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Enbridge's new pipeline behemoth

Enbridge's takeover of Spectra looks like a smart move at a time of shrinking opportunities for pipeline builders

Canadian pipeline operator Enbridge has struck a $28bn (C$37bn) deal to take over US midstream player Spectra Energy. It will create North America's biggest pipeline network and make Enbridge one of the world's largest energy companies.

It's an all-stock deal, which should keep both companies' shareholders happy. Spectra owners will get 0.984 Enbridge shares for each of their Spectra shares, which works out to an 11.5% premium on the companies' respective share prices as of 2 September. The premium is modest but comparable to other recent midstream deals. That should please Enbridge investors because it provides growth while conserving cash at a time when hard tender in the sector is scarce. It also gives Spectra investors a chance to ride a potential share-price recovery at a time when midstream stock prices have been beaten down.

Strategically, the companies should be a good fit. Enbridge is strong in Canada and oil. Its largest pipelines run from the oil sands' huge reserves in Alberta south through the US' refining centres in the Midwest, through Cushing's storage tanks, to the Gulf Coast.

A growing balance sheet

Spectra is big in US gas. Its most valuable assets are its large network of pipes in the northeast, where gas production from the Marcellus, and the infrastructure needed to transport it, has exploded over the past decade. It also owns lines that link northeast gas to the growing liquefied natural gas export hub on the Gulf Coast. And a pipeline network on Canada's west coast linking the huge reserves in British Columbia's interior to the coast where a number of LNG export projects are under development.

Combined, the new Enbridge will own more than 30,000km of liquids pipelines, a 165,600km network of gas transmission lines, 415bn cubic feet of gas storage, linking some of North America's largest resource plays. Its $165bn enterprise value will make it the largest energy infrastructure company in North America by some way and will put it between Sinopec and Schlumberger as the world's ninth-biggest publicly traded energy company, Enbridge says.

Size matters in the pipeline business. Taking on Spectra's assets will protect Enbridge from the oil price cycle, and less exposed to the oil sands' fickle economics in particular.

It will also fill up its stash of new project opportunities at a time when growth is hard to come by. The combined companies would have around $20bn of projects in execution and around $37bn in development, giving it the largest project backlog in the midstream industry, say analysts at investment bank Raymond James. Booming US and Canadian oil and gas production over the past decade, much of which took place in areas that hadn't historically produced much oil and gas, spurred an energy-infrastructure building frenzy. The downturn has since seen that frenzy fizzle.

Add to that a campaign by green groups, emboldened by their success in bringing down the Keystone XL project, to stop nearly every major pipeline project that is proposed, and it has hardly ever been more difficult to build oil and gas-linked infrastructure in North America. The uncertainty around companies' ability to build pipelines in the future also makes existing lines all the more valuable.

Enbridge is strong in Canada and oil… Spectra is big in US gas. The companies should be a good fit

Enbridge knows all about the backlash that has hit pipeline companies. In Canada, its attempts to build the huge Northern Gateway pipeline from the oil sands to the west coast has met resistance from a broad coalition of aboriginal groups, environmentalists and allied politicians that have probably killed its chances. It is also an investor in the $3.8bn Dakota Access Pipeline from the Bakken, which is seeing fierce opposition and protests from Native American groups.

But big deals come with big risks. This downturn is littered with megamergers that fell apart. Most relevant is Energy Transfer Partners attempted $37bn takeover of Williams Company, which saw its economics undercut by sinking oil and gas prices and relations between the companies' executives subsequently turn sour as Energy Transfer tried to get out of the deal. Then there is Halliburton's failed $28bn takeover attempt of Baker Hughes, which Washington killed on antitrust grounds.

Enbridge looks to be on firmer footing on both counts-the timing is better as the downturn appears to have bottomed out and there appears to be little in the arrangement to concern regulators. But in a deal this size, the unexpected problems will almost certainly arise.

Another potential area of concern is the $22bn of Spectra debt Enbridge will be taking on to complete the deal, taking its debt-to earnings before income, taxes, depreciation and amortisation (Ebitda) ratio to a relatively high 6.7x. Moodys, the credit ratings agency, reckons that will come down over the next year, thanks in part to an expected $2bn in asset sales, and considers the deal a net credit-positive for Enbridge, and expects it to hold on to its investment-grade rating.

Amid the difficulties for North America's energy infrastructure builders, strength is now found in size. This deal gives Enbridge that size in a way that makes financial and strategic sense.

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