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Enbridge's C$11.4B plan to simplify caused by MLP sector 'weakening'

Enbridge Inc.s proposal to roll up its U.S. energy pipeline partnerships as part of a larger simplification bid is a consequence of prolonged valuation declines and American tax changes, company executives said.

Enbridge on May 17 announced it was offering a combined C$11.4 billion to acquire all of the outstanding equity securities of its sponsored vehicles Enbridge Energy Management LLC, Enbridge Income Fund Holdings Inc., Enbridge Energy Partners LP and Spectra Energy Partners LP.

Enbridge Energy Partners and Spectra are tax-advantaged master limited partnerships that house much of Enbridge's U.S. assets. While that structure worked for many years, CEO Al Monaco said it is no longer a viable source of financing and growth for Enbridge due to the Federal Energy Regulatory Commission's recent decision to no longer allow oil and gas pipeline MLPs to recover an income tax allowance in their cost-of-service rates as well as the reduction of the corporate tax rate to 21% from 35% in 2017.

"Holding our assets in MLP structures is no longer advantageous," he said on a May 17 conference call. "We've seen a further weakening in the MLP market generally, and, in our case, [it has become] prohibitive to access capital."

The MLP sector has struggled in recent months, with high leverage dragging down the share prices of even those midstream companies that have already simplified their structures through actions such as eliminating required cash payments to general partners. FERC's policy shift amplified investors' frustration, particularly when it came to drop-down partnerships such as Spectra and Enbridge Energy Partners. Spectra alone faced an annual revenue impact of $110 million to $125 million from the ruling since roughly 40% of its business is based on cost-of-service rates.

While the consolidation would enable Enbridge to retain that income tax allowance, CFO John Whelen acknowledged that MLP shareholders may have to pay taxes on the roll-up transactions themselves. "Taxability is really dependent on when you acquire the units," he said during the call. "From our analysis, it looks like there would be minimal tax, if any, paid by the public unit holders of those two vehicles."

Whelen added that Enbridge hopes to close the deals by the end of 2018, which would require a majority of outstanding common unit holders of all of the entities to vote in favor of the plan. Enbridge controls 83% of Spectra units and 35% of Enbridge Energy Partners units.

The company warned that if the MLP unit holders did not vote in favor of the deal, they could face a distribution cut. "Without this restructuring, and in light of the challenging capital markets conditions and the resulting impact on MLP cash flows, Enbridge's view is that EEP and SEP will face the cessation of distribution growth, and compromised distribution outlook to unitholders as early as 2019," Enbridge said in the May 17 release announcing the offers. "Similarly, Enbridge's view is that ENF's uncompetitive cost of capital will inhibit future dividend growth."

Whelen and Monaco said they hoped that rolling up all of their sponsored vehicles would help to alleviate Enbridge's debt overhang that cost the company a corporate rating downgrade from Moody's in 2017.

S&P Global Ratings was cautiously optimistic about prospects for upgrading Enbridge's BBB+ credit rating.

"In our view, the transaction is leverage neutral for Enbridge because it is an all equity transaction and we currently assess the company's credit quality on a consolidated basis," S&P Global Ratings analysts wrote in a May 17 note to clients. "That said, by eliminating the sponsored vehicles Enbridge is reducing the cash leakage from public distributions, which we expect it will use instead to finance organic capital spending opportunities and reduce its debt."

Enbridge's proposal also resulted from a three-year strategic plan unveiled in December 2017, which called for C$22 billion in capital spending, a goal to monetize C$10 billion in noncore assets and a 10% boost to its dividend. During Enbridge's analyst day May 9, Monaco hinted that the MLP issue could be resolved sooner rather than later. "Generally speaking, the financing that we used to be able to do in these vehicles is much harder to do today economically," he said at the time. "So we are looking at that. I think we've been saying from the strategic point of view, it would be nice for us to be able to streamline business a little bit more."

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.