Acquisitions aren't new in the North American midstream sector. But Enterprise Products Partners' (EPD -0.15%) new $3.25 billion deal should get investors thinking about mergers and acquisitions in the sector a little differently. Here's a look at Enterprise's acquisition and what it might mean for the future.

The latest acquisition

In early January, midstream master limited partnership (MLP) Enterprise Products Partners agreed to acquire privately-held Navitas Midstream Partners for $3.25 billion in cash from an affiliate of Warburg Pincus. Navitas owns 1,750 miles of pipelines and cryogenic natural gas processing facilities that, upon completion of a major project in 2022, will have over 1 billion cubic feet per day of processing capacity. It operates in the Midland Basin of the Permian.

A person drawing a picture of a large fish getting ready to swallow a smaller fish.

Image source: Getty Images.

Enterprise describes the Midland Basin as "one of the most economic and prolific crude oil regions in the United States." It wants to be there. Management noted that the deal will give it access to a region that currently contains around 20% of all of the active onshore-drilling rights in the U.S. market.

The region has over 40 producers with Navitas Midstream's future growth stemming from the up-to-10,000 potential drilling locations in the area. Enterprise estimates that's 15 years worth of drilling inventory. Like the rest of Enterprise's business, Navitas' portfolio is largely backed by fee-based contracts.

In other words, Enterprise's acquisition of Navitas is a way to expand its regional footprint while sticking close to its core business model. Management expects the purchase to add $0.18 to $0.22 per share to distributable cash flow in 2023, which would be the first full year of ownership.

This appears to be a decent deal for the midstream giant. But there's a bigger picture here.

More of the same in the future?

Enterprise Products Partners' units currently yield around 7.8%, which is historically high. That helps explain why the MLP is planning on using cash on hand and debt to finance the transaction. Historically, the company's units might have come into play, as well, but with the units trading with such a large yield, it was likely cheaper to avoid a unit sale. 

Part of the reason for the weak unit pricing is the negative view of the energy sector in a world focused on clean energy and ESG investing. This backdrop has also made it more difficult to build substantial projects from the ground up, which often need multiple levels of approval, including at the federal level.

Simply put, it's probably easier to buy an existing asset, which can immediately add to cash flows, than it is to start from scratch for an entity as large as Enterprise. Bigger companies need bigger projects to materially move the needle on the top and bottom lines. Meanwhile, given Navitas' opportunity for future capital spending, it also helps to bolster Enterprise's internally driven growth prospects. 

While the internal-spending opportunity is modest compared to Enterprise's scale, it will help the giant MLP grow modestly through construction & development. Or perhaps it's better to say that the modest internal spending will allow it to keep putting money to work while it looks for more big deals. Acquisitions are lumpy and hard to predict, but they're likely to become more important in the midstream space now that sizable capital-spending opportunities are slowing. 

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There's also an issue of overbuilding in the midstream sector that still has to be worked out, as well. For example, industry watcher Chris Baltimore with Argus recently described pipeline capacity as having gone from "famine to feast" thanks to a building boom in key U.S. energy-producing regions.{https://www.argusmedia.com/en/blog/2021/december/1/podcast-the-crude-report-pipeline-capacity-goes-from-famine-to-feast} Given Enterprise's size it should be able to find investment opportunities in it's business. Really big opportunities for investment, though, the kind that push the top and bottom lines materially higher, could be more difficult to justify right now. The optimistic view of this situation is it could also make it easier for Enterprise to find acquisition targets, given that pipelines that have been built could find it difficult to fill their available capacity. Selling to a larger player like Enterprise might be preferential for these companies over waiting for more demand.  

Not good or bad, it just is

Business environments change over time, and right now, it looks like it's easier to buy than build in the midstream space. Enterprise is one of the largest players in North America and has an investment-grade rated balance sheet, so it's in prime position to be an industry consolidator.

The giant MLP has proven it can successfully pivot along with the market as it looks to keep making money, and supporting its growing distribution, for its unitholders. Which, for conservative investors, is exactly the type of thing you want to see.