Hedgeye for the ETE Guy

The market already has it in for MLPs, but even weak sector sentiment can’t account for Energy Transfer Equity LP’s (NYSE: ETE) slide over the past week.

The $17.7 billion master limited partnership (MLP), which owns the general partner of Energy Transfer Partners LP (NYSE: ETP), has fallen 12.2% over the past 10 days.

By contrast, its subsidiary ETP is down just 3.1%, while the benchmark Alerian MLP Index has declined 5.0%.

While the market clearly didn’t like what it heard in ETE’s latest results, the earnings reaction doesn’t account for all of its slide.

So what gives?  

Sometime in the middle of Monday morning, everyone’s “favorite” short-side analyst, Hedgeye’s Kevin Kaiser, published a note advising investors to buy ETP and short ETE.

Kaiser said ETP unitholders “have long suffered egregious corporate governance and value destruction at the hands of its GP.”

Given what longtime holders of ETP have endured in recent years, I can’t say I disagree with that.

His proposal?: An “unprecedented, though much warranted, transaction of removing a GP from a MLP.” In this scenario, he estimates ETP would have upside of 80% to 140%, while ETE would be worth 60% to 80% less, or around $3 to $7 per unit.

That note was then followed by a Wednesday conference call that apparently had record attendance.

Kaiser’s Roll

Although Kaiser has collected a few big scalps over the years with his short recommendations of various energy sector stocks, it should be noted that he often ended up being right for the wrong reasons.

To his credit, he pores over company filings to find things that others may have overlooked, such as patterns in maintenance spending. But sometimes he deliberately omits context that wouldn’t be helpful to his bearish thesis.

The reality is that he happened to start his career as a short analyst focusing on the energy sector just before oil prices were on the verge of crashing. That fortuitous timing means that some of his targets crashed and burned for reasons that had nothing to do with his actual critique.

Of course, in this business, no one cares if you’re on the right side of a trade for the wrong reasons.

Still, even with the energy sector’s boom-and-bust cycle on his side, Kaiser has also had some pretty noteworthy misses.

But his notes still get a lot of coverage because bored financial journalists love his bluster.

Shortly after publishing his report, for instance, Kaiser tweeted at ETE’s billionaire CEO, “KELCY WARREN LET’S GOOOOOO.”

Even so, as I noted earlier, the general thrust of Kaiser’s criticism mirrors my own and that of many others. Because Warren’s primary ownership stake is in ETE (about 17.4% of units outstanding), he will favor that entity over ETP when his back is against the wall, as it has been over the past two years.

While ETE does subsidize ETP via waivers of its incentive distribution rights (IDRs)—these waivers will amount to more than $600 million in foregone cash flows this year—Warren has undertaken a few different corporate actions that seriously undermined ETP at its weary unitholders’ expense.

The stealth 27% distribution cut that occurred when ETP was merged with Sunoco Logistics Partners LP earlier this year is just one of a few such moves that come to mind.

That’s why this service recommended ETE over ETP, even though it has a much lower yield.

Ultimately, Warren plans to consolidate ETP into ETE, though not until late 2019, at the earliest. But given Warren’s track record, such a move may not be immediately beneficial to ETP unitholders, though this action would effectively eliminate ETP’s general partner.

In other words, Warren is already planning to do what Kaiser recommends, albeit in a way that could be to his benefit and ETP unitholders’ detriment.

A Call to Arms?

Could Kaiser’s call to arms kick off a wave of investor activism in the beleaguered sector? It’s possible.

Some observers have noted that because retail investors fled the MLP space during the energy crash, institutional investors have a much stronger presence in the space now.

And they’re more demanding in some ways. While retail investors mainly care about a high yield and a growing payout, the smart money wants MLPs to get their financial houses in order first.

That means removing unnecessary drains on cash flows, such as excessive debt, onerous IDRs, and never-ending distribution growth.

But the energy crash has already forced many of the sector’s players to make these moves anyway.

There have been a number of consolidation transactions that simplified sprawling midstream empires by merging MLPs with their general partners and eliminating IDRs while paring debt. More have been announced, but are still pending.

And Enterprise Products Partners LP (NYSE: EPD), the biggest publicly trade MLP, recently announced that it would be slowing distribution growth and moving toward more of a self-funding model. That essentially gave permission to other midstream players to do the same.

High Hurdles

As for the Energy Transfer empire, it would be pretty difficult for investors to pull off the stunt that Kaiser is recommending, since the partnership agreement imposes significant hurdles to this type of investor activism.

To remove the general partner, 66.7% of unitholders would have to vote to approve this action, and that would be only after insurgents muster enough support to even call the special meeting that would precipitate such a move.

Further, given the unprecedented nature of this action, it would likely be a knock-down, drag-out battle that could significantly wound both entities. Institutional unitholders are unlikely to want to engage in such a protracted showdown.

Although the basis for Kaiser’s short recommendation is extremely unlikely to happen, it’s still gotten quite a bit of attention. And in the near term, widely publicized shorts can become almost self-fulfilling, even if nothing ultimately comes of them.

That’s what seems to have happened this week. Nevertheless, we’re sticking with ETE.

Stock Talk


Robert L Couch

Hello Ari,
Suppose a retail investor had equal long positions in ETP and ETE. How would those valuations play out under the scenarios presented your assessment?

Ari Charney

Ari Charney

Hi Robert,

To be clear, I think the series of actions underpinning Hedgeye’s valuation assumptions are extremely unlikely to happen, as noted in the section below the “High Hurdles” subhead.

Indeed, in a subsequent interview that came out after his opening salvo, Kaiser seemed to acknowledge that this is a pie-in-the-sky proposal, conceding that it has “high hurdles” and could take “years” to pull off.

By then, it could all be moot anyway, given ETE’s intent to further simplify its complex down the road.

So I think our time is better spent by returning to Earth and considering what’s actually likely to happen.

In the near to medium term, the fates of ETE and ETP remain closely intertwined. Longer term, there’s some uncertainty since we don’t know how a consolidation transaction will play out.

Given the latter, your approach of holding equal long positions in each entity is not unreasonable–it gives you exposure to the Energy Transfer empire’s growth story while mitigating some of the risk that an eventual roll-up will favor one entity over the other.

Ultimately, ETP will be rolled up into ETE, though probably not until late 2019, at the earliest. The terms of that deal will likely favor ETE, assuming it remains the stronger entity at that point.

Regardless, assuming that transaction comes to pass, that means ETP unitholders will eventually become ETE unitholders. So perhaps it doesn’t really matter so much which one is better at this point.

An income investor will naturally favor ETP’s much higher yield. Assuming it can continue to make good on its ample distribution, that may be enough to overlook the potential dilution and stealth distribution cut that could happen two or three years hence if the empire is consolidated.

If, however, they were to remain separate entities longer term, it might make sense to go with the vehicle where management has the vast majority of their money–that would be ETE.

Best regards,

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