March 07, 2009 - 2:16pm EST by
2009 2010
Price: 9.23 EPS $5.04 $2.89
Shares Out. (in M): 53 P/E 1.8x 3.2x
Market Cap (in $M): 487 P/FCF 1.8x 3.2x
Net Debt (in $M): 944 EBIT 298 188
TEV ($): 1,421 TEV/EBIT 4.8x 7.6x

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Williams Partners, WPZ, is an MLP operating in the midstream natural gas processing business with 2 un-recreatable assets in the Rockies (which produce most of the cash flow), and other very good assets in Conway, KS and the GoM.  The MLP was created by the original owner of these assets, Williams Cos (WMB), which still consolidates and controls WPZ, via its 100% ownership of the GP.  The cash yield on WPZ is over 25%, at the high end of similar gas midstream businesses - though those looking like restructuring candidates, like Crosstex and Atlas, have much higher yields.  The MLP market, made up of both retail and institutional investors, is worried that the dividend is not sustainable, as the business has softened considerably from its highs of 6mos ago, and the problems at Crosstex, Atlas and beyond have exposed the variability in earnings (as opposed to the certainty of dividends that had been assumed).  Also, the MLP structure is starting to be viewed as a failed experiment, having taken advantage of cheap debt, and having aggressively sold to broker/dealer retail and hedgefund customers as secure yields, often with additional leverage.  Lastly, management of both WPZ and WMB did a poor job on the Q4 call explaining why the MLP structure matters to WMB, why the dividend is much more secure than perceived by the market, and not highlighting all the levers WMB has at its disposal to secure the payout and maintain WMB/WPZ access to the MLP marketplace for many more assets in the WMB portolfio all of which belong in the MLP structure.

As an aside, WMB also created a gas pipeline MLP (Williams Pipeline, WMZ) whose yield is about 9% and Anadarko's Western Gas MLP (which is in exactly the same Rockies region as WPZ, with less variability of earnings due to no "keep-whole" contracts) trades also at 9% -- so I view the spread between dividend certainty (9%) and uncertainty (25-30%) at about 15-20%.  Realistically, WPZ should trade at about a 15% yield, maybe 12% - and though their asset quality, customer reputation and WMB support might warrant a higher price, the market is just too doubtful at this point, absent a recovery in NGL prices.


There are two reasons that WPZ is different, and the dividend is more secure than perceived by the market: 1) the earning power of the assets themselves (and the quality of the assets, and returns) are misunderstood, and 2) WPZ is very important to WMB and its strategy, and there is evidence that WMB will support the dividend, if necessary, assuming operating shortfalls are modest to moderate

Let's start with the assets: Four Corners and Wamsutter gas gatheirng and processing facilities in the Rockies (San Juan and Green River), whose largest customers are Conoco and BP, both of whom have said they will drill through the cycle.  BP believes their Green River play to be the most exciting in the US, and is only 3 years into the drilling; BP has 8 rigs operating currently, the same as each of the past 2 years, and with no plans to slow down (Devon the same, the other player in this field, with Anadarko a non-op partner).  The San Juan is not growing, but Conoco has said it will keep production flat (its COP's largest US gas field by far, about 50% of US onshore volumes), and the Paradox Basin (BBG/WMB) is to come onstream in a big way by 2010 (go to BBG q4 slides) and those volumes will be processed in these facilities.  The Four Corners is located in 14-15k foot altitudes, on rights of way and other lands for which permits wouldnt be available any more; its gross book PPE value is $1.2bn, its net PPE is $600 or so and it does 100m in the bottom of the cycle (ebitda less maintenance capex) and 200m+ at the top.  Growth is minimal, until Paradox volumes ramp up later this decade.  So returns are 10-20% on gross PPE, and 15-30% on net PPE.  Wamsutter has similar return metrics, though there is more growth due to the early stage of BP's Green River field.  The capital spending ($200m+) to meet BP's volumes will be contractually paid by WMB, in return for a larger take of Wamsutter eocnomics above certain minimums ($70m EBITDA) until such capital is repaid.  The cash flows (ebitda less maintenance capex) from these 2 assets, assuming NGLs were 0, would be $60m F/C and $25m Wamsutter in 2009.  They produce together about 270m gallons of NGLS, all with a Rockies gas cost basis, so 10c frac spread would be $27m annually in cash flow.  Currently, spreads are about 30c (go to FRAC on bloomberg and look at Opal basis), and frac spreads tend to range from 10c to 40c, ignoring the crazy highs of 07/08 of well over $1.  As plastics are the main consumer of ethylene, which is the only use for ethane (lowest margin NGL), the NGL price depend son the price of oil (substitute) and general economy -- obviously both are terrible right now, hence the fear and panic in all the midstream names.

