Boardwalk Pipeline Partners (BWP) – Unit Buyout – 14%+ upside

Current Price – $10.2

Merger Consideration – $11.6+

Upside – 14%+

Expiration Date – Aug, 2018

 

Boardwalk Pipeline is an MLP that is 51% owned by Loews, which also happens to be its GP. At the end of April Loews announced that it is seriously considering exercising its call right to acquire the remaining 49% of BWP units owned by minority holders at a price to be calculated based on formula (average of 180 days of closing prices). However, Loews did not reveal anything with certainty or anything regarding the timing. This caused share price to drop 20% (recovered half way since) as market got scared that Loews will drag out acquisition process till the average price gets more favorable. Other shareholders got vocal as well (here and here).

For further background info as well as regulatory taxation changes that lead to current situation please refer to recent SeekingAlpha and Barron’s articles.

The bet here is that Loews will try to avoid potential litigation by not dragging out the process and will buyout minority holders before the average prices over the last 180 trading days drop below $11.6+

There are two main uncertainties here:

  • Whether Loews will exercise its right and where will BWP trade if it does not;
  • Expected timing of the transaction, which will also determine the buyout price.

The first one is a bit of a guesswork. As can be seen from Barron’s article, BWP share price underperformed MLP index this year and Loews might see this as opportunity to acquire BWP cheaply. If Loews had no real intentions to buy out BWP minority unitholders I doubt they would have mentioned anything regarding the call right. If Loews backs off, then it is likely share price would revert to pre-announcement levels of $11.

Timing is the second uncertainty. Limited Partnership Agreement says:

(b) Notwithstanding any other provision of this Agreement, if at any time: (i) the General Partner and its Affiliates hold more than 50% of the total Limited Partner Interests of all classes then Outstanding and (ii) the General Partner receives an Opinion of Counsel that the Partnership’s status as an association not taxable as a corporation and not otherwise subject to an entity-level tax for federal, state or local income tax purposes has or will reasonably likely in the future have a material adverse effect on the maximum applicable rate that can be charged to customers by subsidiaries of the Partnership that are regulated interstate natural gas pipelines, then the General Partner shall then have the right, which right it may assign and transfer in whole or in part to the Partnership or any Affiliate of the General Partner, exercisable at its option within 90 days of receipt of such opinion, to purchase all, but not less than all, of all Limited Partner Interests then Outstanding held by Persons other than the General Partner and its Affiliates, at a purchase price for each class of Limited Partner Interests equal to the average of the daily Closing Prices per Limited Partner Interest of such class for the 180 consecutive Trading Days immediately prior to the date three days prior to the date that the notice described in Section 15.1(c) is mailed.

(c) If the General Partner, any Affiliate of the General Partner or the Partnership elects to exercise the right to purchase Limited Partner Interests granted pursuant to Section 15.1(a) or (b), the General Partner shall deliver to the Transfer Agent notice of such election to purchase (the “Notice of Election to Purchase”) and shall cause the Transfer Agent to mail a copy of such Notice of Election to Purchase to the Record Holders of Limited Partner Interests of such class or classes (as of a Record Date selected by the General Partner) at least 10, but not more than 60, days prior to the Purchase Date

Opinion of Counsel means a written opinion of counsel (who may be regular counsel to the Partnership or the General Partner or any of its Affiliates) acceptable to the General Partner.

All timing eventually ties to the date on which ‘Opinion of Counsel’ was received. So the expected timing of transaction can be constructed in the following way (with P indicating expected Purchase date:

  • P-90 – General Partner received Opinion of Counsel;
  • P-14 – The last day for calculation of the purchase price, comprised of average closing prices during previous 180 trading days;
  • P-10 – The latest date shareholders need to be notified about the purchase;
  • P – Purchase date.

Management has not revealed whether ‘Opinion of Counsel’ has been received or when (it has full discretion on timing). The risk is that Loews delays this part which would extend the acquisition and lower the average price. However, due to this Loews might be accused of price manipulation and expose itself to potential litigation. So an argument could be made that Opinion of Counsel was received at the time or before Loews made public its ‘serious considerations’ to buy out minority holders.

Below are number of scenarios with different dates for Opinion of Counsel (assuming price for the remaining trading days remains at current $10.25).

Price table

As can be seen from these calculation even if Loews extends the buyout till the end of the year, the resulting purchase price would remain above current levels. Obviously, this analysis assumes that Loews will proceed with the buyout and that the unit price will remain on average at $10.25.

