The managements of Energy Transfer Equity (ETE) and Williams Companies (WMB) are engaged in a high stakes poker game. It’s an absorbing spectacle. Last May WMB announced plans to buy in its MLP Williams Partners (WPZ). As with Kinder Morgan, they felt their size as well as the drag from Incentive Distribution Rights (IDR) from WPZ to WMB was making it hard to identify accretive growth projects. Kelcy Warren, ETE’s CEO, made an unsolicited offer for WMB and after fending him off for several months WMB eventually agreed, grudgingly, to be acquired in September. They dropped their earlier plan to merge with their MLP.

Almost immediately ETE was struck with buyer’s remorse. The deal terms included an $8.10 cash payment from ETE for each WMB share, and as MLPs sank this $6BN payout represented an increasing percentage of the deal as well as an unneeded strain on ETE’s balance sheet. ETE had crafted a complex transaction. They were keen to maintain the GP/MLP structure, since Kelcy Warren clearly recognizes the value in an MLP GP (see Energy Transfer’s Kelcy Warren Thinks Like a Hedge Fund Manager). However, ETE couldn’t simply issue new units to exchange for WMB shares to satisfy the non-cash component, because ETE is a partnership that generates a K-1 and WMB shareholders wouldn’t want to exchange their shares in a corporation generating a 1099 for LP units. So ETE agreed to exchange 1.5274 shares in the newly formed Energy Transfer Corp (ETC) for each WMB share.

ETC is supposed to track ETE for two years following the transaction close through a mechanism designed for the purpose, but it’s a novel approach and it’s unclear how they’ll both trade after that. The complexity shows how keen Kelcy Waren was to buy WMB and so retain their MLP as a stand-alone vehicle still generating IDRs for its GP. But as ETE, WMB and MLPs generally fell, ETE’s CFO Jamie Welch apparently began looking for modifications or even a way out of the deal without having to pay a break-up fee. In fact, Jamie was visible in telling WMB shareholders they should reject the transaction, and last month he was fired.

Whether Jamie was fired because he crafted a poor deal or because he was using the wrong strategy to change it, Kelcy Warren soon went on the offensive. In quick succession ETE announced two transactions designed to make ETE and its doppelganger ETC less valuable by enriching senior management at the expense of other ETE/ETC shareholders including, should the transaction close, WMB shareholders.

On March 10^th Energy Transfer announced a limited offering of convertible units available only to insiders and on preferential terms. They followed this up with a substantial grant of new shares by way of compensation to ETE management to take effect after the closing of the WMB transaction. Both moves served to make ETE/ETC a less valuable currency to WMB shareholders, but the collateral damage was to all the existing non-insider owners of ETE. The clear message to WMB’s board is, sit down with us and renegotiate this deal or we’ll make it progressively less attractive to you.

What was unsaid publicly was no doubt communicated clearly in private; these terms stink and if you disagree we’ll make them worse. If WMB walks away they have to pay ETE a 1.5BN break-up fee, unless it’s voted down by WMB shareholders. If both companies agree to break up, ETE has to pay WMB $410MM, the same fee WMB had to pay WPZ when that deal was cancelled. There is no provision for ETE to walk away, so they’d likely face  a lawsuit for substantial damages if they did. Considering the deal originally valued WMB at $43.50 compared to its Friday close of $15.52, you’d think pursuing such a lawsuit would be challenging. More recently, to confirm what a bad idea the merger was, ETE took its earlier forecast of $2BN in annual synergies down to roughly zero.

Apparently the WMB board never was that enthusiastic about the deal in the first place, with CEO Alan Armstrong opposed while activist hedge fund manager Keith Meister was in favor.

Kelcy Warren has become a billionaire through the Energy Transfer family of businesses which he founded in 1995. The deal’s proponents on WMB’s board, including Keith Meister of Corvex, are struggling to show that their earlier advocacy was astute given the subsequent collapse in both stock prices. These billionaires now rather resemble elephants dancing in a cramped tea room; the question for investors is how to avoid being the crushed china set in the process, for both men hew to their fiduciary obligations only as long as more important considerations don’t intervene.

Two years ago Keith Meister showed his true colors with alarm company ADT, when in April 2014 he relied upon a stock buyback for which he’d advocated to sell his big ADT position back to the company. ADT’s stock price subsequently sank 30%. ADT’s CEO Nareen Gursahaney was shown to be inept (see ADT and the Ham Sandwich Test) while Keith Meister created further obstacles for those who believe all hedge fund managers are misunderstood altruists.

So ETE’s strategy is one of devaluing its acquisition currency to the point that it’s unattractive, while WMB’s is one of holding out presumably in the hope of a big break-up fee. And yet, since what’s good for ETE must be good for WMB, it’s obvious that there’s a shared interest in reducing the cash portion of the deal in exchange for more equity. The outline of an agreement is clear to everybody, but so far a WMB board that was split and an ETE management that has completely changed its mind cannot put their egos aside and find common ground. It’s mostly about the capital structure of the combined entity. If they get that right both sides will win. But it also shows that there’s more than one way to handle the funds of public shareholders. Few players in this story are showing themselves to be responsible stewards of client capital. In years to come, situations like this will beg the question: how would Buffett have handled it. Whatever the answer, it won’t be like this.

We are invested in ETE and WMB.

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