ENB Acquiring Spectra: Ratings Effect Unclear

Enbridge Inc. has announced:

Highlights:
  • •Creates largest energy infrastructure company in North America with C$1651 billion (US$127 billion) enterprise value
  • •Anticipated 15 percent annualized dividend increase in 2017 and annual 10-12 percent dividend growth thereafter through 2024. Industry leading secured project and risked development inventory of C$74 billion (US$57 billion) with C$26 billion (US$20 billion) currently in execution
  • •Complementary and diversified asset base to increase customer service offerings and optionality
  • •Enhanced ability to pursue projects that will improve customer access and service
  • •Strengthens investment grade balance sheet
  • •96 percent of cash flow generated by cost-of-service, take-or-pay, or fee-based contracts
  • •Industry-leading total return potential

Enbridge Inc. (TSX:ENB) (NYSE:ENB) (Enbridge) and Spectra Energy Corp (NYSE:SE) (Spectra Energy) today announced that they have entered into a definitive merger agreement under which Enbridge and Spectra Energy will combine in a stock-for-stock merger transaction (the “Transaction”), which values Spectra Energy common stock at approximately C$37 billion (US$28 billion), based on the closing price of Enbridge’s common shares on September 2, 2016. The combination will create the largest energy infrastructure company in North America and one of the largest globally based on a pro-forma enterprise value of approximately C$165 billion (US$127 billion). The Transaction was unanimously approved by the Boards of Directors of both companies and is expected to close in the first quarter of 2017, subject to shareholder and certain regulatory approvals, and other customary conditions.

DBRS has announced that it:

has today placed all ratings of Enbridge Inc. (ENB), Enbridge Income Fund (EIF), Enbridge Pipelines Inc. (EPI), Enbridge Gas Distribution Inc. (EGD) and Enbridge Energy Partners, L.P. (EEP) Under Review with Developing Implications, as follows:

ENB plans a 15% annualized dividend increase in 2017 and annual 10% to 12% dividend growth thereafter through 2024. This is expected to result in a common dividend payout of 50% to 60% of available cash flow from operations (ACFFO), compared with ENB’s current 50% target payout ratio. ENB also plans to divest of approximately $2 billion of non-core assets over the next 12 months to provide additional financial flexibility. Annual run-rate synergies of $540 million (USD 415 million) are expected, the majority of which is expected to be achieved in the latter part of 2018. In addition, approximately $260 million (USD 200 million) of tax savings are anticipated commencing in 2019. On a combined basis, ENB will have a secured project and risked development inventory of $74 billion (USD 56 billion) currently in execution, with a very strong contractual profile.

With respect to the financial risk profile, ENB stated that it expects to fund future growth in a manner that is consistent with maintaining a strong investment-grade credit profile with key target metrics of 15% funds from operations (FFO) to debt and five times debt-to-EBITDA. DBRS notes that both ENB and SEC have significant capex programs over the medium term, with ENB’s being back-end loaded and SEC’s being front-end loaded, with the combination smoothing out the overall pattern somewhat over the 2017 to 2019 period. DBRS expects near-term pressure on ENB’s credit metrics to continue as a result of assumption of SEC’s existing debt and the relatively high near-term capex ($12.9 billion in 2017), partly offset by issuance of substantial common equity. Execution risk with respect to generating expected proceeds from the proposed asset sales is also present.

Spectra’s subsidiary Westcoast got a passing mention from DBRS:

DBRS Limited (DBRS) has today placed the ratings of Spectra Energy Capital, LLC (Spectra Capital, or the Company) and the ratings of the Company’s DBRS-rated subsidiaries Under Review with Developing Implications. The entities covered under this rating action are:

— Westcoast Energy Inc., First Preferred Shares – cumulative, redeemable rated Pfd-2 (low)

DBRS will further review the potential impacts of the Transaction on Spectra Capital’s ratings and the ratings of Company’s DBRS-rated subsidiaries, with an aim to resolve the Under Review – Developing Implications status.

S&P took a more cheerful view:

  • •Diversified energy companies Spectra Energy Corp. and Enbridge Inc. have announced an agreement whereby Enbridge will acquire Spectra in a stock-for-stock merger transaction totaling C$37 billion (US$28 billion). The combined company will be the largest energy company in North America and one of the top five global energy companies based on a pro forma enterprise value of about C$165 billion (US$127 billion).
  • •We are placing our ratings on Spectra and its financing subsidiary Spectra Energy Capital LLC.on CreditWatch with positive implications.
  • •At the same time, we placed the ratings on master limited partnership Spectra Energy Partners LP and operating subsidiary Texas Eastern Transmission L.P. on CreditWatch with positive implications.
  • •We expect to resolve the CreditWatch listing when the transaction closes sometime in the first quarter of 2017, at which time we expect to raise the rating on Spectra Energy Corp. and Spectra Energy Partners and Texas Eastern one notch to ‘BBB+’, which is in line with consolidated group credit profile of Enbridge Inc.


