Greetings, welcome to the Energy Transfer conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I'd now like to turn the conference over to Tom Long, Chief Financial Officer. Thank you. Please go ahead.
Yeah. Thank you, operator, and good morning, everyone, and welcome to our call. We really appreciate all of you joining us today. This morning, we will discuss yesterday's announcement whereby Energy Transfer Equity and Energy Transfer Partners have entered into a merger agreement providing for the acquisition of ETP by ETE in a unit-for-unit transaction. I'm also joined today by Kelcy Warren, Matt Ramsey, John McReynolds, Tom Mason, and other members of the senior management team who are here to help answer your questions after our prepared remarks. I'll begin today with an overview of the transaction, one we are obviously very excited about as we combine ETE and ETP into one partnership. As a reminder, we will be making forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934.
These are based on our beliefs as well as certain assumptions and information currently available to us. Starting with an overview of the key terms of the transaction, ETE and ETP have entered into a merger agreement providing for the acquisition of ETP by ETE for $27 billion in ETE stock. Current ETP holders will receive 1.28 times ETE common units for each public ETP common unit, implying a price of $23.59 per unit, based upon ETE's closing price immediately prior to the announcement of the transaction. This represents an approximately 11% premium to the previous day's ETP closing price and a 15% premium to the 10-day volume weighted average price. The transaction is expected to be immediately accretive to ETE's DCF per unit, and we expect to maintain ETE distribution per unit. This transaction is expected to significantly increase DCF coverage and retain cash flow.
A little bit on the strategic rationale of this transaction. This will create a more simplified ownership structure. With the simplification, we are eliminating the IDRs, which improves our overall cost of capital to facilitate continued growth. It also increases retained cash to accelerate deleveraging. We're expecting a DCF coverage ratio of 1.6 to 1.9 times coverage, which equates to approximately $2.5 billion-$3 billion of annual retained cash. This greatly reduces our external common or preferred equity funding needs going forward. We do expect the pro forma partnership to be rated investment grade. Turning to a few more details on the structure of the transaction. The GP of ETE will be issued new Class A units of ETE such that the general partner and its affiliates will retain the current voting interest in ETE. We will talk a little bit more about this shortly.
ETE does expect to refinance its term loan and revolver, at which point its senior notes become unsecured. We anticipate the pro forma partnership launching an exchange offer whereby ETE note holders could exchange their notes for ETP notes with similar economic terms. As you can see, this simplified financial structure greatly strengthens our balance sheet and credit profile and positions the company for future growth. Going forward, we will target a leverage ratio of 4 to 4.5 times. Now, I'm going to turn the call over to Tom Mason for an overview of the Class A units.
Thanks, Tom. Currently, I think as people know, Kelcy Warren and Ray Davis, John McReynolds, and others own a significant amount of ETE outstanding common units, and the math shows it's about 31% of the outstanding units. Obviously, a very large block of voting control and interest in ETE. With the merger, there will be a significant number of ETE common units issued to the ETP holders, which effectively reduces that ownership level to about 13.5%, therefore resulting in a significant dilution to the voting interest of this group. As you all know, prior to this transaction, ETP has been the entity that owns the operating assets for the Energy Transfer family, particularly the transportation midstream business, and therefore financed its projects through a combination of debt and equity issuances.
Therefore, the equity was being issued primarily at ETP, and as a result, ETE did not historically issue much equity. Therefore, the voting interest of the control group was not affected by the financing activities and particularly the equity issuances of ETP. The post-merger ETE will be the issuer of equity to finance its growth projects. As Tom Long discussed earlier, the new equity issuances of ETE are not expected in the near term due to the levels of retained cash related to the expected cash distribution coverage levels. Over time, ETE will be issuing equity because there'll be growth projects that will need to be funded through a combination of debt and equity.
The boards of both ETE and ETP recognized this issue of potential solution going forward at the ETE level, and they're very obviously cognizant of the successful track record of ETE's general partner, which many people know as LE GP, which Kelcy Warren controls. Therefore, both boards wanted to preserve the control of ETE's general partner. The result of this thought process was the concept of the Class A units. The other factor as part of this thinking was that under the ETE's partnership agreement, the general partner of ETE, which again is LE GP, has a contractual right to purchase common units from ETE whenever ETE issues common units, so that LE GP can maintain the relative equity voting interest or equity interest percentage of ETE.
