Howard: Midstream Investors Say ‘Don’t Tread on ‘MMP’

Hinds Howard is a portfolio manager at CBRE Investment Management where he evaluates listed energy infrastructure and transportation companies in North America and coordinates research of listed transportation companies globally. He is based in Wayne, Pa.

In a merger slightly less surprising than the recently announced LIV/PGA merger, midstream corporation ONEOK (OKE) announced the $18.8 billion acquisition of Magellan Midstream Partners (MMP), a prominent publicly traded partnership (or MLP). The deal between two titans of Tulsa, Oklahoma, has certainly made waves in a space that already has so few remaining large companies.

The OKE/MMP merger process looks to be the primary drama for a sector that has largely lacked drama during the last few years. There’s potential for investor pushback, issues with proxy services recommendations, potential alternative bidders, recutting of the deal between the parties and the eventual unitholder vote sometime in the fall if the current deal stays on track.  

The origins of Magellan

Magellan is the seventh-oldest MLP currently trading. It began its life in 2001 as Williams Energy Partners (WEG), which went public in a 2001 IPO. It was the original dropdown MLP, spun out of Tulsa-based Williams Cos. (WMB), which then used WEG to acquire the Williams Pipe Line (refined products pipeline system) from WMB for $1 billion in 2002. The dropdown story was a short one, however, because in 2003, WEG became one of the original orphaned MLPs when a financially distressed WMB sold its general partner stake to private equity firms Madison Dearborn and Carlyle/Riverstone and changed its name to Magellan Midstream. 

MMP was also in the first wave of general partner IPOs. In 2006, the new sponsors took the general partner stake public as an entity called Magellan Midstream Holdings (MGG) in a $539 million IPO. Shortly after that, it was the second MLP to simplify when it merged MGG into MMP at the start of a wave of simplification deals in 2008-2010 in the fallout from the global financial crisis. 

After that first decade of chaos, MMP settled down and established itself as one of the most stable, best-run partnerships in the sector. While other MLPs were issuing massive amounts of equity and doing splashy M&A, Magellan was disciplined with CEO Mike Mears at the helm. The big success that decade was MMP’s acquisition and reversal of the Longhorn Pipeline, which had taken refined products from El Paso to Houston but in 2013 began shipping crude oil in the other direction.

That capital discipline led to a pristine balance sheet and a premium valuation. That balance sheet and lack of growth capital made MMP attractive for a corporation like OKE. Free cash flow accretion and avoiding corporate taxes for a few more years are good reasons for OKE to get involved, even if there is no significant overlap of assets that would drive commercial synergies.

Investor pushback

Soon after the OKE/MMP merger was announced, MMP’s fourth-largest investor (but with only a 3% stake), Energy Income Partners, published its intention to vote against the merger, explaining that it believes the taxes paid by MMP investors as a result of the sale will exceed the premium offered and potential growth from the combined company. Also, the letter noted that midstream investors would prefer to make up their own minds as to how much MMP vs. OKE they own, rather than be forced to own the combined entity. This last argument speaks to the desperation of active midstream investors looking around the space and seeing only a few remaining names from which to choose.

Proxy firms will make their recommendation on the deal, and that recommendation could go either way. The campaign on both sides will intensify from here. Because of its corporate history, MMP has limited insider ownership, unlike most MLPs, which typically have large sponsor or founder stakes that help push deals like this through. That will make the voting more interesting than normal. A simple majority of the MMP units outstanding is all that is needed.

The guidance from management on timing of a vote is in the third quarter, so maybe the fireworks happen in September. The S-4 should be out soon (or may be out by publication of this column), which will have more detail on the process and any other potential bidders that were involved. With a break fee on the deal of $275 million, it is possible MMP could receive and take a superior bid without much pain, but no obvious alternative bidder exists.

Buckeye (BPL) and its buyout by IFM in 2019 is maybe something of a comparison, but that included a large premium and it was all cash in a time when MLP stock prices were struggling. In that transaction, 55% of the unitholders voted for the deal, 2% voted against. Back in 2014, TRGP bought Atlas Pipeline Partners, but the insider ownership was much chunkier there, so not much of a comparison. In that transaction, the deal was approved by 53%. The challenge, depending on how the proxy firms lean, will be to find retail unitholders and make sure they vote. 

Expect more drama from here, including more letters from investors and replies from management, and maybe there will be more fireworks in the form of additional bids. But the deal is probably not going to work accretion-wise for a tax-friendly bidder (another MLP), because MMP already trades at a high valuation relative to other MLPs. For me, any of those outcomes are fine—I’m just happy to have something to talk about.