(Bloomberg Opinion) -- Tallgrass Energy LP, a pipeline business being acquired by Blackstone Group Inc., has a theory about why share prices fall:
Stock price is down. It was down to around $14 or $15 when Blackstone made their offer and that was due to sellers.
There is a lot of backstory, so let’s back up. In January, Blackstone agreed to acquire the general partner of Tallgrass’s master limited partnership, along with a 44% interest in Tallgrass itself, from various owners, including several executives of the company, for $3.3 billion. The stock closed at about $22 that day. It subsequently collapsed. In late August, Blackstone offered to buy out the rest of the ordinary shares at $19.50 each, a 40% premium to where Tallgrass was trading but below January’s level.
What really needled investors, though, were side letters to the deal that effectively guaranteed several senior executives a price of $26.25 per remaining share. These had actually been disclosed in a March filing, but David Dehaemers, the CEO, had soothed investors’ nerves about them on a call in April (I wrote about the letters here).
So he was determined to set the record straight on Wednesday evening’s earnings call. Apart from his insight on why the stock was down, he wanted to lay out some facts that some of those “blathering on” about the side letters might have missed. First, part of the premium being paid related to the general partner interest, worth “give or take $480 million,” or “about $4 a share,” or “for those of you that have to deal in pennies,” $3.82 a share. Second, the residual premium to the price ordinary shareholders are offered — $2.93 a share, or 15%, according to my penny-counting device — relates to things Blackstone apparently demanded from the insiders, such as lockup agreements and non-compete contracts. He also emphasized the collapse in the stock had not resulted from selling by either Blackstone or insiders.
Whatever the reason for the drop in the stock price — which is always and ever the result of some sort of selling — the bigger problem, it seems to me, is that management cut a deal with Blackstone that effectively severed their alignment with ordinary investors.
No one denies the general partner commands a value of its own in these sorts of partnership deals. The problem is that this could have been structured in a more straightforward way, like a separate cash payment de-linked from the ordinary share price. Ditto for any value ascribed to non-compete agreements and so forth. As it is, by agreeing to a price floor, insiders effectively got a put option on Tallgrass’s stock, protecting them no matter what Blackstone offered the ordinary investors. In effect, the lower the offer, the bigger the implied value ascribed to those insidery things.
Indeed, Simon Lack, managing partner at SL Advisors LLC (a Tallgrass shareholder), says that, “perversely,” such a side deal motivates management to agree to a lower price for the stock, in order to make it more likely the acquirer actually does the deal (you can read his blog post from September here). Daniel Wilson, a manager at Longnecker & Associates, a compensation and governance consultancy, says he has never seen this structure used before in an acquisition. “You want the management team to fight to the death for the highest price possible,” he says, adding that, at the very least, the explanation given on Wednesday evening’s call should have been disclosed up front.
We have seen this sort of thing before with master limited partnerships and similar structures in the energy business. Back in 2016, Energy Transfer LP issued some preferred convertibles that were the equivalent of insiders settling into first class while the ordinary investors turned right to the narrow seats, broken armrests and $10 snack boxes. So it’s a problem that extends beyond Tallgrass and explains to a large degree why such partnerships have been largely deserted by generalist investors and, more and more, have converted to higher-rated C-Corps.
Ethan Bellamy of Robert W Baird & Co. Inc., the only analyst to raise the topic of the side letters on Wednesday evening’s call, sums it up well:
Where are the clients’ yachts? From WeWork to the Anadarko management payouts, insiders appear to be profiting at the expense of investors. This is a major problem for the stock market and American capitalism.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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