It's an interesting concept because LE GP is the one who can exercise that right, but also the calculation is such that it can maintain not only LE GP's interest, but that of its affiliates as well. As I mentioned earlier, the LE GP and its affiliates currently own about 31% of the outstanding ETE common units and would be diluted down to about 13.5% after giving effect to the merger. In lieu of exercising this right, and in fact, LE GP will agree to waive its preemptive right to purchase its kind of pro rata share of the additional ETE common units that would be issued in this merger, there will be a new class of units called Class A units that will be issued to LE GP.
These Class A units represent limited partner interest in ETE that will be not entitled to any cash distributions and will not have any other economic attributes. They're purely voting interests. The Class A units will be entitled to one vote per unit and will vote together with the ETE common units as a single class on all matters that come before the ETE unit holders. As a result of this, the control group of LE GP and its affiliates will maintain their current combined voting interest. Pre-merger and post-merger, the percentage interest of voting will remain the same. Again, the boards believe that was important to preserve the long-term continuity and successful track record and strategy of existing overall management at the top of the family. Just a twist to that is that this would not last forever.
There's a provision that future issuances of common units by ETE would also be subject to an anti-dilution adjustment as well, that ETE would issue additional Class A units, in the future, the control group of LE GP and its affiliates would still retain the same relative voting interest as they have prior to the closing of the merger. This anti-dilution right for future issuances will continue as long as Kelcy is a director or officer of LE GP. That's kind of it in a nutshell. Back to you, Tom.
All right. Yes, thank you, Tom. That really concludes our prepared remarks. Operator, let's go ahead and open the call up for questions.
Certainly. Ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Again, that is star one to ask a question at this time. Our first question comes from the line of Shneur Gershuni with UBS. Please go ahead.
Hi. Morning, guys. Nice to finally have one entity. Just to start off, I was wondering if you can talk about your targeted leverage metrics. You're obviously directing some of the accretion towards debt paydown. Is there a leverage target you're trying to hit of, say, 475 or four and a half times? Are you looking at it on trying to be a BBB mid? I'm just trying to understand kind of what you're targeting, and then once you get there, with the expectation that some of the accretion from the deal would then be directed towards unit holders.
Yeah. It's actually a very good question. The target that we're going to go forward look at here is probably four to four and a half times, in that range. When you're a company of our size, you can appreciate, and you have the mix of earnings that we have, meaning so much of ours are fee based, in that 85% range. That's obviously a very solid balance sheet when you look at that. These are the same things we talk to the rating agencies about that we show them. I think it's the way you worded the last part of that question. It's probably a very fair statement that as we get to that 4.5 level. We're looking out at other factors like our capital, our CapEx spend, where the equity is, et cetera.
I think you can see that we can fund pretty much most of our equity with the excess cash, the retained cash. We'll navigate all those factors in determining the last part of your question on the distribution.
Okay, fair enough. Just a second question. You have a targeted coverage range of, I think it was 1.6-1.9, I think you just mentioned. Can you walk us through what drivers get you to the higher end of the coverage range? Does this imply that 2Q was a fairly strong quarter, and then are there opportunities out there for you to invest to get to the top end? Could we see CapEx be running at a similar pace that we've seen for the last two years?
Yeah. Listen. I know we're having this call today, we're a week away from the earnings, so we're not going to get ahead of ourselves on that. We'll stay away from the second quarter. I will tell you the range that we've put out there, that 1.6-1.9 is what we've been looking at as we pulled these two together, as we went through all the analysis and everything else. That's where that's coming from, our numbers. The other thing that I don't want to get in front of is the S-4. Obviously, whenever that comes out, we will then have more of the projections. You'll get to see more of the coverage, et cetera. Rest assured, we're going to move expeditiously on getting that filed as soon as possible.
Great. Thank you very much, guys. I appreciate that, I'll jump back in the queue.
Our next question comes from the line of Jeremy Tonet with JPMorgan.
Good morning. Congratulations. Certainly the transaction the market has been eagerly awaiting. Congratulations there. Tom, I was just wondering if you could walk us through the conversations with the rating agencies and what were the key issues they were focused on. In particular, it looks like Moody's is looking for certain things before stabilizing the Baa3 rating.
Yeah. No, you bet. Going back to probably a lot of our conversations that I know we've had over the last quarters, investor meetings, investor conferences, et cetera. I think all of you all know that we've been staying in close contact with the agencies, keeping them updated on projects. I would say that the projects are probably one of the key items. We still feel good about all the guidance that we've given out on the projects. Likewise, as we look at the leverage metrics, and you look at that coverage, I can't emphasize enough that when you combine the two companies and you have that coverage in the range that we're talking about right now, and you see the financial stability that that brings to the enterprise here, I would tell you that that's the primary points of conversation that we've had with them.
