Williams will split itself into two standalone publicly traded corporations, the Tulsa-based company said last week, in a move aimed at value enhancement that has been on the minds of company executives for a while.

The Williams board has approved a plan to spin off its exploration and production (E&P) unit via an initial public offering (IPO) in the third quarter of up to 20% of Williams’ interest in the business and, in 2012, a tax-free spin off to Williams shareholders of the remaining interest.

Following the spin off, shareholders will own a stake in Williams, an owner/operator of North American midstream infrastructure and natural gas pipeline assets; and, separately, a large-scale, independent North American diversified E&P company with interests in South America. Williams said both the growth potential and overall valuation of its assets will be enhanced as a result of separating its businesses, a move that has been contemplated since at least late 2008 (see NGI, Nov. 10, 2008).

“We have a clear, specific plan to maximize shareholder value while strengthening Williams’ investment-grade credit profile,” said Williams CEO Alan Armstrong. “Williams has generated significant value by operating as an integrated natural gas company. As we look to the future, though, we are convinced that the capital efficiency created by separating into two distinct investment opportunities will allow shareholders to realize greater value.

“Williams will focus on meeting the robust demand for infrastructure created by the new, abundant supplies of domestic natural gas. The new E&P company will focus on competitively developing and producing these gas and oil resource plays.”

Following the spin off, Williams will be a large-scale infrastructure company with a business focus on enabling producers and end-users to optimize the value of North America’s significant resource plays, Williams said.

Analysts at BMO Capital Markets were pleased.

“While the announcement comes a few months earlier than we expected, we are not ones to look a gift horse in the mouth, and [we] see the quicker path to certainty a welcome development,” they said in a note following announcement of the plan. “We expect the initial positive reaction [on Wall Street] to be sustained…”

On Thursday, the first day of regular trading following the announcement, Williams shares gained more than 8% to end the day at $30.08 after setting a new 52-week high of $30.95.

“We believe the IPO route is being pursued partly in order to maintain an investment-grade rating at the parent [and we expect (Williams) parent-level debt to become meaningfully lower] with the added benefit of incremental free cash available to dividend to shareholders in a yield-hungry market,” the BMO analysts said.

The company said it expects to continue to have investment-grade credit ratings. Williams’ largest component will be its ownership interests in Williams Partners LP. Williams also will continue to hold and grow its Canadian midstream and U.S. olefins businesses. Williams also owns a 25.5% interest in Gulfstream, which it likely will drop down to Williams Partners in the future in exchange for cash and/or additional partnership interests, the company said.

Williams Partners will continue to be a diversified master limited partnership with expected continuing investment-grade credit ratings. The partnership has an asset portfolio that includes large-scale interstate natural gas pipelines and geographically diverse midstream assets.

The new E&P company is expected to be one of the largest independent producers of natural gas in the United States. At year-end it had approximately 4.5 Tcfe of proved reserves and 15.9 Tcfe of proved, probable and possible reserves, Williams said. The new E&P will have new, relatively undeveloped acreage positions in the Marcellus Shale and North Dakota’s Bakken oil play, as well as positions in key Rockies basins, including the Piceance, Powder River, San Juan and Green River.

The new E&P company will have positions in the Barnett Shale and Arkoma Basin and, through its controlling 69% interest in Apco Oil and Gas International Inc., will have South American reserves and production in Argentina as well as E&P contracts in Colombia.

Standard & Poor’s Ratings Services (S&P) placed its “BBB-” corporate credit rating on Williams and its operating subsidiaries Williams Partners, Transco and Northwest on CreditWatch with positive implications.

“The CreditWatch listing reflects our view that Williams’ consolidated credit profile will improve following the spin off of the E&P business,” S&P said. “We view the E&P business as notably riskier than Williams’ pipeline and midstream segments due to its cash flow volatility and the significant capital requirements needed to maintain production levels and reserves. As a result, we believe the pro forma business profile will likely improve to strong because we estimate that about two-thirds of the company’s cash flows will come from relatively stable fee-based sources.

