Please ensure Javascript is enabled for purposes of website accessibility

3 M&A Deals That Would Just Make Sense

By Matthew DiLallo – Apr 2, 2018 at 8:05AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

These companies could create big-time value for investors by joining forces.

M&A activity in the energy sector has started heating up over the past couple of months. Not only was there a pricy merger in the oil patch, but also two more master limited partnerships (MLPs) bit the dust. Those MLP transactions are just the latest in a string of deals in the sector over the past few years. More appear likely since too much redundancy, and high fees within the space, have weighed on valuations in recent years. That's why I think more dominoes will fall, with the following deals likely to come down the pipeline since they make the most sense.

Already looking into it

In late February, Antero Midstream Partners (AM -0.96%) and its parent, Antero Midstream GP (NYSE: AMGP), announced plans to hire advisors that will assist them in exploring, reviewing, and evaluating potential measures to improve the valuations of the two companies. That's after both declined 20% over the past year even though each has rapidly increased distributions to investors. Among the options they're likely to consider is merging the two entities.

Two men shaking hands with arrows pointing upward.

Image source: Getty Images.

That option makes sense because it would eliminate the costly incentive distribution rights (IDRs), which entitle Antero Midstream GP to a growing portion of Antero Midstream Partners' cash flow. Currently, those fees consume more than 30% of the company's cash flow and are on pace to rise above 40% over the next five years. That 30% level is worth noting since that's where we've seen many other MLP roll-up transactions occur. Given that the companies are already looking into a transaction, I'd say there is a high probability they announce one in the coming months.

Taking the first step

EQT Midstream Partners (EQM) is already in the midst of an ownership restructuring. In late February, its parent company, EQT Corp., announced a series of moves to separate itself from its midstream business. These included dropping down its remaining midstream assets to EQT Midstream as well as merging it with another MLP it owns, Rice Midstream Partners. Further, it plans to sell the IDRs of Rice Midstream Partners to EQT GP Holdings (NYSE: EQGP) and spin off its ownership interests in both EQT Midstream and EQT GP Holdings into a separate publicly traded entity.

While that complex flurry of moves will get EQT out of the midstream business, it doesn't solve the redundancy problem, nor the fact that EQT Midstream pays out more than 35% of its cash flow in the form of IDRs to EQT GP Holdings, which could grow to more than 40% in five years. That's why it wouldn't be a surprise to see an additional roll-up transaction after the spin-off where that new midstream company gobbles up both EQT Midstream and EQT GP Holdings to form one stronger entity.

A dollar bill folded as an arrow that goes down but them back up higher.

Image source: Getty Images.

It's only a matter of time

Western Gas Partners (WES -3.21%) hasn't publicly stated any desire to complete a simplification transaction with its parent, Western Gas Equity (NYSE: WGP), that would eliminate the costly IDRs, which currently consume more than 35% of the company's cash flow. In fact, on its fourth-quarter conference call, CEO Ben Fink stated that "while numerous MLP restructuring transactions have been recently announced, we have nothing new to say on this topic." That statement comes even though the percentage of cash paid out to Western Gas Equity is within the range of most other recent restructurings and seems to have started weighing on their valuations over the past year, since both have slumped more than 25% in that time frame. 

Fink did go on to state that "at the appropriate time, we'll proactively address the structure if we believe that our cost of capital could present an impediment to the fundamentals of our business." That's not the case at the moment, since Western Gas Partners doesn't need to issue equity this year to finance its expansion program. However, the company can't keep investing in growth projects at its current rate, and paying its high-yielding distribution, without issuing additional equity in the future, which will only get more expensive if the valuation keeps falling, and the IDRs continue rising. That makes it increasingly likely that the companies will look to get out ahead of this need by making a move to eliminate those IDRs sooner rather than later.

The next wave is coming

Antero Midstream, EQT Midstream, and Western Gas Partners pay some of the highest management fees to their parents in the MLP space. That's why it makes so much sense for these companies to explore merging with those entities to not only get rid of the fees but form one stronger midstream company. By eliminating the weighty costs and redundancy, these combined entities could create more value for investors in the future than if they remain on their current paths.

Matthew DiLallo has the following options: short June 2018 $25 puts on Antero Midstream Partners. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Western Midstream Partners Stock Quote
Western Midstream Partners
WES
$26.25 (-3.21%) $0.87
EQT Stock Quote
EQT
EQT
$44.51 (-0.89%) $0.40
EQT Midstream Partners Stock Quote
EQT Midstream Partners
EQM
Antero Midstream Partners Stock Quote
Antero Midstream Partners
AM
$9.79 (-0.96%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
342%
 
S&P 500 Returns
110%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/05/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.