ONEOK to Acquire Rival Magellan, Becoming a More Diversified Midstream Operator

On Sunday, midstream service provider ONEOK ($26 billion market cap) agreed to acquire rival Magellan Midstream for about $19 billion in a cash-and-stock deal expected to close in the third quarter of this year.

The acquisition is expected to be immediately accretive to earnings and make ONEOK the second-largest pipeline operator in America.

The combination of these firms will also help ONEOK expand from being primarily a natural gas transporter in North Dakota's Bakken formation to a major market player with over 25,000 miles of pipeline, including far more exposure to crude oil and refined products.

Even though the acquisition will cause net debt to jump from around 3x to 4x earnings, this improved income diversification should lead to a more stable cash flow stream and provide deleveraging opportunities.

ONEOK's payout ratio looks to remain around 60%, well below the firm's target of below 85%. As such, the company should have opportunities in the next few years to raise the dividend – but debt reduction may remain a priority in the near term.

In light of the benefits of a more diversified and stable cash flow stream and the firm's solid dividend coverage, we are upgrading ONEOK's Dividend Safety Score within our Borderline Safe bucket from 54 to 60.

That said, around 85% of ONEOK's pro-forma cash flows will be fee-based and tied primarily to the volume of commodities flowing through its pipelines and processing plants. 

While this does not directly link ONEOK's performance to volatile commodity prices, prolonged downturns in oil and gas prices can cause drilling activity to plunge as producers shutter unprofitable wells to preserve liquidity.

As a result, ONEOK's gas infrastructure system, which will still represent over 60% of cash flow following the merger, can experience significantly reduced volumes when the energy market hits a cyclical downturn, hurting cash flow and pressuring the company's dividend coverage and debt metrics.
 
Unlike some rivals such as Enterprise Products Partners (which we suggested may be a better fit for some Magellan investors), ONEOK's business is not well supported by take-or-pay contractual arrangements, which force customers to pay for a minimum level of volume regardless of how much they ship.

Even so, the combined firm's portfolio of essential midstream assets is profitable, hard to disrupt, and poised to generate good cash flow as long as oil and gas remain a vital part of the world's energy needs.

We will continue to monitor how the acquisition unfolds and provide updates as needed.