All very compelling.
Great. It sounds like some of these mega projects are really close to the final finish line here.
Yes. They're in line with everything we've put out. No updates on those right now. We feel good about them.
That's helpful. Thanks. Then just one last question. Does today's transaction kind of influence your thoughts on whether or not establishing a C corp currency could make sense for the family? I guess just any updated thoughts on that point.
Hey, Jeremy, this is Kelcy. We're still very open-minded to that. This does not preclude that at all. We're so much driven here by we just don't like paying tax if we can avoid it, as you know. To the extent that there was a compelling economic reason for us to form, let's say an Up-C or Sidecar C, whatever, then we are certainly looking at that, and we'll act upon that if we think that's in the best interest of all of our unit holders.
That's very helpful. Thanks for your answers. That's it for me.
Our next questions come from the line of Harry Mader with Barclays.
Hi, good morning. Two questions. First, Tom, can you just talk a little bit about the mechanics of making the ETE and ETP bonds pari passu? I know you mentioned a potential exchange offer for ETE bonds with new ETP bonds that have similar terms, are you also going to look to put cross guarantees in place between the two boxes?
Listen, we've obviously put a lot of thought into this already. Like we've always done on all the consolidations we've done, we will tweak them as we move along. Please kind of take this answer as kind of what I laid out in the prepared remarks is that right now what we are looking at is obviously paying down the revolver up at the ETE level as well as that term loan. That will then trigger no security. At that point, we're anticipating that we would look at an exchange offer to bring everything down to the ETP level. I don't know that there's really a lot of necessity when you talk about cross guarantees, et cetera, because of what we're doing and the way we're going to structure through this.
Please take it that it's a little bit dynamic, but we thought it was important to go ahead and lay out what our current plans are.
Okay, thanks. In terms of refinancing the ETE term loan and revolver, would you do that with new ETP issuance?
Yes. That's the plan.
Okay. Thanks for that. Second, the press release talks about some of the benefits of the deal, one of which is putting yourselves in a better spot to potentially pursue strategic M&A. When you think about the four to four and a half times target leverage ratio, is that a target ratio you would like to hit before thinking about pulling the trigger on M&A? Or should we not view that as a limiting factor in terms of the time when you guys could do something?
I think that's fair. The one thing I would add to it is, as you know, in any of these transactions, when you look at them, you always look at what the pro formas numbers look like with the transaction, and that four to four and a half is what we're focused on.
I would add, I think it's safe to conclude that if there is a very compelling M&A opportunity that might somehow be slightly negative towards that goal of a four to four and a half. We would certainly meet with the rating agencies, get their opinions as to the way we're doing things and our view on things. As we have in the past, every major acquisition we've done at Energy Transfer, we have conferred with the rating agencies. We will continue to do that. So, we're going to be smart about our M&A and careful. The four and a half, like Tom said, four to four and a half is very important to us.
Okay. Thank you both.
Our next questions are from the line of Ross Payne with Wells Fargo.
Congratulations, guys, on the combination. Just kind of following up on Harry's comments here. I guess the question I'd have on the pay down of the revolver at ETE and term loan, would you do that with free cash flow, or are you actually thinking of issuing bonds to refinance that? Second of all, are future bonds going to be at ETE or ETP? I thought I heard ETP.
No, first part of your question, it would be with issuing of bonds, and they would be at ETP, which is where the assets, et cetera, will be.
My second question is on the ratings. Do you anticipate stable outlooks out of S&P and Fitch? Second of all, for Moody's, do you have any kind of timeline you think you might be able to get back to stable?
This is one of those that you don't ever want to get out in front of the rating agencies. We do expect to get investment grade. Obviously, we'll show them all of our credit metrics, et cetera. I don't want to get out in front of the reports they'll come out with. As you've seen, I think Moody's has already come out with theirs. I think you could probably anticipate the other two coming shortly. Let's wait till those come out. It's also going to be waiting until the time that we close up on this thing.
Okay, great. All right. Thanks, guys. Again, congratulations.
Okay. Hey, let me just add real quick. On the Moody's that just came out, they did say that they expected stable with that, just for the record.
Nice.
Okay.
Thank you.
Okay, thank you. Our next question comes from the line of Keith Stanley with Wolfe Research.
