Shares of Magellan Midstream Partners NYSE: MMP rose by as much as 16% during the opening of Monday's trading session, while the stock's price action retreated to close the day up by 12.99%; the move is due to undeniably good news for shareholders. ONEOK NYSE: OKE has struck a deal to acquire Magellan Midstream Partners for a total sum of $18.8 billion; the transaction will be broken down into ONEOK reaching all of Magellan's outstanding common stock for a price of $67.50 per share, a term receiving the full credit of Monday's monster rally.
When and if the transaction closes, current Magellan shareholders will own approximately 23% of the pro-forma company. Hence, the consideration offer comes in the form of $25 in cash per share on top of 0.6670 shares of ONEOK common stock.
Considering current Magellan Midstream analyst ratings, the price under consideration is more than a fair assessment. Analysts had placed a consensus target on the stock for $56.64 per share, with a top-side target reaching as high as $60.00 per share. Thus, shareholders are receiving an 18.3% premium valuation from analyst consensus. In addition, Magellan Midstream charts will show that this acquisition price represents the middle of a robust price channel formed from 2015 to 2019 before the underlying business fundamentals were stress-tested and valuations reached rock bottom.
Strategic Synergies
As a combined firm, ONEOK being the one to move onwards in the financial markets, investors would benefit from having a clear picture of what to expect from this merger. Accretive earnings per share for ONEOK will equal a roughly 3% to 7% increase from 2025 through 2027, with some additional benefits to be reaped by current shareholders. In addition, the new company now expects around four billion dollars of annual free cash flow.
Judging by ONEOK's focus on deploying free cash flow toward dividends and high ROIC (return on investment) projects, investors today can reasonably hope for a bright future.
Diversification in products and underlying markets will also benefit investors moving forward, as the stock could face less volatility from smaller company financial swings. Currently, ONEOK derives 60% of its revenue from natural gas liquids, 26% from natural gas gathering and processing, and 14% from its pipelines. Considering the violent price swings natural gas has seen throughout 2020-2023, especially during the speculative months of the Russian invasion in Ukraine, diversifying the product line is the best move.
The new company will benefit from the diversification of Magellan's crude oil and refined products, with the pro forma entity now deriving only 72% of its revenues from natural gas compared to a previous 100%. What is more important is the new fee structure that the pro forma business will adopt, significantly reducing their commodity price volatility exposure. Considering current ONEOK analyst ratings pointing to a near 30% upside, these synergies and added growth potential could show investors taller ceilings regarding target prices.
Risk Pays Off
Considering the potential downside, investing in a company's equity is considered the 'riskier' move. However, investors placed to benefit from this new combined entity are in for what seems to be a high reward-to-risk ratio. Magellan Midstream has historically achieved an 18.5% ROIC (return on invested capital), considered top-tier, considering the peer average of only 9.3%. ONEOK has earned a lower ROIC of 13.9% over the years; combining the two profitable operations and effective capital allocation strategies will likely keep beating the peer averages.
With a standalone free cash flow level of only one billion dollars, ONEOK showcased extreme financial discipline, as its financials will show. With investing in double-digit ROI projects and being able to maintain - and even grow - dividend payments, a new expected four billion dollars in free cash flow will reward previous discipline. The pro forma company expects these elevated free cash flow levels to be allocated toward debt reduction and dividend increases and allow for some share repurchase programs. Among payouts and buybacks, what matters most to investors is that the manager remains eager to invest in high ROIC projects with these new funds to boost further growth.
Management also points to new leverage objectives, which will reap the benefits of controlled economic swings during volatile commodity cycles like the ones experienced lately. With a 2026 expected net debt to EBITDA ratio of only 3.5x, the company seeks to achieve and retain investment grade ratings on its debt securities, allowing it to finance any future projects management cheaply deems worthy of investing in.
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