NYSE: CHK), whose big bet on shale gas paid off with historic rates of production but is suffering mightily now from the combination of high debt and low gas prices.

Energy Transfer Partners and its parent Energy Transfer Equity have been remarkably affective at raising low-cost capital to finance their growth. And despite Moody’s putting the former’s credit rating on watch for downgrade, there’s no sign conditions won’t stay loose enough for it to easily finance the Sunoco deal.

That gives this deal much better-than-even odds of success. And that in turn will go a long way to assuring the same is true of Energy Transfer’s wider strategy.

My forecast is this MLP is going to reward investors with some of the best returns in its industry–and that we’ll eventually be according Mr. Warren the same credit we now do Mr. Duncan and Mr. Kinder.

There is still a bit of ground to cover before then. And all investors–particularly those who own its units–will want to keep a careful watch on the numbers between now and then.

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