Magellan’s Deal With Oneok Could Derail. Should Berkshire Step In?

Management for Magellan Midstream Partners (ticker: MMP) has gone on the offensive following the recent release of the proxy statement for the transaction, highlighting what it views as misconceptions about the deal about taxes. It is also emphasizing what it sees as the benefits to its investor base.

“This transaction captures full value today for Magellan unitholders that would be difficult to realize otherwise,” Aaron Milford, Magellan’s CEO, recently told Barron’s. 

One problem is the value of the deal has declined along with Oneok’s (OKE) share price since the transaction was unveiled, which may make it more difficult to gain approval from Magellan investors.

Magellan units were up 1.0% Monday to $60.09, above the pre-deal price of around $55. The premium of the deal value relative to pre-deal Magellan unit price has shrunk to about 16% from 22% initially. Oneok stock was up 1.5% Monday to $58.42 and was down about 8% since the deal was unveiled.

The deal proxy indicates that Magellan wanted to leave the door open to a potentially superior offer by negotiating a relatively modest breakup fee of $275 million in such a scenario.

One possible buyer is

Berkshire Hathaway

(BRK. A, BRK. B), which owns several natural-gas pipelines and is active in the utility space. Berkshire could offer, say, $70 a share in cash for Magellan, above the $67.50 initial value of the Oneok deal per Magellan partnership unit, and the current deal value of about $64 per unit based on Oneok’s share price.

Oneok is offering $25 a share in cash and 0.667 of Oneok stock for each Magellan unit.

Berkshire CEO Warren Buffett doesn’t like to participate in corporate auctions but he could possibly make a take-it or leave-up offer to Magellan. Berkshire had no immediate comment on the speculation about its potential interest in Magellan. 

Magellan has an attractive asset base as a leading transporter of crude-oil products such as gasoline and diesel fuel, with a large pipeline network mainly in the center of the country. Oneok is heavily involved in carrying natural-gas liquids and has minimal overlap with Magellan.

There isn’t a lot of growth at Magellan and there is risk as the U.S. moves to more electrified vehicles. But the transition to EVs may not come quickly, and it could be even slower for diesel-power vehicles and commercial airplanes, which are big consumers of oil. The company generates considerable free cash flow.

One risk to the deal is that the bulk of the Magellan unit holders—an estimated 50% to 60%—are individual investors. And retail investors often don’t vote in big numbers in proxy and other votes. That could imperil the transaction since it requires the affirmative vote of half of Magellan’s roughly 202 million units outstanding. A non-vote is equivalent to a “no” vote. 

Barclays analyst Theresa Chen wrote in a note earlier this month that the primary risk with the transaction is the vote by Magellan unit holders.

There also has been criticism from individual investors because of a big tax bill for longtime holders. Energy Income Partners, an institutional investor with a 3% stake, has come out against the transaction in part due to the tax issue, arguing the tax paid by many investors will exceed the premium offered by Oneok and other potential benefits of the merger. 

Magellan, like other pipeline or midstream companies, pays a lofty distribution of 7% that has largely been tax-deferred. Given the way the deal was structured, Magellan holders will face a large tax liability for what had been tax-advantaged distributions (the partnership equivalent of dividends) that they have received. Oneok is structured as a corporation.

Magellan put out a presentation that at indicated that long-term investors—those with a holding period of 10 years or more—could pay an average of about $24 a unit in taxes, sizable relative to the initial deal price of $67.50.

Magellan argues that the returns on Magellan units and those of other MLPs is “tax deferred, not tax free. The question is generally when, not if, taxes are paid,” it said in a presentation.

The counterargument is that many investors like to defer taxes for as long as possible and that those who plan to die holding Magellan units can now potentially avoid taxes entirely based on current estate-tax rules.

Barron’s has heard from several retail holders of Magellan who are unhappy with the deal. One of them, Robert Carl, a Georgia investor, wrote a letter to Magellan opposing the deal, stating that it “makes no economic sense to us whatsoever.” He cited an enormous tax bill that he and his family will incur on their investment.

Carl isn’t enthusiastic about the combination, arguing there are “few, if any, operational synergies.” He also highlights Magellan’s higher return on capital and credit rating.

The companies have talked about getting $200 million or more in synergies annually. 

In a recent statement, Magellan said: “Our pending merger with ONEOK will create a stronger and more diversified midstream company and deliver significant value to Magellan unitholders. The transaction provides a significant upfront cash component and an opportunity for Magellan investors to benefit from the upside potential and attractive cash dividend of the combined company.”

In announcing the deal, Oneok has lauded it as one that will bring “ together two premier energy infrastructure businesses with strong returns on invested capital and diverse free cash flow generation.” It added that the “acquisition creates a more resilient energy infrastructure company that is expected to produce stable cash flows through diverse commodity cycles.”

Oneok and Magellan are aiming to close on the transaction in the third quarter. 

But the deal faces unexpected obstacles that could derail those plans.

Write to Andrew Bary at [email protected]