Hi, good morning. Wanted to ask on the timing. Fairly accelerated here from what you thought earlier in the year when you talked about kind of second half of 2019. Can you just kind of go over what's changed, I guess, in the outlook and how you're thinking about things since earlier in the year? Are you expecting much better results sort of than you did six months ago? Just thoughts on the timing being accelerated here.
Yeah. Kind of going back, I think, once again, to all the communications that we've had during these quarterly calls as well as investor meetings is, I think we've been very clear on the fact that it was protecting the investment grade rating was the key factor. Likewise, we continued to just have dialogue, keeping the agencies updated on these projects. As you know, that was probably a real touch point. I think this is something that we really wanted to do as soon as possible. If you looked at it, the reason why you would say into 2019, you would take the projects, and then you would have each one of those ramping up over a four-quarter period. Once again, I'm not going to get into giving any guidance or early results for the quarters or anything else.
In fairness, we will have the call next week, but we likewise, when we get the S-4 out there, I think we'll be able to talk even more about your question right now because it'll have the projections in there, and then we'll be able to talk in more depth.
Got it. Okay. Could you clarify the 1.6 to 1.9 times coverage? What timeframe should we assume for that? Is that a 2019 expectation, 2020? How should we think about what that reference is?
No, that really kind of references at closing and going out. Once again, it'll be in the S-4, but that's based upon the terms that we've got, the 1.28 exchange ratio, distributions staying at where ETEs currently are. I guess what we're telling you is that that's where this is coming out, and then as these projects come on, I think you'll start seeing it stay within that range. We can talk more about that when we get the S-4 and those projections out.
Great. Sorry, one other quick one just on M&A, since you talked about it a little earlier. The press release notes an interest in having better equity currency, both to make growth accretive and for strategic deals. Any updated thoughts on level of interest and optimism on being able to execute on acquisitions over the next year? Just what you're seeing in the market.
Yeah. This is Kelcy. Well, first of all, probably you know this, Keith, a monkey could make money in this business right now. It's not hard. There's kind of the wrong time to be buying things, really. There's some players that are not involved in basins that are on fire right now and yet have good assets and would be strategic fits for us. There are others that are involved in those basins, but typically those assets are just ridiculously priced and just will not make sense for us until the music stops. We would like to be very strategic. I don't think there's any bargains to be had right now, but we think M&A is very important for our unit holders, that we maintain an aggressive M&A view and a smart approach to that. We will continue to do that.
Thank you.
Our next questions are from the line of Michael Blum with Wells Fargo.
Hey, good morning, everybody. First question is on the leverage target of four to four and a half. When do you expect to hit that level? I guess that's really the first question.
Michael, as you know, we were targeting to get below five in order to be able to sit down with the agencies and protect our investment-grade rating. I know we keep kind of touching upon the when part of it. The tough part is I really want that S4 to get out there and get the projections out. Then we'll be able to talk, like I said, in more depth on it. I think you can start seeing that tied to these projects as they start ramping up. Projects obviously we're very excited about. So as you see Rover, ME2, ME2X, et cetera, start coming over that 2019 timeframe, you'll start seeing that come up.
I think it's worth just reminding everyone once again that our de-leveraging was occurring due to the projects, the EBITDA catching up with all the funding we've been doing over the last few years. We're seeing that now. We're starting to see that occur. Once we get this S4 out and we get to walk through the projections a little bit more, I think you'll be able to see a little more detail as to when.
Okay, great. I appreciate that, and my next question is along the same lines, so we'll see how much you'll answer, but just trying to get your thoughts on long term on how you're thinking about distribution growth at ETE relative to distribution coverage, and is this something where you want to get to that four to four and a half leverage target before you would contemplate distribution growth? Any kind of thoughts you can share there would be helpful.
Michael, Kelcy. I think the latter part of your question is accurate. We would like to get to that level. We feel a responsibility. As you know, we've been saying we wanted to do this transaction as soon as we felt we would be maintained in investment grade. That matters greatly to us, and we're going to conduct ourselves in a way that we deserve that investment grade. Yes, the second part of that question is we would like to get to those kind of 4.5 times. Michael, we have a duty to our unit holders. That's what MLPs are supposed to do. I think most people have forgotten that. We're supposed to reward our unit holders and increase our distributions. We will, in fact, resume that at the appropriate time.
Great. That was really helpful. My last question is, I guess once you get through this transaction, any new or different thoughts on what happens to Sunoco? Thanks.