Currently I am betting that Opinion of Counsel was received before Loews announcement (i.e. before 30/04/18) which would suggest that shareholders will be notified about the buyout over the coming month and units will be acquired at $11.6+, which is 13.5% upside to current prices.

Another way to trade this is through options or spreads – with the increased risk of loosing entire investment with OTM options if the assumptions above do not materialize.

I am long straight equity and also long September call spread.

17 COMMENTS

  1. Thinley w

    Thanks for the article DT. If Loews backs off, why do you think that the share price would revert to pre-announcement levels of $11?

    1. dt

      No hard reason for that. This is where BWP traded before investors started digesting what Loews call right really means. The stock actually traded up (to $12.7) in the first half an hour after Q1 result announcement (30th of April). Then during conference call management mentioned that Loews is considering exercising its call right and that 13D would be filed later that day (which happened around 12pm). The start of the decline in the stock price approximately coincided with management’s announcement during the call. So from this I am guessing that market viewed Q1 results as quite favorable (stock was up almost 15%) and then Loews announcement simply killed it all.

      I do not have any strong arguments from valuation perspective if you are asking for that.

  2. makarid makarid

    Thank you dt for this idea. In the post your are writing “expiration date: Aug, 2018”.Any reason for that? Is this an estimate or there is somewhere written?Thanks

    1. dt

      August selection is a bit arbitrary – simply if unit buyout is not announced over the summer I do not think the transaction will happen.

  3. makarid makarid

    Definitely something is going on,on the LP space. It has to be about the new tax rules or something.I don’t know what has changed,because i am not US citizen. There are 2 more mergers in LP space,one with OCI Partners (OCI with OCINF) and one with ClearBridge CEF (CBA with EMO).Maybe the latter has nothing to do with taxes because it is a CEF,but i don’t believe that it is coincidence. LP’s are attractive for some tax reason.

  4. Rick Sanchez

    bit of a price move up today on 6/25 (up 6%) on no news, vs. Alerian MLP Index down 2%

  5. Rick Sanchez

    A Delaware judge gave the green light to a public settlement of a lawsuit brought by a pair of Boardwalk Pipeline Partners LP investors that accused Boardwalk’s holding company and parent Loews Corp. of tanking Boardwalk’s stock price to make it a more attractive buyout target for Loews.

    Vice Chancellor J. Travis Laster of the Delaware Court of Chancery on June 25 issued a letter to the legal teams for the investors — TAM Capital Management Inc. President Tsachy Mishal and Paul Berger, who personally owned a combined 533,938 common units of Boardwalk as of May 22 — as well as the partnership, Loews and subsidiary Boardwalk Pipelines Holding Corp., encouraging them to present a negotiated settlement to the court publicly.
    —————————————————————————————————————–
    From the COURT OF CHANCERY OF THE STATE OF DELAWARE dated 6/25/2018:

    Dear Counsel:
    The in camera presentation that counsel has proposed seeks an advisory opinion about settlement approval. The parties should follow the standard practice of presenting a settlement. The fact that the terms could be market-moving does not warrant departing from regular order. Many aspects of this court’s docket have market-price implications. If counsel have concluded that the terms of the settlement fall within a range of reasonableness and should be approved, then they should proceed with confidence. If the fairness of the settlement is so dubious as to require an advisory opinion before counsel are willing to make it public, then perhaps it should not be presented.

    Sincerely yours,
    J. Travis Laster
    Vice Chancellor

    1. dt

      Just realized that in my calculations I have used adjusted closing prices (which adjusts for dividend payouts). The actual closing prices were higher. Correcting for this the 180-day average ending June 29th is expected to be c. $12.05 per share.

  6. work 22

    good call— BWP just settled the class action lawsuit. Trading $11.46 bid pre market Tuesday June 26th…

  7. Rick Sanchez

    do you guys plan to hold until next week then? I’m of a mind to lock in my gains now

  8. Rick Sanchez

    Loews says the GP will purchase the transaction units on July 18 for $12.06/unit, totaling ~$1.5B.
    Thanks again for the idea!

