The MarkWest Merger’s Real Winner
We finally have another big merger in the heavily bruised MLP sector, even if the deal reminds us that some MLPs have been bruised much more than others.
The recent good fortune of the refiners has trickled down to their affiliated logistics partnerships, which offer investors modest yields alongside rapid distribution growth backed by dropdowns.
That outperformance, in turn, was very likely the driving force behind this morning’s announcement that MPLX (NYSE: MPLX), the logistics affiliate of Marathon Petroleum (NYSE: MPC), will acquire MarkWest Energy Partners (NYSE: MWE), mostly via a tax-free exchange of equity.
Based on the MLPs’ July 10 closing prices, the deal implied a 32% premium for MWE unitholders. MWE units were only up 10% in early market action because in fact the merger represents a big sale of MPLX units by its sponsor Marathon on advantageous terms to MWE unitholders, who will end up owning 71% of the common units in the dramatically enlarged MPLX. Marathon’s stake in MPLX will drop from 71.5% to 21%, but on the other hand the merged entity will be roughly three times as valuable as the pre-merger MPLX.
The partnership plans to increase its distributions by 29% this year and at a compounded 25% annual rate through 2017. It will have ample scope to do that because — even after today’s 12% decline — MPLX units were yielding just 2.7%, versus MWE’s 6.1% yield as of last week.
So this is only the latest in a string of equity deals significantly limiting current payouts to limited partners in exchange for promises of faster distribution increases. Even if these are kept, as they are likely to be here and elsewhere, it will take some time to get back to the old yield levels. For example, holding the unit price constant, MPLX would have to grow its yield by 25% for four years to get back above MWE’s 6.1%.
Even then, limited partners will be getting a worse deal, because having already bought out the incentive rights held by MWE’s general partner in a prior transaction, they’ll now be subject to a 50/50 split on future profits from assets they will finance in their entirety as a result of Marathon’s incentive distribution rights in MPLX.
That’s what makes this such a great deal for Marathon, and why MPC shares were up 9% on the news in the early going, nearly matching MWE’s gain.
There are undoubtedly some cost and operating synergies to the merger and a real diversification benefit from the two parties’ disparate income streams, MWE’s coming largely from Marcellus and Utica natural gas gathering and processing and MPLX’s from the shipping of crude oil and refined fuels to and from Marathon’s refineries.
But the principal benefit here (accruing even more heavily to Marathon than the early price action suggests) is in financial engineering that curbs current payouts from MWE’s assets while encumbering future cash flows with generous sponsor incentives.
For that reason we will not advise MWE shareholders to wait for the deal’s expected closing in the fourth quarter and exchange each MWE share for 1.09 MPLX units and $3.37 in cash. The course we’re taking in our Growth Portfolio is to cut our exposure to MWE in half today and wait for a better exit price on the rest of the position. Sell half of MWE. But note that longtime MWE investors may have tax incentives to continue as MPLX unitholders.
As for Marathon, we’ll discuss its value proposition in the next issue of MLP Profits.