Oneok's (OKE) $18.8 billion deal for Magellan Midstream Partners (MMP) announced over the weekend shouldn't come as too much of a surprise. After all, the oil and gas pipeline and storage industry has been ripe for consolidation. What perhaps did take investors off guard was the steep drop in Oneok stock when markets opened Monday.
While it's not uncommon for shares in an acquiring company to falter after making a deal announcement, Oneok stock gapped down as much as 10% at one point soon after the opening bell. Magellan Midstream Partners stock, for its part, popped 15% on the news.
All mergers and acquisitions come with risk, naturally. But the Oneok-Magellan deal, which would create an oil and gas pipeline giant, is especially tricky, analysts say.
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UBS Global Research analyst Brian Reynolds said he expected a negative market reaction to the Oneok merger announcement. Not only is the deal dilutive to existing shareholders because of the added debt, but it also requires Oneok shareholders to accept a strategy of diversification into the oil side of the oil & gas transportation and storage industry.
Magellan specializes in crude oil and refined products, while Oneok's core operations are in gas pipelines, natural gas liquids and natural gas gathering and processing.
"We think investors will resist a leverage dilutive deal in the current macro environment, as benefits from diversification, earnings per share accretion and free cash flow accretion will ultimately be a 'show me' story," Reynolds wrote in a note to clients.
The analyst maintained his Buy recommendation on Oneok stock, but he did remove it from his "Top Picks" list.
Oneok stock: buy the dip?
To recap: on Sunday, Tulsa, Oklahoma-based Oneok said in a press release that it will acquire all outstanding units of Magellan in a cash-and-stock transaction valued at approximately $18.8 billion, including assumed debt.
Magellan shareholders will receive $25 in cash plus 0.6670 shares of Oneok common stock for each outstanding Magellan common unit. That represents a 22% premium to May 12 closing prices. Oneok will also assume $5 billion of Magellan's debt.
The company resulting from the transaction will have a total enterprise value of $60 billion, Oneok said. In the oil and gas pipeline industry, only Kinder Morgan (KMI), with an enterprise value of $74 billion, and The Williams Cos. (WMB), at $62.2 billion, would be more valuable than the combination of Oneok and Magellan, according to data from S&P Global Market Intelligence.
Oneok said the Magellan deal adds a "leading, and primarily fee-based, refined products and crude oil transportation business" to its existing operations.
"Magellan's stable, primarily demand-driven businesses are expected to generate significant free cash flow due to low capital expenditure requirements," Oneok added. "This acquisition creates a more resilient energy infrastructure company that is expected to produce stable cash flows through diverse commodity cycles."
Oneok's desire for diversification is eminently understandable given sluggish economic forecasts, rising recession fears and an increasingly uncertain energy outlook.
Truist Securities analyst Neal Dingmann, who rates OKE stock at Buy, said the acquisition "notably boosts" Oneok's scale and potentially signals more deals to come.
"We view the deal as largely positive given the relatively low valuation versus recent deals and the potential earnings growth profile of the assets all while maintaining largely solid financial," Dingmann wrote in a note to clients. Oneok branching out into the oil business should also deliver significant cost savings, the analyst added.
"From an operational standpoint, we think the complementary nature of the assets could result in the company hitting at least $200 million of operational synergies once the companies become fully integrated," Dingmann said.
Although Wall Street is generally bullish on Oneok stock, giving it a consensus recommendation of Buy, conviction is lukewarm. Of the 18 analysts covering OKE surveyed by S&P Global Market Intelligence, six call it a Strong Buy, three say Buy, eight have it at Hold and one slaps a rare Strong Sell rating on the name.
With an average target price of $71.69, the Street gives Oneok stock implied price upside of about 20% in the next 12 months or so. Add in the high dividend yield, and the implied total return comes to roughly 26%.
The market gave something of an initial thumbs down to what Reynolds rightly calls a "show me" story. That said, the selloff in Oneok stock does appear to provide an attractive entry point for optimists. Even the Street's lowest price target of $61 gives Oneok stock implied price upside of about 6% in the next 12 months or so. Add in the dividend yield, and the implied total return tops 12%.
The pending deal could serve as an overhang on OKE stock for some time. And the operational results won't be known until well after the merger closes. For now, at least, analysts are sticking with Oneok, betting that the risks of the Magellan acquisition will be well worth the rewards.
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