Once upon a time, like a few months ago, a merger between Energy Transfer Equity (NYSE: ETE) and Williams (NYSE: WMB) would have been cause for a celebration. On Monday the crime was punished with a public whipping, ETE units and WMB shares losing more than 12% apiece while the MLP sector as a whole shed 6% en route to a new bear-market low.

Bigger is not better at the moment in a midstream sector most investors are either boycotting or continuing to flee amid slumping energy prices. Promises of billions in long-term cost savings and the reputation of Energy Transfer chief Kelcy Warren as a shrewd dealmaker meant little to a market plainly preoccupied with worst-case scenarios.

The good news is that the worst case for Williams is by now widely known, so perhaps priced in. It involves a sharp and prolonged decline in U.S. energy production that has not yet taken place, but is sure to come if overseas demand doesn’t perk up and prices don’t recover. The pipeline operator has already had to renegotiate at least one gas gathering agreement to provide a retrenching producer with short-term cost savings, and other customers are likely clamoring for similar relief.

The slump explains how an Energy Transfer offer worth $48 billion when it was first publicized in early July was valued at less than $33 billion as of yesterday. The proposed equity exchange ratio didn’t change, but the merger partners’ respective valuations have since tumbled.   

Even so, Williams was able to extract important improvements on the original Energy Transfer offer. One is that it’s now willing to pay up to $6.05 billion of the aggregate purchase price in cash, rather than equity. That works out to a likely split of $8 in cash and 1.5274 of newly issued shares tracking ETE units for each WMB share.

The new ETC common shares will pay common dividends equal to ETE distributions, and will in fact be backed by ETE units held by an incorporated ETE subsidiary. Because the common dividends are unlikely to have the same tax deferral benefits as the underlying units, Energy Transfer will also issue a “contingent consideration right” entitling ETC shareholders to compensation for the potential discount on ETC shares relative to ETE units over a two-year period following the closing of the deal, currently expected in the first half of 2016. Energy Transfer has also committed to paying ETC dividends equal to ETE distributions through 2018.  

To merge with Energy Transfer, Williams had to abandon its prior plan to absorb its Williams Partners (NYSE: WPZ) MLP, which will now remain a publicly traded affiliate of Energy Transfer’s. WPZ unitholders will instead receive a $428 million breakup fee, though 60% of that will never leave corporate coffers as a result of Williams’ equity interest in its MLP.

The exchange of WMB shares for ETC stock will not trigger capital gains taxes, though these will still apply to any cash payments received under the buyout.

Source: Energy Transfer presentation

Though the market is in mood now to appraise the deal’s upside, it is considerable for what would be, by far, the largest U.S. midstream company and one of the world’s largest energy concerns, marrying Energy Transfer’s Gulf Coast concentration and continental reach to Williams’ strategic footprint stretching from the Marcellus in the Northeast all the way down the Atlantic Seaboard.

Energy Transfer estimates $300 million to $400 million in annual cost savings as a result of the deal by 2017. It also expects the transaction to be immediately accretive to its cash flow and distributions, which is simply a byproduct of the $6 billion in new borrowing it will undertake to finance the cash component of the buyout. ETE distributions are expected to continue increasing at the current pace of more than 30%-plus annually, and the hope is for longer now that it can profit from selling Williams assets to WPZ as well as its other MLP affiliates.

Portfolio Update

Betting on Warren, Buying Williams

This is another big gamble by Warren, who’s quickly built Energy Transfer into a giant by taking advantage of market dislocations and might have once again bought low. The domestic oil and gas production is not going away, and is very cost-competitive against overseas alternatives for meeting the world’s still growing energy demand. The low prices that currently obscure these facts are likely to head higher over time, which should make this deal look great for Energy Transfer eventually.