“The remaining one-third has exposure to commodity prices, primarily natural gas liquids. Pro forma financial ratios will worsen. However, the remaining businesses can tolerate more aggressive financial leverage due to the inherently more stable cash flows. We do not maintain ratings on the E&P company and are not commenting on its standalone creditworthiness…”

Armstrong will continue as Williams CEO; Frank MacInnis will continue to serve as non executive chairman of the Williams board of directors. Williams said it will determine and announce new E&P board and management positions in conjunction with the initial public offering process.

The separation of Williams into two companies will not require a shareholder vote but will be subject to regulatory approvals, the receipt of a tax opinion from counsel and/or IRS rulings, the execution of intercompany agreements, finalization of the capital structure of the two corporations, final approval of the Williams board and other customary matters.

The board also said it plans to boost the quarterly dividend, with an initial increase of 60% to 20 cents/share for 1Q2011. The company said it is targeting an additional 10-15% increase in the quarterly dividend beginning with the dividend payable in June 2012.

Williams also announced 2010 earnings and operational results last week.

Non-cash impairment charges in its E&P unit drove the company to a 2010 net loss of nearly $1.1 billion ($1.88/share) compared with net income of $285 million (49 cents/share) in 2009.

The charges were due to a decline in forward natural gas prices and included pre-tax charges of about $1 billion for an impairment of goodwill and $678 million related to certain proved and unproved gas properties, primarily in the Barnett Shale. Pre-tax costs of approximately $648 million in conjunction with the restructuring of Williams Partners LP also contributed to the net loss.

Adjusted income was $760 million ($1.28/share) compared with $552 million (94 cents/share) for 2009. The improvement was driven by increases in the company’s Williams Partners and “other” segments, partially offset by lower results in E&P.

For 2010 Williams Partners reported segment profit of nearly $1.6 billion, compared with about $1.3 billion for 2009. The 20% increase is primarily due to higher per-unit NGL margins. Slightly higher natural gas liquids equity volumes and new fourth-quarter production capacity, also contributed to the improved results.

“The continued demand for large-scale infrastructure to serve the growing resource plays will continue to provide new investment opportunities throughout 2011 and beyond,” Armstrong said.

The company’s E&P unit reported a loss of more than $1.3 billion for 2010, compared with segment profit of $391 million for 2009 due to charges and impairments. E&P adjusted profit was $321 million, compared with $483 million in 2009.

The decline in segment profit on an adjusted basis is due primarily to lower gas production, higher gathering, processing and transportation expenses, in addition to higher operating taxes and lease operating expenses, Williams said. These items were partially offset by higher net realized average prices for natural gas.

Total U.S. production increased 4% from third quarter to fourth quarter 2010. Williams said it expects average annual daily production to increase by 9% and 10% at guidance midpoints in 2011 and 2012, respectively.

During 2010 Williams’ net realized average price for U.S. production, including hedging gains, was $5.23/Mcfe, which was 8% higher than the $4.85/Mcfe realized in 2009.

Williams said its proved natural gas and oil reserves at year-end were about 4.5 Tcfe, including international reserves of approximately 0.2 Tcfe. About 94% of total proved reserves are gas, with about 59% proved developed and 41% proved undeveloped, reflecting a continuation of the increase in the ratio of proved developed to undeveloped.

Williams added 528 Bcfe through 2010 U.S. drilling activity for an adjusted proved developed domestic reserves replacement cost of $1.87/Mcfe. Year-end proved, probable and possible (3P) reserves increased by 7% to 15.9 Tcfe from 14.8 Tcfe at year-end 2009.

“Our new positions in the Bakken and Marcellus turned 2010 into a transformational year,” said Ralph Hill, president of Williams’ E&P business. “We diversified both geographically and in terms of our product slate. We have significant scale in these areas now, similar to the framework we established in the Piceance and Powder River basins.”

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