Williams Cos. Inc. (WMB)

[ogbull]

Williams: Heads I Win, Tails I Really Win

http://seekingalpha.com/article/3414936-williams-heads-i-win-tails-i-really-win

Aug. 7, 2015 1:19 PM ET

Williams recently rejected an unsolicited takeover bid with a 30%-plus premium. In doing so, the share price increased dramatically, but has since retreated.

Today’s value proposition is predicated on the likelihood of another bid or else the company continuing on as it had planned.

On June 21st of 2015, Williams (NYSE:WMB) announced that it had rejected an unsolicited proposal to be acquired for $64 per share - which at the time represented a 32% premium. The company indicated that the offer "significantly undervalued" Williams and went on to announce that the board had authorized a process to "explore a range of strategic alternatives." The alternative options included actions such as a merger, sale or the continuation of current plan.

Which brings us to the basic coin flip scenario: either Williams is acquired/merged in the short-term or the current plan continues as outlined. Which one is more likely is hard to say, but as this article title suggests it seems to be a "win-win" type of situation. Let's explore both possibilities to get a better feel for each potential outcome.

Sale Or Merger Doesn't Happen

On May 13, 2015, Williams announced an agreement to acquire all of the public equity of MLP, Williams Partners L.P. (NYSE:WPZ). This deal paralleled the previous Kinder Morgan (NYSE:KMI) "roll up" and touted many of the same benefits including: higher dividend guidance, lower cost of capital, tax benefits and a simplified corporate structure.

Perhaps the most relevant piece of information for the income investor was the enhanced dividend guidance. Prior to the May acquisition announcement, here's what the prior guidance looked like:

2015 = $2.38

2016 = $2.68

2017 = $3.01

The new guidance is quite a bit more robust. Here's what the company expects to pay moving forward:

2015 = $2.47

2016 = $2.85

2017 = $3.21

2018 = $3.61

2019 = $4.06

2020 = $4.57

Note that this year's numbers are based on already made payments to go along with the expectation of paying $0.64 and $0.66 in the third and fourth quarters. Moving from 2015 through 2020 the company anticipates growing the payout by 10% to 15% per annum. The above numbers represent the midpoint of these anticipations. Moreover, these dividend expectations were reaffirmed during the most recent earnings release.

This situation would more or less represent a "bonanza" of both dividend and total returns. In the same presentation, the company suggested that 14% to 19% total returns per year through 2020 were quite possible. This sounds a bit lofty, but indeed could be the case in the above assumptions come to fruition.

Over the five and a half year period you might anticipate receiving $19.60 in dividend payments - representing roughly 40% of today's share price. Based on a 4.25% future dividend yield (a baseline provided by the company) this would indicate a future price of roughly $108. Expressed differently, based on the above dividends and today's price, you might anticipate total yearly returns around 19%. (With a 7% future yield, this would represent annual returns on the magnitude of 10% per year, so it's not as though things have to work out perfectly.)

Of course these assumptions may not hold, but it follows that there is at least a propensity to see outstanding results in the coming years. A high starting yield that grows quite fast tends to offer a solid value proposition.

Sale Or Merger Does Happen

On the other side of the coin, you still have the possibility of a sale and merger going through. In fact, recent news has suggested just that. For the second scenario, let's suggest that Williams receives another bid in the short term. Naturally the offer price would be presumably higher - if you already turned down $64 per share, happy to continue on with your original plan, it seems unlikely that a $60 bid would entice further action.

In this scenario you'd expect a higher price, call it $70 per share. It should be made clear that this isn't a prediction, merely a way to think about the process. Depending on the timeline involved, shares might quickly appreciate by 40%. This seems like a difficult thing to suspect, but it's important to remember that the share price already reacted this way on the mention of such a prospect.

So to begin, if Williams is acquired, you'd start out with a much higher share price in the short term. After that, you have a few options: you could continue to hold your shares until the transaction date and through the new company or you could elect to redeploy into similar or new securities. Similar securities might include companies like Kinder Morgan, Spectra Energy (NYSE:SE) or ONEOK (NYSE:OKE) - all of which have comparatively high starting yields to go along with robust dividend guidance. Even without much growth, solid returns could still be had.

To continue with the illustration, perchance you chose to reinvest into a blend of three above pipelines. Your new starting yield would be roughly 6% with a collective expected dividend growth rate of about 8% per year.

This is indeed an interesting situation. On every dollar invested in Williams today you'd expect to collect about five cents or so in dividends. If you suddenly saw a much higher price (call it 40% higher) and were able to reinvest at a 6% yield, that same dollar invested would be generating about 8.4 cents in dividends. This exceptional increase in anticipated income makes a large difference.

With $10,000 invested, it would mean that you would go from expecting to collect about $500 to $840. In turn, you'd anticipate that $840 to grow by roughly 8% over the years. Over a five-year period you might go on to collect $1,200 per year in half a decade. The future dividend yield is hard to anticipate, but at a 5.5% future yield, for example, this would mean that your principal would double over the period.

Here's what that looks like in Williams share terms: buy at ~$49, price goes to $70, reinvest at 6% yield, expect that payment to grow by 8% annually. In this scenario your total returns would be on the magnitude of 20% per year. Now once again you have the caveat of nothing being guaranteed: perhaps the buyout doesn't happen, perchance you can't reinvest at that rate, and it's conceivable that pipeline companies won't provide their anticipated dividend growth. Yet it remains that there is once more the propensity for spectacular returns moving forward.

Those are the two basic sides of the Williams "investment coin." The first scenario being that the company just keeps moving on: Williams already declined a takeover bid, and it could very well do so again. In this case, the company is anticipating exceptional dividend growth. In turn, this growth could generate quite impressive total returns. According to the company's own presentation, this could be on the magnitude of 14% to 19% annually. This is indeed a very solid baseline.

On the other side of the coin you have the real possibility of a winning takeover bid. In suggesting that the company will "explore strategic alternatives" it's not the process that the board has objected to, but merely the price. As such, a higher bid in the short-term is a real possibility.

If either of these two events occurs, as illustrated above, today's investor would be quite happy in the years to come. Granted there are certainly more possibilities: not as fast of growth, a different deal, the possibility of dividend cut, bankruptcy, all of it. It's always prudent to keep the potential outcomes in mind. Not only that, but it's always important to develop your own expectations. Personally I would contend that the two most likely outcomes are the ones outlined above, or they at least provide a baseline train of investment thought. If this turns out to be correct, an investment in Williams could indeed turn out to be a "heads I win, tails I really win" situation.