Pipeline companies ONEOK (OKE 0.26%) and Magellan Midstream Partners (MMP) are merging to create a $60 billion energy infrastructure giant. The transformative transaction will form a much more diversified energy midstream company. The deal also has significant financial and tax benefits, enhancing the combined company's ability to support a high-yielding dividend.
However, despite those positives, the combination is a bit of a head-scratcher since the pairing isn't a great strategic fit. Here's a closer look at the deal and why it might not pay off in the long run.
Drilling down into the deal
ONEOK is acquiring Magellan Midstream Partners in a cash-and-stock transaction valued at $18.8 billion, which includes the assumption of Magellan's debt. ONEOK is paying $25 billion in cash and 0.667 shares for each of Magellan's common units. That gives it an implied deal price of $67.50 per unit, a 22% premium compared to last Friday's closing price. That's a big-time premium for the 7.6%-yielding master limited partnership (MLP).
Despite that hefty premium, ONEOK expects the transaction to be highly accretive. The pipeline company anticipates the deal will increase its earnings per share next year and boost them by 3% to 7% per share annually from 2025 to 2027. Meanwhile, it sees free-cash-flow per-share accretion averaging more than 20% annually from 2024 through 2027.
Two main factors drive these financial benefits:
- Deal synergies: By combining, the companies expect to save at least $200 million annually. They see the potential for more than $400 million in future deal synergies.
- Tax benefits: ONEOK expects it will be able to defer paying the new corporate alternative minimum tax from 2024 to 2027 by acquiring Magellan.
ONEOK expects the deal to materially increase its free cash flow after paying dividends. The combined company foresees producing about $1 billion in annual excess free cash flow over the next four years. That will give the company additional capital for debt reduction, growth-capital spending, and higher shareholder returns through dividend increases and share repurchases. The company expects to grow its dividend, which currently yields 6%, while maintaining a payout ratio below 85%.
Finally, ONEOK expects to maintain a strong credit profile. It anticipates ending next year with a debt-to- earnings before income, taxes, depreciation, and amortization (EBITDA) ratio of 4.0 times. Meanwhile, it sees its leverage ratio falling below 3.5 times by 2026 (which is close to its current level) as it completes expansion projects.
Diversification or diworsification?
The combination of ONEOK and Magellan Midstream Partners will create a much larger scale and diversified midstream company:
Image source: ONEOK.
As that slide showcases, the deal will combine ONEOK's natural gas liquids (NGLs) focus with Magellan's concentration in refined petroleum products. The company believes this will allow it to increase utilization of the complementary systems and potentially cross-sell products to customers.
However, the two companies aren't an ideal strategic fit. While they operate in many of the same regions, ONEOK focuses on gathering natural gas from producers and turning it into NGLs primarily used by the petrochemical industry. Meanwhile, Magellan's core business is to move refined products from refineries to market centers. A better strategic fit for ONEOK might have been a more upstream-focused midstream company that gathers crude oil in the regions where it gathers natural gas.
Another potential concern with this combination is the potential future disruption from electric vehicles, which could eventually sap demand for refined petroleum products. While the rest of the industry is transitioning toward cleaner energy (like natural gas and renewables), ONEOK is moving toward oil and refined products. Meanwhile, unlike many peers, neither company has started investing much money to transition their business to lower carbon energy. However, their enhanced financial flexibility will enable ONEOK to increase investment in lower-carbon businesses in the future.
Finally, ONEOK is acquiring a platform with limited visible growth prospects. Magellan only expected to invest $120 million this year and $40 million in 2024 on a couple of small expansion projects. For comparison, ONEOK expects to invest $1.1 billion to $1.2 billion on growth-capital projects this year. It also has several large-scale expansions under development.
Not a perfect combination
ONEOK and Magellan Midstream Partners are joining forces to create a more diversified energy infrastructure company. While the deal has many financial benefits, it's not a perfect strategic fit. Because of that, it might not be a long-term growth driver once the tax benefits wear off since the deal will send ONEOK's carbon footprint in the wrong direction. ONEOK will need to use its improved financial flexibility to line up additional sources of growth to give it the fuel to continue growing its high-yielding dividend in the coming years.