“The CreditWatch listing on Spectra and its operating subsidiaries reflect our expectation that we will raise the ratings in line with those of Enbridge Inc.,” S&P Global Ratings analyst Michael Grande said. “Spectra will become a wholly owned subsidiary of Enbridge, and we expect Spectra’s 2017 consolidated EBITDA of about US$3.2 billion will account for about 40% of the combined company’s pro forma cash flow.”

… and, with respect to Westcoast:

  • •On Sept. 6, Enbridge Inc. announced a merger with Spectra Energy Corp. in a share exchange transaction. When the merger’s completed, Spectra subsidiary Westcoast Energy Inc. will become a wholly owned subsidiary of Enbridge Inc.
  • •We are placing our ratings, including our ‘BBB’ long-term corporate credit rating, on CreditWatch with positive implications.
  • •The CreditWatch placement reflects our view that once completed, Westcoast Energy could be considered core to Enbridge Inc., which would lift the rating.


“The transaction would introduce group support from Enbridge, currently a higher rated entity than existing parent Spectra Energy,” said S&P Global
Ratings credit analyst Gerald Hannochko.

The CreditWatch placement reflects our view that if the transaction closes as expected, Westcoast would likely become core to Enbridge Inc., and the rating and outlook would be equalized with those on Enbridge Inc.

An upgrade is likely if the transaction is completed, and if we assess Westcoast’s group status as core.

Part of the apparent disagreement is that S&P rates Enbridge preferreds as P-2(low) and Westcoast as P-3(high), inverting the ranking of DBRS, which has Enbridge at Pfd-3(high) and Westcoast at Pfd-2(low). Credit ratings are not an exact science!

Affected issues are:

ENB.PF.A, ENB.PF.C, ENB.PF.E, ENB.PF.G, ENB.PR.A, ENB.PR.B, ENB.PR.D, ENB.PR.F, ENB.PR.H, ENB.PR.J, ENB.PR.N, ENB.PR.P, ENB.PR.T, ENB.PR.Y

W.PR.H, W.PR.J, W.PR.K

Update, 2016-9-7: Moody’s affirms Ba1 Preferred rating and maintains negative outlook:

Moody’s Investors Service has affirmed the Baa2 senior unsecured ratings for Enbridge Inc. (Enbridge) and its subsidiaries Enbridge Income Fund (EIF) and Enbridge Energy Limited Partnership (EELP).

“The transaction is credit positive for Enbridge because Spectra brings increased size and scale, and helps create the largest midstream company in North America with a more diverse asset portfolio,” said Gavin MacFarlane, Moody’s Vice President — Senior Credit Officer. “But the company’s combined leverage remains elevated. We are maintaining a negative rating outlook for Enbridge until we see the company execute the transaction, the large capital program in 2017 and deleveraging plans.”

Moody’s maintains a negative rating outlook for Enbridge based on the company’s very high levels of leverage. As of June 2016, Enbridge’s ratio of debt-to-EBITDA was 7.2x, while Spectra’s was about 5.8x and on a combined last twelve months basis their leverage was about 6.7x. The higher combined leverage is owing to the larger size of Enbridge relative to Spectra, as Spectra accounts for roughly 40% of the combined entities’ EBITDA. Moody’s continues to expect the financial metrics of both companies to improve as they progress with their capital programs. At the same time, Enbridge has announced $2 billion of asset monetizations that Moody’s expects will incrementally reduce leverage at ENB. Moody’s views the prospect of asset monetizations as credit positive and considers this as a meaningful change from a financial strategy perspective, as this represents the first time this decade that management has sought to sell assets out of the group to fund its capital program. The combination of the two entities provides more levers for management to pull in order to manage pressure on credit quality.

The negative outlook on ENB reflects its high leverage and execution risk associated with its plan to delever in a timely fashion. ENB has a plan to do so by the end of 2017 and a number of options at its disposal to reduce leverage. However, if the company fails to execute and debt-to-EBITDA of about 5.5x is unlikely to be achieved by the end of FY2017, the company could be downgraded.

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