Some merger announcements cause lots of head-scratching among investors because the combinations don't appear to make much strategic or financial sense. That leaves people concerned that the deals could have disastrous consequences.

Others, however, are so logical that it's more surprising that they didn't happen sooner. The announcement that refining giant Marathon Petroleum (NYSE:MPC) will combine its two master limited partnerships (MLPs), MPLX (NYSE:MPLX) and Andeavor Logistics (NYSE:ANDX), into one large-scale midstream company would certainly seem to be one of the latter situations. The deal makes perfect sense because it will enhance MPLX's growth prospects and financial profile, improving the long-term sustainability of its 8.5%-yielding distribution.

Two people shaking hands with an energy facility in the background.

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Drilling down into the deal

Marathon is merging Andeavor Logistics -- which it acquired last year when it bought that company's parent -- into MPLX, an MLP it formed in 2012 to drive its midstream growth strategy. The MLPs will complete a unique unit-for-unit exchange:

  • Public unitholders in Andeavor Logistics will receive 1.135 units of MPLX for each Andeavor unit they currently hold. That represents a 7.3% premium to that company's recent trading price.
  • Marathon Petroleum, meanwhile, will receive 1.0328 units of MPLX for each of its Andeavor units. That implies a 2.4% discount to the trading price before the deal's announcement.

Overall, the transaction values Andeavor at $14 billion, which is a roughly 1% premium to its valuation before the deal's announcement. One aspect of the merger worth noting is that Marathon is giving up some value in the transaction. However, the benefits of the deal should far outweigh that short-term hit.

Why this merger makes sense

This transaction does three things for MPLX. First, it enhances the company's portfolio by increasing its presence in the fast-growing Permian Basin. Andeavor controls a large-scale oil gathering system in the region, which will compliment MPLX's gas gathering and processing business in the area. By combining these assets, the company will operate a full-service midstream operation in the region. In addition to the greater scale in the Permian, MPLX and Andeavor Logistics own similar assets focused on transporting, storing, and processing oil and gas in other areas of the country.

Second, the company will be able to earn higher returns on future expansion projects by leveraging its larger-scale platform to secure more attractive opportunities. For example, the company recently agreed to partner with Plains All American Pipeline and ExxonMobil on their Wink-to-Webster oil pipeline. Not only will MPLX invest in that pipeline, but it will also supply crude to that system through Andeavor's oil gathering assets in the Permian. In joining forces with those companies, MPLX will earn higher investment returns than it would have on a separate project it was pursuing.

Finally, the combination will improve MPLX's financial profile. The MLP already covers its high-yielding distribution by a comfortable 1.4 times. However, it sees that level increasing as expansions come online over the next two years. That enhanced coverage, when combined with the company's increased scale and diversification, should improve its credit profile. That could lead rating agencies to upgrade its credit rating, which would lower the company's borrowing costs and improve its access to capital.

This transaction continues MPLX's evolution into a diversified, large-scale midstream company. The MLP will operate "wellhead-to-water" assets, which includes gathering systems that move oil and gas from wells into longer-haul pipelines that send it to processing complexes and export facilities along the coast. That allows the company to make more money as it moves hydrocarbons across the entire midstream value chain.

An even better high-yield investment

This combination will enhance MPLX's portfolio, increase its returns, and improve its financial profile. Better yet, it didn't pay a high premium for all these benefits, especially considering Andeavor's unit price has been under pressure ever since Marathon bought its parent in anticipation of this deal. Because of all that, MPLX's high-yielding payout, which it has increased for 25 straight quarters, will become even more sustainable over the long-term and will probably continue heading higher.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.