Conway and Discovery GOM pipeline and the very small carbonate trend serving sour gas in offshore Alabama make up the other assets.  Discovery (like Wamsutter) is equity accounting, adding more confusion for investors, and also has about 50m gallons of annual NGL production, with a mid-teen bypass fee should ethane rejection need to occur.  Ex NGLs Discovery does about $50m in Ebitda less maintenance capex, and WPZ owns 60%.  Discovery also has about $40m of cash, not consolidated onto WPZ balance sheet, though I assume this will be used internally, and not dividended out.  There is also business interruption insurance due WPZ and property insurance due Discovery which I am ignoring (from the Hurricane).  Conway is gas/NGL storage and frac-ing in the key hub of Conway, KS and this asset produces about $23m of cash flow.  Carbonate trend produces about $2m in cash flow.

In summary, assuming no NGLs, the business produces $180M ebitda, $140m of cash flow (after maintenance capex and pre-interest), interest is $60m annually (no near term maturities, investment grade debt).  Virtually no growth capex is required, as major projects at Wamsuuter are paid for by WMB, and F/C has plenty of excess capacity to handle all the Paradox volumes.  $80m is thus available for dividends, which would be insufficdent to generate IDRs to WMB, so that is $1.50 annually of dividends.  The risk to this number is that volumes in the F/C and Green River decline substantially, which I dont believe will occur.  In order to get to the current dividend payout ($2.54/shr) with IDRS (which total about $28m), frac spreads need to be 25c.  I'll allow readers to make their own frca spread predictions, but it is important to note that while frac spreads can be negative, WMB can reject ethane and therefore NGLS can never be a money-loser.

Now to WMB support: though implicit, WMB support is mis-understood because the MLP analsyts dont cover WMB (and vice versa, except in one case) and no analyst has fully thought through and reported the strategic rationale and importance of WPZ to WMB.  WMB has transformed itself from a pipeline/midstream and energy trading company into an integrated natural gas player (because of the purchase of the old Bill Barrett Corp a decade ago; the midstream and pipeline business are FCF positive, and are re-invested in the E&P business (which itself is misunderstood, and is one of the lowest cost players in the country).  For Williams, were they to spend say $200m on their own balance sheet to meet BP's volume requirements in Wamsutter, assuming a 20% return, they would take 7 yeras to get their money back (2yrs construction, 5yrs in service @ 20% returns); what the MLP model allows WMB to do is spend the same money for 2yrs, bring it into service and then sell it into an MLP in say year 1 or 2, getting their money back faster.  The quid pro quo, is that the MLP investor wants a yield (sometimes a slow as 6% in the recent bubble years when WPZ traded at $40), but usually about 10-15% -- which is sufficient to make the model work if the assets produce over that figure through the cycle.  In order for the model to work, WMB has to support the dividend in order to give investors added confidence, if necessary by eliminating the IDRs (something I forsee happening, if only because Magellan, Buckeye, Markwest and Copano have all done the same, and WPZ would be at a cost of capital disadvantage).  But lets go to the math: with IDRs paying $28m and WMB owning 11m WPZ shares, a $1 dividend cut eliminates $40m of cash flow to WMB, and $42m of dividend payments to the public (42m shrs of 53 owned by outside investors, some of whom are WMB holders too).  The question an investor must ask: is it worth $40m to WMB to permanently ruin their preferred access to the MLP market? My answer is no.  The other question an investor must ask: is it worth it to Williams to cut the dividend, then buy in the 40m shares for as cheaply as possible? I believe the answer is no, because WPZ would then be consolidated, the use of cash is better (higher return/higher growth) elsewhere especially in E&P, and the liquidty is required to meet E&P obligations and ambitions through the downcycle.  Further, investors in WMB want the company split eventually, and the GP/LP strucutre is a very easy way to do so, slowly but surely.  Lastly, there is a history of WMB creating value for its MLP shareholders: Magellan was sold to private equity during the Enron days to raise cash and those MLP holders did very well.

I should also add that the WMB balance sheet has a number of midstream assets which belong in the MLP structure (which has significant corporate tax advantages), the largest of which is Opal (a key processor and gatherer for Encana and the players in the Pinedale fields of WY).  At a 25% yield, it is economicaly impossible to downstream assets, unless WMB values WPZ units at 12-15% and takes stock themselves, as El Paso did in December.  So something has to change here, and while an economic pickup would be helpful, as would rising oil prices which would lift NGL prices, I believe the change is going to come from more explicit support from WMB for WPZ, a better IR and PR communications strategy and greater realization that there is a base level of dividends below which WPZ payouts do not go (say, $1.50 with NGLs at 0, versus $2.54 today), whose near-certainty ought to get a 10% yield (Western Gas as comp), or a $15 stock price.




more explicit support from WMB for WPZ payout, better IR and PR communications strategy and greater transparency in reporting and presenting, which allow investors to realize that there is a base level of dividends below which WPZ payouts do not go (say, $1.50 in a world of 0 for NGLs)

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