Wall Street came to appraise the merger of Energy Transfer Equity LP (NYSE: ETE) and Williams Cos. Inc. (NYSE: WMB)—and decided to bury it.

Traders, convinced that the deal won’t happen, no longer price the companies as a combined entity and have returned to treating them as individuals, Jefferies LLC analyst Chris Sighinolfi told Bloomberg.

The latest loss of confidence that the merger would go the distance came with last week’s disclosure that a key component of the deal may not be tax-free. Energy Transfer provided more detail regarding its previous disclosure that lawyers at Latham & Watkins LLP could not issue a “721 opinion,” concluding that a transfer of the Williams assets into Energy Transfer Partners LP following the merger would be tax-free.

In a transcript of the May 5 earnings call with analysts provided by Seeking Alpha, Energy Transfer’s Chairman and CEO Kelcy Warren removed any doubt about the deal’s status.

“We can’t close,” he said in response to a question by Neuberger Berman’s Yves Siegel. “We don’t have a transaction that can close. So I want to be very clear, we can’t close this transaction. We have a merger agreement. We have obligations under that merger agreement. We take that very seriously. We intend to honor all of our commitments under the merger agreement, but we can’t close this deal. We don’t have a deal that’s closeable.”

Unless it’s restructured.

Warren made it clear that a substantial restructuring of the agreement could succeed, and among those changes would be dropping the $6 billion cash component and making the merger an all-equity transaction. That won’t happen, Darren Horowitz of Raymond James & Associates wrote in a note to clients, because Williams is unlikely to agree to change the terms.

While the merger and related transactions are complicated, there are three key parts to the transaction involving Energy Transfer and Williams:

  • The merger of two corporate entities, in which an acquiring corporation formed by Energy Transfer essentially acquires Williams;
  • The acquisition of acquiring corporation stock by Energy Transfer Partners LP in exchange for cash to fund the cash part of the consideration paid to Williams shareholders in the merger; and
  • The drop down of the Williams assets, post-acquisition, by the acquiring corporation into Energy Transfer Partners in exchange for a partnership interest.

Timothy Devetski, Houston-based partner with Sidley Austin LLP If the last two aspects of the deal were treated separately, then there would be no tax dilemma, Timothy Devetski, Houston-based partner with Sidley Austin LLP, told Hart Energy. Section 721(a) of 26 U.S. Code states that a contribution to a partnership in exchange for a partnership interest is effectively tax-free.

What complicates matters is that the partnership is also paying cash for stock of the acquiring corporation. That combination, which was contemplated as part of the original deal, now raises red flags at Latham. As disclosed by Energy Transfer, Latham is now bringing into question whether some of those funds can be allocated to the partnership dropdown deal.

Latham advised its client, Devetski said, that a decline in ETE’s market value also makes the separation of these two steps more difficult and their combination more likely.

“They’re saying, ‘you’re paying $100 for stock that’s only worth $50,’” Devetski said. “Because of that, the difference between those two things is a consideration that needs to be taken into account as part of the partnership dropdown, and therefore it makes the partnership dropdown at least partially taxable.”

Williams disputes this characterization and, according to the disclosures, has offered some alternative non-taxable restructuring possibilities.

That is clearly an outcome that Energy Transfer wished to avoid when it struck the then-$38 billion deal last September, which would have given it control of 71,000 miles of pipelines in the U.S. The merger is now worth an estimated $21 billion.

That makes June 28, the closing deadline, the next significant date in this saga. That is when either party has the right to walk away if it is not complete.

Joseph Markman can be reached at jmarkman@hartenergy.com and @JHMarkman.

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