This Energy Midstream Mega-Deal Will Be A Winner

U. S. natural gas pipeline giant ONEOK (OKE) is set to buy Magellan Midstream Partners (MMP), which owns a pipeline network that primarily transports crude oil and refined products for $18.8 billion.

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This is going to be huge for investors…

Magellan shareholders will receive $25 cash and two-thirds of an ONEOK share for each unit of stock they hold, representing a 22% premium to the company’s closing price before the deal announcement.

 

A Look at the ONEOK-Magellan Midstream Deal

This proposed deal will create one of the biggest oil and gas infrastructure companies in North America—a company with an enterprise value of $60 billion and a sprawling 25,000-mile network of pipelines stretching from North Dakota to Texas.

Pierce Norton, CEO of ONEOK, described the transaction as “transformational,” adding:

The combination of ONEOK and Magellan will create a diversified North American midstream infrastructure company with predominately fee-based earnings, a strong balance sheet and significant financial flexibility focused on delivering essential energy products and services to our customers and continued strong returns to investors.

Norton is right. And so is my colleague, Tim Plaehn, who loves the deal.

But don’t tell that to Wall Street, which hated the deal so much that ONEOK’s stock plunged 10% after the announcement.

Wall Street seems to be questioning the commercial logic from ONEOK in stepping out of its core natural gas transportation business to buy Magellan’s crude and refined fuels pipelines. Analysts think the businesses are so different that ONEOK management will not be able to handle it.

In a recent article about the merger, Tim wrote: “In its current form, ONEOK is a very well-managed energy midstream company. The shares yield about 6.5%, and earnings and cashflow will increase for 4% to 6% dividend growth.” Tim went on to quote a few highlights from ONEOK’s press release about the Magellan acquisition:

  • The transaction is expected to be earnings per share accretive beginning in 2024, with an accretion of 3% to 7% per year for 2025 through 2027.
  • Free cashflow (different from EPS) accretion is expected to average more than 20% from 2024 through 2027.
  • Free cashflow after dividends and growth capital investments will increase by about $1.0 billion yearly in the first four years after the merger.

“Bottom line,” Tim concluded, “The combined company will generate tremendous and growing free cashflow. That should lead to strong dividend growth. ONEOK has a history of dividend growth. The current rate is 28% higher than the dividend declared after the company rolled up its controlled MLP in 2017.”

I believe Magellan Midstream’s focus on crude oil and refined product logistics is a complement to ONEOK’s natural gas and natural gas liquids (NGL) franchises.

This will turn out to be a big benefit in the event that NGL pricing (which has been on the decline lately) continues to drop due to robust NGL production. Magellan’s other liquids-focused assets will pick up the slack. Keep in mind that NGLs typically make up 55% to 60% of ONEOK’s annual EBITDA.

And even if you ignore this deal, ONEOK has great growth prospects, thanks to its plans in Mexico.

The company has filed for approval for a new pipeline to connect ONEOK pipes (Roadrunner pipeline) at the U.S. and Mexican border, where a final investment decision is expected this year. Mexican gas demand growth has long been an attractive area. ONEOK’s peer TC Energy (TRP) has projected its Mexican earnings to double over the next few years.

And at its core, both ONEOK and Magellan Midstream are still energy pipeline businesses. And both companies own increasingly rare assets. Let me explain…

 

The Future of the Pipeline Business

For pipeline builders, the shale era brought a wealth of opportunities. As gushers of oil and natural gas suddenly erupted in places such as North Dakota and Pennsylvania, the need for a vast expansion of the plumbing that moves fuel around the country was obvious. That’s what led to a decade-plus-long boom that produced thousands of miles of new pipelines.

The shale growth story is not over in the U.S. oil and gas patch, but it is slowing. And for certain, the associated pipeline building boom has pretty much run its course. An increasingly inhospitable regulatory environment has delayed or canceled a number of major projects.

These circumstances make acquisitions one of few remaining paths to growth. ONEOK management understands the current reality—and it is correctly looking at its future prospects, considering the energy transition.

ONEOK is starting to look for new growth opportunities in moving around low-carbon fuels, such as hydrogen and biofuels or transporting carbon dioxide from carbon capture and storage projects…even though none of those businesses currently exists in scale. In discussing the Magellan deal, ONEOK’s CEO, Pierce Norton, told analysts that the new company’s larger size would make it better prepared for the big changes coming “down the pipe,” adding: “Scale does matter going into the future, especially going into wherever energy is going.”

Norton continued: “As far as hydrogen and…renewable fuels, those kind of things that can move through these [pipelines]. The future is going to determine that. It’s going to be determined by what the customers are desiring and the cost. But having these two companies combine sets us up for that opportunity.”

I agree with Tim Plaehn’s assessment…there will likely be high single-digit to double-digit dividend increases starting next year for the combined companies. If you buy shares of OKE now, you will be happy with the investment for the next decade. Buy it under $62 a share.

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