Well, Joe Kim sitting here looking at me. We love Sunoco. Sunoco we view as a great opportunity for Energy Transfer. Sunoco has a different set of assets. They've got fantastic management. They know that Sunoco really needs to reinvent themselves a little bit. They need to be more of a wholesaler. I'd love to see them be more of a pipeliner, actually, in refined products business, terminal company. I would like to see them get more into hard assets. Joe knows that.
I'm very pleased with what I'm seeing coming from Sunoco, and we're very patient with Sunoco assets, and we have great expectations.
All right. Thank you, Kelcy.
Thank you.
Our next questions are from the line of Elvira Scotto with RBC.
Hey, good morning. Just three quick ones, questions from me. Absent M&A, is the goal for pro forma Energy Transfer to be equity self-funding over the long term?
That is the goal. It's a dynamic situation as you look at all the great projects that the commercial team constantly have on the drawing board. It's going to be a lot dependent upon the CapEx spend each year, organic CapEx spend. It could be a little bit dynamic, but I think the goal is for the excess cash, let's call it the retained cash, is to be covering the equity side of the funding.
Thanks for that. I think I know the answer to this, but will this transaction be a non-taxable event to ETP unit holders?
That is correct.
Great. My final question, and I think you touched on this, but does this transaction have any impact on the ETP preferreds?
No, it does not have any impact on the ETP preferred.
Great. Thanks. That's all I had.
Our next question comes from the line of Jean Ann Salisbury with AllianceBernstein.
Hi, good morning. I just have one, and you've touched on it a bit, but if you are to have unexpected further delays on ME2 and Rover, should we worry that that could impact the fourth quarter timing?
I'm sorry, can you say the very last part? Should we be worried about what?
Should we worry that that could impact the fourth quarter timing? Like you'd have to push it back if those two projects were to get significantly pushed back.
Yeah. Let's break each of the projects down. As you know, Rover, we're already getting probably over two-thirds of the demand charges on Rover.
Yeah.
It really comes down to, I think, what your proper question is on ME2. Yes, clearly there could be some impact from that. Once again, I'm trying not to get into the rest of the year, any type of projections or forecasts, but our overall base business is obviously doing very well. I think that when you look out and you kind of look at the numbers, we've got a situation that's very manageable to be able to get these projects online, and they're going to be such great projects in the way they're going to ramp up, et cetera.
Okay, great. That's the only one for me. Thank you so much.
Our next question comes from the line of Dennis Coleman with Bank of America.
Yeah. Good morning, and congrats from me as well. Just one for me as well. Most have been asked, coming back to distribution policy, if I can, just to try and see how you're thinking about this. 1.6 to 1.9 coverage is a big move up, and it's a lot of dollars, as you pointed out. Was there any consideration of maybe having a one-time boost to the Energy Transfer Equity distribution with this transaction to offset the cut at ETP at any time? Was that ever part of the thinking?
Part of the thinking, yes. Again, as everyone knows on this call, we've been saying for a while that it was time to do the consolidation of ETE and ETP. We also let the market know that we saw that transaction occurring as ETE buying ETP. We also said that until we get comfortable, and like Tom said earlier, we're going to see all the rating agency assessments, we believe, by today sometime. Once we get comfortable that we're going to maintain our investment grade, we will, in fact, go forward. Distribution increases right now really don't support what we're trying to do, which was our goal to do this sooner than later. At some point, going back to the previous questions, however, we do feel a duty to grow our distribution.
We'd like to see that occur after we get to 4.5 times or less on leverage.
Okay. Just trying to understand sort of the thinking there. Again, congrats. That's it for me.
Thank you.
Our next question comes from the line of Adam Breit with Truist Securities.
Yeah. Hi, good morning. One quick question, Tom, for you. The 4 to 4.5 times leverage target, is that more of a rating agency adjusted number with proportionate JV debt? Or are you talking more about a credit facility adjusted number, which is a lot lower than that?
No, that's definitely rating agency. As you know, there's slight differences as to how each one of them look at that's definitely rating agency is what we're referring to.
Got it. Thank you.
Yep.
Thank you. This concludes today's question and answer session. I'd like to turn the floor back to Tom Long for closing comments.
Obviously, I think as all of y'all can see how excited we are about this transaction and getting to this stage of being able to bring these companies together. To be able to create approximately $90 billion enterprise under this simplified structure. Also with this very enhanced financial stability that we've talked about here today, which all should come back to, obviously, a much lower cost of capital. Thank all of you once again for joining us today, and we look forward to any follow-up questions or conversations we will have with y'all. Thank you.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.