  9. Jim Rivest

    For those shareholders who hung on until the end, there is a little more cash coming your way.

    https://courts.delaware.gov/Opinions/Download.aspx?id=326390

    “The current plaintiffs objected to the Original Settlement. On September 28, 2018, the court declined to approve the Original Settlement. Because the current plaintiffs had prevailed on their objections, the court permitted them to take over the litigation. The court subsequently certified a plaintiffs’ class consisting of: Any natural person or entity who held Boardwalk limited partnership units on July 18, 2018 and whose units were purchased on that date by Boardwalk GP, LP, together with their heirs, assigns, transferees, and successors in interest, but excluding Defendants, their successors in interest and assigns, and any natural person or entity that is a director, officer or affiliate of any of the foregoing.”

  10. Jim Rivest

    Bloomberg
    Matt Levine

    Loews / Boardwalk Pipeline

    The Federal Energy Regulatory Commission regulates the maximum rates that natural gas pipelines can charge to customers. The rate regulation essentially allows the pipeline company to recover its “cost of service,” that is, its operating costs plus a reasonable return on its invested capital. In 2005, FERC decided that pipelines organized as partnerships, which do not pay corporate taxes, could act as though they had to pay corporate taxes in calculating their costs.[1] This allowed partnership pipelines to charge higher rates than they otherwise would, and led to a boom of publicly traded pipeline partnerships, often called “master limited partnerships” or “MLPs.”

    Loews Corp., a big conglomerate, formed an MLP called Boardwalk Pipeline Partners LP, put some pipeline assets into Boardwalk, and took it public in 2005. Because the FERC rules were new and controversial at the time, it included a provision in the Boardwalk partnership agreement that allowed Loews to take it private again if the rules changed. The idea was that if the FERC rules changed such that MLPs could no longer include hypothetical taxes in their rate calculations, then it would be bad for Boardwalk to be a public partnership, and so Loews would be able to force all the Boardwalk shareholders (technically, unitholders — holders of limited partnership interests) to sell their shares and take it private. (Then it would be a corporate pipeline and get to charge for taxes again.) This “call right” was written to say that if Boardwalk got an opinion of counsel saying that Boardwalk’s status as an MLP “has or will reasonably likely in the future have a material adverse effect on the maximum applicable rate that can be charged to customers,” then Loews can buy back all the Boardwalk shares at a price equal to the average closing prices over the six months before it exercises the call.

    In March 2018, responding to a court decision, FERC announced a new policy that MLPs will not generally be able to include hypothetical taxes in calculating their rates, exactly the thing Loews had worried about in 2005. In the actual world of 2018, though, this news was not particularly bad for Boardwalk. A lot of its revenues come from negotiated rates that are not really affected by FERC maximum rates. Also the FERC rate-setting process is complicated; Boardwalk could keep charging its old rates until someone filed a “rate case” asking it to change, and the rate case is a long multi-factor regulatory determination, not just “reduce your rates by 20% because you don’t pay taxes” or whatever. Also the Tax Cuts and Jobs Act of 2017, which reduced federal corporate income taxes, reduced the advantages of being an MLP: MLPs don’t pay corporate taxes, but corporate taxes aren’t as high as they used to be. Also the tax accounting for FERC rates is complicated, and the way that FERC crafted the transition from the old regime to the new one — specifically how it treated deferred tax liabilities — might actually be good for MLPs’ rate calculations.[2]

    So in March 2018, when FERC announced that MLPs would no longer be able to charge for hypothetical taxes, Loews and Boardwalk did not panic. They analyzed the potential impact of the changes and decided that they would be manageable; the worst case was a negative impact of about $20.5 million, but it could be much better depending on the specific rules that FERC used to transition the deferred tax liabilities.[3]

    But there was that call right. And Boardwalk and Loews got to thinking about it. Boardwalk’s shares were trading at historically low prices, and arguably the reason for that was a classic “public markets are too short-term-focused” reason. MLPs are generally income investments; people buy them because they pay high dividends. Boardwalk cut its dividend in 2014 to reinvest more in growth[4]:

    In 2014, Boardwalk stunned investors by cutting its quarterly distribution from $0.5325 to $0.10 per unit, making Boardwalk one of the lowest yielding MLPs in the industry. Boardwalk’s trading price fell from the low $30s to the low $10s almost overnight. The unit price never again approached its former levels.

    Between 2014 and 2017, Boardwalk spent $2.077 billion on capital expenditures, including $1.6 billion in growth capital expenditures. During the same period, Boardwalk distributed $405.1 million to unitholders. There is evidence that investors were unsure about how to value the growth capital expenditures.

