Brookfield Infrastructure (NYSE:BIP)(NYSE:BIPC) made a bold bet during last year's market meltdown on an eventual recovery by purchasing more than $600 million of shares in beaten-down publicly traded infrastructure companies. That wager has already paid off. Brookfield has since cashed in on some of those investments, pocketing a hefty $60 million profit.
However, it has retained a stake in some of those companies hoping that at least one would lead to a larger transaction. We now know the identity of one of those targets: Canadian midstream operator Inter Pipeline (TSX:IPL). That's after Brookfield publicly revealed that it has offered to take Inter Pipeline private. Here's why it sees value in the beaten-down energy infrastructure company.
Details on the potential deal
Brookfield has offered to pay at least 16.50 Canadian dollars ($13.03) for each share of Inter Pipeline that it doesn't already own, implying a 23% premium from the recent closing price. That price point values Inter Pipeline at CA$13.5 billion ($10.7 billion). It's offering existing investors the option of receiving CA$16.50 per share in cash or 0.206 shares of Brookfield Infrastructure Corporation. Brookfield already owns a 19.6% interest in Inter Pipeline, making it the company's largest shareholder.
However, Brookfield has made it clear that its initial offer is only a starting point for negotiations. It wants access to certain inside information to complete its due diligence. If it likes what it sees, the company could bump the offer price up to between CA$17.00-CA$18.25 per share ($13.42-$14.41).
Brookfield has been trying to negotiate privately with Inter Pipeline. However, it hasn't gotten very far because Inter Pipeline has a different view on its valuation, fueled by a very positive future outlook for commodity prices and its growth prospects. Brookfield hopes that it can jump-start the negotiations by making its overtures public.
Why the interest in Inter Pipeline?
Inter Pipeline operates a world-scale energy infrastructure business primarily backed by stable, long-term contracts. It owns four types of infrastructure assets:
- Oil sands transportation (59% of 2020's EBITDA): Its pipelines transport 2.3 million barrels per day (BPD).
- Natural gas liquids (NGL) processing (16%): Inter Pipeline operates 140,000 BPD of NGL production capacity.
- Conventional oil pipelines (12%): It operates a more than 2,400-mile pipeline network in Western Canada.
- Bulk liquid storage (13%): Inter Pipeline owns 19 million barrels of liquid storage capacity in Europe.
Roughly three-quarters of the earnings generated by these assets come from cost-of-service contracts, while another 15% are fee-based, making them very stable revenue streams. The other 10% of the company's revenue comes from commodity-based activities or product margins, which vary with commodity prices and volumes.
The overall stability of Inter Pipeline's earnings profile aligns with Brookfield's strategy of owning highly contracted infrastructure assets that generate relatively steady cash flow. However, the crude oil focus of its earnings makes Inter Pipeline an interesting target for Brookfield Infrastructure. It has historically preferred to invest in natural gas-focused midstream assets given that fossil fuel's lower carbon emissions profile. That gives it a competitive advantage over oil in an environment where carbon emissions are becoming an increasing concern. It's Inter Pipeline's focus on crude oil, particularly its concentration in the carbon-intense oil sands region, that has weighed on its valuation.
The other interesting aspect of this target is that a significant portion of Inter Pipeline's value proposition is in the Heartland Petrochemical Complex that it's developing in Canada. The company is investing roughly CA$4 billion ($3.2 billion) to build the petrochemical plant, which should be operational by next year. It could produce an incremental CA$450 million to CA$500 million ($355 million-$394 million) in average annual EBITDA, which is a sizable amount considering that Inter Pipeline only generated CA$730 million ($575 million) in adjusted EBITDA through the first nine months of 2020. Brookfield wants more details on this project, which could lead it to raise its offer price.
Seeing deep value in oil infrastructure
Brookfield Infrastructure is a value-oriented contrarian investor at heart, which is what makes Inter Pipeline an appealing opportunity. While the market is looking past oil pipelines to a cleaner future, Brookfield believes that the economy will rely on fossil fuels for years to come, enabling these assets to continue generating cash. It wants to buy the rest of Inter Pipeline so it can squeeze as much value out of its existing infrastructure as possible while capturing the upside opportunity of Heartland.
However, Inter Pipeline's management team also sees this value and believes the market and Brookfield aren't giving it anywhere near full credit for this potential. There's no guarantee they'll agree on a deal. Even if they don't, Brookfield will still end up with a victory, since its initial purchase during last year's market sell-off is now much more valuable thanks to the oil market's continued recovery.