CEQP - Crestwood Preferreds Consent Compensation Provides More Than Fair Value

2023-10-03 07:00:00 ET

Summary

• Crestwood is seeking consent to remove certain features from the preferreds.
• The feature with the most value is a penalty rate for suspended preferred dividends but the scenario where this feature has value is even less likely than bankruptcy.
• In return for consent, the company is offering an 18-cent cash fee and a put option worth 28 cents.
• The compensation offered for consent comfortably exceeds the fair value of the features they are asking to remove.

Written by Landlord Investor

Crestwood ( CEQP ) is in the process of merging with Energy Transfer ( ET ) after which CEQP's preferreds will become ET preferreds. CEQP has commenced a consent solicitation for their preferreds. This article analyzes the offer and explains why the consent compensation is more than fair value.

CEQP is asking for consent to remove some features from the preferreds and in return is offering an 18-cent consent fee plus a sweetening of other terms of the preferred.

There is one feature they are asking to remove from the preferreds that have significant value and some others that have de minimis value. The feature with value is a penalty rate that applies if the preferreds are suspended. This feature does not make the preferreds safer but provides a small amount of compensation under a very narrow set of circumstances.

Fair Value Of Deficiency Penalty Feature

The only scenario in which this feature would have value is if ET suspended dividends on their preferreds but did not go bankrupt (in bankruptcy, the accumulated preferred dividends almost never have value). In that scenario, the feature would be worth 5 cents per quarter if the preferred was suspended. The preferred would need to be suspended for more than three quarters before the feature's value would exceed the 18-cent consent fee.

But the scenario where the preferreds are suspended and the company doesn't eventually succumb to bankruptcy is rare. More rare than bankruptcy itself. And the chance of bankruptcy at ET is small. As a BBB rated company, statistically ET has a 1.4% chance of bankruptcy over five years. However, I think the actual chances are lower than that, no more than 1%. The chance of the preferreds being suspended but no eventual bankruptcy is even less, maybe 0.5%. So, you have a 1 in 200 chance of making 5 cents per quarter in deficiency penalties. Even among companies that suspend preferreds, suspending them for more than three quarters is rare.

Also, the penalty feature does not make the preferreds any safer. The preferreds will still be pari passu with ET's existing preferreds. So if the ET preferreds (which don't have this feature) are suspended, then these preferreds must be suspended as well.

Assigning 5 cents to the value of the deficiency penalty feature is probably an overestimate.

The $9.85 Put Has Significant Value

In addition to the 18-cent consent fee, the solicitation also raises the strike at which holders can put back shares to the company when the merger closes. The strike was formerly $9.22 and they are offering to raise it to $9.85.

The value of this put can be calculated using Black-Scholes. Based on the $9.52 closing price prior to the offer and assuming the merger takes three months to close, the value of the put is 28 cents.

At today's price for the preferreds of 9.71, the put is still worth 17 cents. But I think using the price prior to the offer is the more logical way to value the put.

Not Consenting Risks Your 18 Cents

If 2/3 of preferreds holders provide their consent, the measure passes. However, if the measure passes and you do not provide your consent, you do not receive the 18-cent consent fee even though you still lose the features.

This offer is essentially providing you a risk-free return on your money (assuming the merger closes). The return consists of the 18 consent fee, the dividends paid by the preferreds until the merger closes, and a guarantee that your preferreds will be worth no less than $9.85 (plus accrued dividends) when the merger closes. It makes no sense to take a juicy risk-free return and find a way to create risk out of it by putting your 18-cent consent fee at risk.

Even if you don't plan to tender at $9.85 when the merger closes, if the market crashes between now and the market close, you'll have the opportunity to sell at $9.85 and reinvest proceeds in something that's a huge bargain. Otherwise, you can keep your shares, pocket the 18-cent fee, and enjoy the dividends forever as the preferreds will remain uncallable (and the chance of a suspension is very low).

Consent Compensation Is More Than Fair Value

The total compensation for consent is the 18-cent fee plus a put option with a Black-Scholes value of 28 cents. That's a total of 46 cents or 4.8% over the closing price on the day prior to the offer being made.

While there may not be a good reason for you to exercise the put option and it may expire worthlessly, the 18-cent consent fee still provides you more than fair value. The deficiency penalty feature is worth no more than 5 cents. The other changes they are asking for are worth less than 5 cents combined. So, they are asking to remove features with at most 10 cents of value, and in return they are providing you 18 cents in cash and a put option worth 28 cents.

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