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Energy Transfer, Sunoco Talk Long-Term Value as Investors Scorn Merger

Investors haven't reacted favorably to Sunoco Logistics Partners LP's (SXL) announcement on Monday that it would acquire its owner Energy Transfer Partners LP in an all-stock deal, as it remains unclear how the new entity will deal with distributions, debt and growth once the deal closes.

The companies billed the merger as a way to enhance scale and diversity in the Permian Basin, Appalachian Basin and on the Gulf Coast, saying the combination would provide better opportunities to integrate SXL's natural gas liquids (NGL) business with ETP's gas gathering, processing and transportation business. The companies expect the merger to provide cost savings of more than $200 million annually by 2019 and strengthen the balance sheet further with distribution savings.

But management said the combined partnership is expected to achieve near-term distribution increases in the low double-digits. The details are still being worked out, which appears to have the market on edge. Management said it doesn't provide guidance on distributable cash flow (DCF), or what's available for payments to unitholders.

"We're going to right-size coverage for the pro forma entity," SXL CEO Mike Hennigan told analysts during a call late Monday to discuss the transaction. "Our credit metrics are important to us and our balance sheet is very important to us and the growth profile all come into play. We thought to give you some flavor, we would come out with the low double-digits, but there's still some more work to fine-tune that."

Analysts agreed that while ETP has said it was exploring options to simplify its business structure, the deal seemed to catch investors off guard. Under the agreement, which is expected to close in 1Q2017, ETP unitholders would receive 1.5 common units of SXL for each common unit they own. The deal is valued at $19.93 billion. SXL's $2/unit annual distribution is smaller than ETP's $4.22/unit distribution. While distributions are likely to be cut in the near term, the savings achieved, combined with growth projects and debt reduction could set investors up for higher yields in the long term, even if they don't see it that way now, analysts said.

"Today, ETP holders have their yield cut...in exchange for a no-premium takeout, while SXL owners have their asset base diluted to shore up ETP's unsustainable payout," analysts at Tudor, Pickering, Holt & Co. said of the market's adverse reaction to the announcement. The companies’ units dropped by about 7% each on Monday. The losses have continued during a record-setting stretch for the markets. SXL closed at $26.19/unit on Friday (Nov. 18) and finished at $23.77 on Tuesday, while ETP closed at $39.37/unit on Nov. 18 and closed at $35.19 on Tuesday.

"I'm not paying attention to the market today, so I'm not really up to speed," ETP CEO Kelcy Warren said after the markets closed on Monday. "However, it's been clear to me for a while...that the market seems to be rewarding financial health over distribution growth. I think in the instance of this merger, we are absolutely playing down the middle of the fairway of what the market expects. I think the market, probably sooner than later, will begin to price this currency exactly where the other currencies that have done substantial distribution cuts are priced. Anything happening in the short term, I don't get too alarmed about. But I think long term, we're good."

Absent the merger, ETP said it would have needed to consider a 15-25% cut in its distributions to reduce leverage and increase its future DCF growth profile. Hennigan noted that projects like the Rover Pipeline, the Revolution midstream system and Mariner East 2  pipeline that are coming online in Appalachia next year would set the company up for growth beginning in 2018.

"We've been strategically looking for a while to back integrate our crude and NGL platforms closer to the wellhead," he said. "We have been successful in some acquisitions externally, but we have a similar opportunity right here in the family as the ETP liquids business is a set of complementary assets to what SXL has today. As a company, we have strategically emphasized the Permian and Marcellus basins. That's an area where we see additional commercial synergies on a quicker timeframe as one entity, as opposed to two separate currencies. It's more efficient from a capital and cost standpoint to be one team."

ETP's management will take over the new partnership, while SXL executives will stay on in leadership roles in Philadelphia to oversee that side of the business. The combined company will be called Energy Transfer Partners. The wholesale fuel distribution and retail business, Sunoco LP, remains unchanged for now.

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