    The idea is of course that you cut the dividend, invest the money in growth, grow, and then eventually pay a much higher dividend. But Boardwalk was in the middle of that process. The present value of its future dividends had gone up because of its investments in growth, but its current dividends had not. And the public MLP market, a niche market that really cares about current yield, did not give it credit for that growth.

    So if Loews could exercise the call right, it could buy back all the shares of Boardwalk cheaply and then own all that upside itself. It estimated internally that there was “$1.557 billion in ‘Value Creation’ that” it could get by exercising the call right. There was no real advantage anymore to keeping the pipeline assets in an MLP — the favorable tax treatment was going away, and corporate taxes were lower anyway — and there was an advantage to buying them back cheap. So Boardwalk and Loews executives asked: Can we exercise the call right?

    Oversimplifying, the question there is, did Loews have the right to call Boardwalk’s shares if FERC’s tax treatment changed in the way it worried about in 2005, or did Loews have that right only if the tax treatment changed and it was bad for Boardwalk? Because the exact thing Loews had worried about in 2005 — FERC rule changes that would prevent MLPs from charging customers for taxes — had occurred. But it turned out to be fine. But Loews wanted to exercise the call right anyway, because that would be profitable.

    So it went out to its lawyers and asked them to give it an opinion saying that FERC’s rules were changing in a way that “has or will reasonably likely in the future have a material adverse effect on the maximum applicable rate that can be charged to customers,” as required by the partnership agreement. This was a tricky opinion to give. The new FERC rules weren’t final, for one thing, and it wasn’t clear what the final rules would say. Also they wouldn’t have a material adverse effect on Boardwalk’s revenue, on the actual rates it actually charged customers. But they might have a negative effect on the “maximum applicable rate,” or what is more technically called the “recourse rate,” the FERC-set rate that customers would pay if they didn’t come to a different agreement. They would only have this effect if customers filed a rate case, and there’d be a lot of other factors to consider in any rate case, and blah blah blah, but in some oversimplified sense if you could charge customers for taxes before and now you can’t, sure, the regulatory rates you can charge them will go down in some straightforward arithmetic sense.[5]

    So that’s what Boardwalk’s lawyers at Baker Botts LLP considered: They ignored all the messy economic realities and focused on the simple arithmetic of not charging for taxes anymore.

    The Baker Botts team clarified that their rate expert had not analyzed the Revised Policy’s effect on Boardwalk’s rates. Instead, the analysis considered “Hypothetical Rates.” Notes taken by a Baker Botts partner reveal that everyone focused on the core issue: There would be “no actual change—no effect yet screw min[ority].” That was obviously a “challenging fact.”

    Of course I am, here and elsewhere, quoting from a court decision in a lawsuit against Boardwalk. Helpfully the decision includes a picture of those notes:

    The new FERC rules would have no actual effect on Boardwalk’s business, but they would affect the “hypothetical rates” it could charge, which would (arguably) allow it to exercise the call right and buy all the shares back cheaply, which would “screw min,” which is a “challenging fact.” It’s a good summary of the situation! Not the sort of note you want to turn over in litigation, but a good summary nonetheless.

    The lawyers got more or less comfortable issuing the opinion, and at the end of April 2018 Loews and Boardwalk started to signal that they would exercise the call right. The market reaction was bad:

    Subjected to the overhang of the pricing formula, Boardwalk’s trading price declined steadily. The units closed at $10.94 on May 1, then at $10.88 on May 2. On May 3, the price fell to $10.01. On May 4, it fell to $9.56. On May 7, the units closed at $9.26. …

    As investors began to understand the effect of the Call Right, they became outraged.

    But a bad market reaction was good for Loews. In May 6, 2018, Deutsche Bank AG research put out a note about “the ‘Prisoner’s Dilemma’ that Loews had created”[6]:

    Stakeholders could expect no higher price for shares of BWP than $11.50 unless Loews chose voluntarily to tender at a higher share price (or chose not exercise at all). Given that the probable “best” the stakeholders could do seemed to be around $11.50 in August 2017, there seemed to be little incentive to hold onto BWP shares above that price. And so the stock has begun to fall. However, as the stock falls, so too does the 180-average price for which Loews can demand tender. This has engendered a real-time game theory practice known as “the prisoner’s dilemma.” By this logic, the stakeholders assume the worst of their fellow stakeholders and aim to sell first in order to arguably . . . get a better price than those who wait. This has created a pile-on where stakeholders are willing to part with their shares below what some might argue is fair value. And no shareholder has the incentive to pay more than this price if Loews has the option to tender below that price level.

