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Energy Transfer Scoops Up Southern Union for $7.9B

Energy Transfer Equity LP (ETE) agreed Thursday to acquire Houston's Southern Union Co. (SUG) for $7.9 billion, including $4.37 billion of debt, which when combined would create one of the largest U.S. natural gas midstream operators, with more than 44,000 miles of domestic natural gas pipelines and 30.7 Bcf/d of transportation capacity.

By comparison El Paso Corp.'s interstate gas pipeline system, now considered the largest in the country, has a pipe system that is about 42,000-miles-long with 26 Bcf/d of capacity and 19 Bcf/d of throughput.

SUG's assets "are extremely complementary to our assets," ETE Chairman Kelcy Warren told analysts during a conference call Thursday. In addition to creating the largest pipeline system in the United States, the combined company would create "the largest company in terms of gas volumes moved..."

SUG Chairman George L. Lindemann called the merger "the right next step for the company's growth...I've known Kelcy for many years and admire his management style and the ETE portfolio he has built. We have a shared vision for our companies. Our businesses and networks are highly complementary and together will provide a broader range of services and product offerings to existing and future customers."

ETE's gas operations today comprise more than 17,500 miles of pipe and related facilities in Texas, New Mexico, Arizona, Louisiana, Arkansas, Mississippi, Colorado, Utah and West Virginia. Its intrastate operations include 7,700 miles of gas pipe and three storage facilities in Texas; interstate pipeline systems Transwestern and Tiger that total 2,875 miles and a half-stake in the 185-mile Fayetteville Express Pipeline joint venture; and 7,000 miles of gathering pipes, three processing plants, 17 gas treating facilities and 10 gas conditioning plants.

ETE owns the general partner and 100% of the incentive distribution rights of midstream operators Energy Transfer Partners LP (ETP) and Regency Energy Partners LP (RGNC), as well as 50.2 million ETP limited partner units and 26.3 million RGNC limited partner units. ETP (70%) and RGNC (30%) are joint venture partners in Lone Star NGL LLC, which owns and operates natural gas liquid (NGL) storage, fractionation and transportation assets in Texas, Louisiana and Mississippi. In addition, ETP is one of the three largest retail marketers of propane in the United States, serving more than one million customers across the country.

The merger would give ETE about 15,000 miles of SUG gas pipelines and gas systems in the Southeast, Midwest and Great Lakes region that include:

SUG's Southern Union Gas Services unit also provides 5,500 miles of gas gathering, transmission, treating, processing and redelivery and NGLs in Texas and New Mexico. Through its local distribution companies Missouri Gas Energy and New England Gas Co., SUG also serves more than a million gas end-user customers in Missouri and Massachusetts.

A "very important" component of the merger plan is what the additional gas infrastructure will provide for ETE to help with "contracted basis" issues, said Warren.

"The margin paid to move gas from one point to another has contracted dramatically," he explained. "One reason for that is that we've built pipelines from supply-long areas to other areas, and over time those [other] areas have become congested as well. We've gone from one supply-glutted area to another supply-glutted area.

"The complement of these assets is very important. Energy Transfer has more access to shale plays than any other in the U.S.; not yet in the Marcellus but we will be there over time. In the Barnett, Haynesville, Eagle Ford [shales], Permian [basin], Bossier...We take more volumes out of those shale plays than any other pipeline. The Southern Union assets go from those supply hubs to many market-consuming hubs. That's a big thing.

"What's happened to us is that we've been very vulnerable...to basis contractions; this reduces our vulnerability."

ETE wants to expand its West Texas services, where NGL production is quickly rising, noted Warren.

"We believe West Texas is perilously close to problems with takeaway NGL capacity," he said. The SUG infrastructure there would alleviate some problems and give the combined company a more integrated system.

"What's going on right now in the Permian Basin and in southwestern New Mexico is pretty mind boggling," Warren said. "There's been a huge decoupling in the price of crude and NGLs...the value of natural gas will be depressed for a period of time, and I personally believe it will be low compared to NGLs...Consequently, the rig counts have increased dramatically and therefore, more NGLs are produced with no takeaway capacity...

"Lone Star is near capacity; we can add a little bit relatively inefficiently by adding pumps...Other takeaway capacity is full or near capacity now. I personally see a train wreck coming. We need more capacity soon or it's going to be a problem. We're committed to doing that...Competitors are kind of announcing pipelines, which is humorous to me. They may be successful," but Warren doesn't see an impact on ETE's projects.

"This acquisition pushes us to where I want to be. I see..a huge complement to ETE shareholders, a huge complement."

SUG, said Warren, has done a "remarkable job of hedging over the period of time they've owned these assets. We'll continue that strategy but slightly differently...I'm not bullish on natural gas prices. I hate to say that; I wish I [were.]" Gas prices will remain low "in the short term, two to three years...and when you look at ETP, primarily an operating partnership, we have almost no commodity exposure. As a percentage, if we did nothing, the amount of commodity exposure at ETP is very, very small."

SUG, based in Houston, would become a subsidiary of Dallas-based ETE, which now includes master limited partnership (MLP) subsidiaries Energy Transfer Partners LP (ETP) and Regency Energy Partners LP (RGNC). The transaction, expected to be completed early next year, could provide "multiple asset dropdown" opportunities for the two MLPs, ETE noted.

Under terms of the agreement, which has been unanimously approved by both boards, SUG stockholders would exchange their common shares for newly issued ETE Series B units with a value of $33/share, or about $4.2 billion. The implied value of the units is about 17% higher than SUG's closing price on Wednesday. The $7.9B total purchase price represents an 11.6x multiple to SUG's trailing 12-month GAAP EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) of $682 million.

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