On Sunday, midstream corporation ONEOK (OKE) announced that it will acquire MLP Magellan Midstream Partners (MMP) in a cash-and-stock deal valued at $18.8 billion. The deal comes as a surprise and represents a relatively rare example of M&A among unrelated public companies in the midstream space. We believe the deal premium and implied multiple have positive read-through for other midstream MLPs, though the tax implications could be a fly in the ointment for MMP holders.
Transaction Details
The deal outlines consideration of $25 in cash and 0.667 shares of ONEOK stock per MMP unit. Based on closing prices from May 12, the implied price of $67.50 per unit represents a 22% premium. For context, MMP last closed above $67 in September 2019. The transaction, which is subject to customary closing conditions, is expected to close in the third quarter of 2023.
The deal is expected to be accretive to earnings per share beginning in 2024. The free cash flow per share accretion is expected to average greater than 20% from 2024 through 2027. Synergies are estimated to be at least $200 million annually with the potential for synergies to exceed $400 million within 2-4 years. Free cash flow after dividends and growth capital is expected to average ~$1 billion annually for the first four years following the closing of the deal. Excess cash may be used for debt reduction, growth capex, and shareholder returns including dividends and/or equity repurchases, as OKE remains committed to growing its dividend. The combined company is expected to have a pro-forma net debt-to-EBITDA of ~4.0x at year-end 2024 with leverage expected to fall below 3.5x by 2026.
Unique Asset Bases Result in Diversified Combined Company
ONEOK and Magellan have some geographical overlap among their assets, but their operations are very different. OKE is primarily focused on natural gas liquids (NGLs), with gathering & processing and natural gas pipelines rounding out the business. MMP is largely focused on refined product pipelines (i.e., those that move gasoline and diesel) and oil pipelines. Growth opportunities in midstream have largely favored natural gas and NGLs, while growth opportunities for oil and refined products have been more limited. By combining unique asset bases, the transaction will result in a larger, more diversified corporation. MMP’s asset base and expertise may also accommodate new export opportunities for OKE.
Among MLPs, MMP has been known for its capital discipline, steady distribution growth, and generous buybacks in recent years – positive attributes that will be missed by MLP investors. As discussed on the call this morning, MMP holders will see a lower dividend upon close, but given enhanced growth prospects of the combined company, there is likely more dividend upside in the long run. MMP’s business generates significant free cash flow given modest capital requirements, which will drive the expected step change in free cash flow for the combined entity.
Taxes an Important Component to This Deal
For MMP and OKE holders, tax implications are a key part of this transaction. For MMP holders, the deal will be a taxable event. Based on our understanding, taxes will need to be paid on return of capital distributions received over the years (basis recapture) and any potential capital gains relative to the purchase price. Basis recapture is taxed at ordinary income rates with a 20% qualified business income deduction (read more). For long-time MMP holders, the tax impact may be significant. We are not tax experts, and MMP holders should consult with their tax advisor for details unique to their situation. The announcement noted that the premium offered and the cash component may help with the tax implications for MMP holders.
Without getting too far into the weeds, the deal has tax benefits for OKE that are estimated at $3 billion with a net present value of $1.5 billion. In short, the impact of the corporate alternative minimum tax for OKE is expected to be pushed from 2024 to 2027. Tax benefits could potentially increase if new projects are completed or additional acquisitions are made. It is difficult to speculate whether this transaction may serve as a catalyst for more dealmaking in the space or the extent to which potential tax benefits could motivate additional consolidation.
Valuation
The transaction value implies a 12.0x multiple relative to MMP’s estimated 2024 EBITDA. For context, as of May 12, MMP was trading at 10.4x 2024 EBITDA. MMP has typically garnered a premium valuation relative to other midstream names, and it boasts the highest EV/EBITDA multiple among constituents of the Alerian MLP Infrastructure Index (AMZI), which had a weighted average forward EV/EBITDA multiple of just 8.5x as of May 12. While acknowledging MMP’s historical premium, the deal has positive readthrough for other midstream MLPs and highlights the value of midstream’s fee-based business model.
Bottom Line
ONEOK’s acquisition of Magellan will result in greater free cash flow generation and a more diversified corporation upon closing. MLP investors will likely miss the positive investment attributes provided by MMP. For MMP holders, the deal premium is likely welcome, but the tax implications may potentially sting.
AMZI is the underlying index for the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB).
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