    Boardwalk’s shareholders — including a hedge fund, Bandera Partners LLC — started complaining (1) that Loews should not be able to exercise the call right and (2) that in any case it was manipulating the stock price by talking about exercising the call right, pushing the stock price down so that when it eventually exercised the call right it could pay a lower price.

    But Loews did it anyway. It got the opinion, exercised the call right and paid $12.06 per share; the acquisition closed on July 18, 2018. “Hours after the closing,” FERC issued a final rule on the treatment of taxes for MLPs that was generally very favorable to MLPs, including particularly on the transition for deferred tax liabilities (“ADIT”):

    FERC reiterated that its policy would not automatically permit MLP pipelines to recover an income tax allowance in their cost of service, but MLPs would not be precluded from arguing in a rate case that they were entitled to an income tax allowance based on an evidentiary record.

    Critically, FERC stated that MLPs that were no longer entitled to an income tax allowance could eliminate their overfunded ADIT balances without returning the balances to rate payers (whether by refund or amortization). …

    The Final Rule meant there would be no effect on Boardwalk’s recourse rates.

    Oh well! Turns out everything was fine.

    Bandera sued on behalf of Boardwalk shareholders,[7] arguing that Loews wasn’t actually allowed to exercise the call right because nothing bad had happened. The FERC’s new rule does not have “or will reasonably likely in the future have a material adverse effect on the maximum applicable rate that can be charged to customers,” Boardwalk’s rates did not go down, there was no problem.

    Last Friday Vice Chancellor Travis Laster of the Delaware Chancery Court issued a 194-page opinion agreeing with Bandera. He found that Boardwalk was not entitled to exercise the call right, and that the legal opinion it got from Baker Botts “did not satisfy the Opinion Condition because outside counsel did not render it in good faith.”[8] And he found that the present value of Boardwalk’s shares — based on management’s own projections of future revenue and distributions — was $17.60, awarding shareholders damages of $5.54 per share or about $690 million total.

    We talked yesterday about a dispute between JPMorgan Chase & Co. and Tesla Inc. over some warrants. In 2014, JPMorgan bought some warrants from Tesla. It worried about the risk of Tesla being taken over, which would probably be bad for the value of those warrants, so it wrote a takeover protection into the warrants: If Tesla announced that it was being acquired, JPMorgan could adjust the terms of the warrants to preserve fair value. In 2018, Elon Musk tweeted that he was going to take Tesla private. He wasn’t; it was just a lark that lasted a few weeks and that no one took particularly seriously. But JPMorgan adjusted the terms of the warrants anyway, giving itself an extra $160 million of value. JPMorgan’s essential argument is that the risk it had worried about and protected against came true, so it got to use the protection it had built for itself. Tesla’s essential argument is that the risk came true in a way that did not harm JPMorgan — that actually benefited it — so it was just opportunism for JPMorgan to use that protection.

    This is kind of the same case! In 2005, Loews worried about MLPs losing their ability to count taxes in their rate determinations. So it wrote a protection into the MLP agreement: If FERC changed the rules about taxes, Loews could buy Boardwalk back. In 2018, FERC changed the rules about taxes. This worked out fine for Boardwalk, for various specific business reasons. But Loews bought Boardwalk back anyway, getting itself an extra $1.5 billion of value. Loews’s essential argument was that the risk it had worried about and protected against came true, so it got to use the protection it had built for itself. Bandera’s essential argument was that the risk came true in a way that did not harm Loews — that actually benefited it — so it was just opportunism for Loews to use that protection.

    In general this is a hard class of dispute, and I sort of sympathize with the opportunists? If you worry about X, it can be sensible to write a contract saying “if X happens then I get a huge windfall,” to offset the badness of X. And then if X happens and it’s not bad, well, sure, that’s a nice windfall for you. Often that is better and more predictable and easier to administer than having to prove after the fact that X was actually bad, and that you suffered and should be compensated.

    Here, though, Loews thought it had written that, but hadn’t quite. In fact it did have to prove that what happened was bad — that it was a “material adverse effect” — and it couldn’t do that, so it lost.

Leave a Reply