Pipeline operator Energy Transfer Equity LP sweetened its deal for rival Southern Union 21 percent to about $5 billion, as it works to muscle out a competing offer from Williams Companies Inc .

Southern Union Chief Executive George Lindemann and Chief Operating Officer Eric Herschmann also volunteered to cancel the controversial consulting and non-compete agreements they signed as part of the original deal with Energy Transfer that would have paid them each $50 million over five years.

Southern Union has signed on to the $40-a-share cash and stock deal from Energy Transfer, which tops Williams' bid by about $1 a share, or around 2.6 percent. The deal would nearly double Energy Transfer's pipeline capacity and position it for future gas demand.

The offer is below the Southern Union stock's Friday close of $40.37. After the announcement, the company's shares rose 2.9 percent to $41.53, suggesting investors are hoping Southern Union will still receive a higher bid.

Under the deal, Southern Union shareholders can elect to swap their common shares for $40 of cash, or 0.903 Energy Transfer common units.

This deal creates strategic benefits that could not be achieved through any other industry combination, Southern Union's Lindemann said in a statement.

The new deal replaces the complicated $33-a-share deal ETE launched last month, which would have been payable in newly issued series B units of Energy Transfer.

Williams followed that with its unsolicited $39 a share cash bid.

Southern Union owns and runs more than 20,000 miles of pipelines in the U.S. Southeast, Midwest and Great Lakes regions as well as Texas and New Mexico. It also owns local gas distribution companies that serve more than half a million end-users in Missouri and Massachusetts.

Despite weak natural gas prices, production has been rising as energy companies pile into shale fields -- underground rock formations rich in oil and gas.

Increased production from shales such as the Marcellus in the eastern United States has also benefited companies transporting and processing natural gas, like Williams, Southern Union and Energy Transfer.

COULD WILLIAMS BID HIGHER?

Dallas-based Energy Transfer said it has secured about $3.3 billion in committed financing from Credit Suisse and received signed support from 14 percent of Southern Union shareholders.

The maximum cash component of the Energy Transfer bid would be 60 percent of the total deal value, and the unit component can fluctuate between 40-50 percent, Energy Transfer said in a statement.

Energy Transfer also said it raised the break-up fee if Southern Union walks away to $162.5 million, compared with a $92.5 million break-up fee in the original deal that rose over time to $135 million.

Carl Kirst, an analyst for BMO Capital Markets, said that given how much Williams has said a deal for Southern Union could add to its bottom line, there is no doubt that Williams has the capacity to continue bidding more.

But Kirst said that Williams needs to consider whether it will now be too expensive to top Energy transfer, given changes to the break-up fee and the cash component of the deal.

If Williams does decide to come out and counter, odds are it's not going to take just a dollar, he said. They are going to have to put something out that once again establishes to Southern Union's bid that this is a superior offer.

The master limited partnerships (MLPs) that compete with Southern Union trade at a valuation of roughly 11 times 2012 earnings before interest, taxes, depreciation and amortization (EBITDA), according to an analyst who was not authorized to speak to the press.

The latest bid values Southern Union at roughly 9.6 times 2012 EBITDA, which paired with tax costs to drop the company's assets into MLPs means the bids are starting to get expensive, the analyst said.

In connection with the deal, Energy Transfer said it plans to drop Southern Union's 50 percent stake in Citrus Corp -- owner of the Florida Gas Transmission pipeline system -- down to its master limited partnership Energy Transfer Partners for $1.9 billion in cash after the deal closes.

The drop-down will allow Energy Transfer Equity to deleverage its balance sheet, the company said.

Credit Suisse is acting as ETE's financial adviser, while Evercore Partners and Goldman Sachs are advising the special committee of Southern Union's board that is working on the deal.

(Additional reporting by Krishna N Das in Bangalore; Editing by Maju Samuel, Dave Zimmerman)

Energy