Why Enbridge paid $37-billion for Spectra – and also sought Hydro One

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In the middle of a merger era, and in the aftermath of a major acquisition by its chief Canadian rival, it can seem like Enbridge Inc. is shelling out $37-billion for Spectra Energy Corp. to stay toe-to-toe with its competitors.

That narrative, however enticing, isn't quite right.

At an investor day a little less than a year ago, Enbridge laid out its priorities. Chief among them was to diversify its business. The energy giant is heavily weighted to what it calls liquids, which is mostly another term for oil. Ironically, oil has become a bit of a dirty word in the energy world because of what's happened to crude prices, forcing many companies to rework their game plans.

Publicly, Enbridge chief executive officer Al Monaco has expressed goals to expand in power and natural gas. Privately, he's already pursued deals to achieve them. When the Ontario government started mulling a monetization of Hydro One, its massive electricity distribution utility, Enbridge expressed interest in buying the company, according to someone familiar with the talks.

At the time, Ontario was still figuring out what to do with Hydro One. In the end, the government decided to take the utility public, so that it could be sold in chunks, allowing it to retain a piece and benefit if power asset prices rose over time (and they have). Buying the utility would have been major for Enbridge – Hydro One went public with roughly a $12-billion valuation – but ultimately there was no deal.

With Hydro One out of the picture, Enbridge got even more vocal about why it wanted to expand its natural gas portfolio. "More diversification of supply means more reliability," Glenn Beaumont, the company's head of gas distribution, said at the investor day last October. "So we are working on behalf of our customers to access these lower-cost natural gas supplies in the nearby northeast U.S., including, of course, Marcellus and Utica, all of which helps to maintain and extend our price advantage."

The Spectra deal, announced Tuesday, ticks those boxes. Enbridge currently has 3,560 kilometres of long-haul gas pipelines, while Spectra owns 27,520 kilometres – notably, Spectra's run right through the northeast U.S. The target also has enviable midstream assets – or natural gas processing plants – in British Columbia's Montney formation. Combined, the two companies will generate roughly half of their cash flow from natural gas.

"You're diversifying between oil and gas; you're diversifying by geography," Enbridge's CEO said, summarizing the deal.

What he left out, but can't be forgotten: TransCanada Corp. is Enbridge's chief Canadian rival, and in March TransCanada announced plans to acquire Columbia Pipeline group for $13-billion (U.S.) in March. The prized assets in this deal were pipelines in the Marcellus and Utica shale gas regions.

So yes, Enbridge had already laid out its strategy at the time of the TransCanada deal, but watching a rival strike first can't be easy. The new Spectra deal also lands amid of flurry of pipeline and power combinations. Exactly one year ago, Emera Inc. announced it was buying TECO Energy for $10.4-billion– cue the ironic jokes about Labour Day being a quiet period in North America – and in February Fortis Inc. bought ITC Holdings Corp. for $11.3-billion.

Asked "why now?" on a conference call Tuesday, Enbridge's Mr. Monaco didn't reference any of these deals. He stressed both companies are sitting pretty, but the they wanted to assure they had a solid future past 2020. "We had some pretty robust standalone growth," he said. "The first three or four years look very strong [because of committed capital projects] … but now is the time to be thinking about how to position for the future."

Spectra, though, hinted there was some urgency in the last little while. Although the two companies had held talks for years, Greg Ebel, Spectra's CEO, said "the stars lined up" in the last few months.

Because their discussions have lasted for so long, the deal is well thought through. This wasn't a rush job. The companies met with rating agencies before announcing the transaction to lay out their goals for debt reduction, and the two CEOs worked together to present an all-stock deal. (In other words, this isn't one company putting in a hostile bid for the other simply to build an empire.)

Together, the CEOs stress investors will benefit because there will be huge dividend growth – 15 per cent in 2017, and then 10 to 12 per cent annually until 2024. The cash and debt saved by doing the all-stock deal will be "spent" on shareholders.

It's the perfect time to pitch such a strategy, because dividend stocks are in favour. Whether it'll be the right call in five year's time is a little less certain.

A similar uncertainty exists around the combined company's growth plans. They've got a solid idea of what to do for the next three years, but aren't exactly sure what they'll devote their attention and capital to past 2020.

Asked about his intentions, Mr. Monaco acknowledged he wasn't quite sure. "It's almost a toss up," he said, adding he has ample choices.