EUR 850.00 For Business Accounts Only

Morningstar | MPLX Announces Long-Awaited Andeavor Logistics Takeover, but We're Disappointed

A bit more than seven months after the acquisition of Andeavor by Marathon, we finally have the long-awaited acquisition of Andeavor Logistics by MPLX. We had noted several times previously than we expected a combination, given parent Marathon's ownership of 64% (63% post-merger) of both entities and the need to simplify. We had also expected a very limited premium to be offered, given public unitholders would have virtually no standing to object, which also turned out to be the case, with a blended exchange ratio of 1.07 times, a 1% premium to the market. Andeavor Logistics was trading at a 12% yield prior to the deal announcement, which means it is not useful to Marathon as a dropdown vehicle given the inability to pay a premium multiple for dropdown assets. We expect to lower our fair value estimate for MPLX by about 10%-15% to reflect what we believe to be a substantial overpayment on MPLX's part, while boosting Andeavor Logistics up to 5% to reflect our revised MPLX fair value estimate. However, we still expect to consider MPLX undervalued after our update. We anticipate the deal to close in the second half of 2019.

The ultimate terms of the deal and management commentary surrounding expected cost savings, capital savings, and strategic rationale was disappointing. At a blended exchange ratio of 1.07 times, MPLX is offering units worth $47.08 in exchange for Andeavor Logistics units worth $39.50 based in our fair values, roughly a 19% premium. Given the substantial leverage MPLX and Marathon had in the deal in terms of majority ownership and the acknowledged higher-quality assets on MPLX's side, we would have preferred to see a more material use of debt as part of the transaction to reduce the issuance of undervalued MPLX units.

This switch would have also flowed more direct cash to parent Marathon upfront, which we think it would see as a plus. Further, MPLX only offered cost synergies of $25 million, a minuscule portion of the combined partnerships' expected $5.3 billion in EBITDA and no immediate capital spending efficiencies. Finally, MPLX's proposed strategic rationale for the combination mainly focused on the Permian opportunities, but Andeavor Logistics would only generate perhaps $100 million of its expected $1.4 billion in 2019 EBITDA from the Permian, and $200 million-plus by the end of 2020.

In short, despite the ability to take a deep dive into the assets for many months, it looks like the Andeavor Logistics portfolio is substantially more challenging to optimize by MPLX management than we thought. This speaks to difficulties of the large gathering and processing asset base (about 45% of EBITDA) and California storage assets located in non-attractive regions, where MPLX remained relatively silent on its outlook. In our view, we would have preferred to see a larger use of debt to fund the transaction, which would have likely taken debt/EBITDA beyond the currently expected 4 times upon completion of the deal, and then substantial asset sales of noncore assets to reduce leverage back to a more palatable 4 times. The asset sales would also provide opportunities for cost-cuts and capital savings, particularly if the assets are more capital-intensive gathering and processing plants. With no plans for immediate asset sales, capital savings, and minimal cost savings, MPLX has its work cut out for it.

There are several other interesting elements of the deal. First, Andeavor Logistics unitholders will receive 1.135 units of MPLX for each Andeavor Logistics unit, while Marathon will only receive 1.0328 MPLX units for each Andeavor Logistics unit, for a blended exchange offer of 1.07 times. This split offer means that Andeavor Logistics unitholders receive a 7% premium for their units, while Marathon actually takes a discount. We believe MPLX wanted to avoid a repeat of the Spectra Energy Partners scenario, which was originally offered a takeout at no premium by Enbridge, but eventually had to pay a 10% premium to pacify unhappy unitholders. Unlike Enbridge's original proposed offer, this deal has already been accepted by both MPLX and Andeavor Logistics conflicts committees and board of directors. Second, Andeavor Logistics unitholders also took a substantial shadow distribution cut of 27% to an implied $2.99 per unit from $4.12 previously. Third, we agree with MPLX that the deal is slightly accretive to distributable cash flow per unit, as our estimates put the gain at about a half a penny per unit. Without Marathon agreeing to take a discount on their units, the accretion would have disappeared.

The combined entity is expected to generate 2019 EBITDA of $5.3 billion, distributable cash flow of $1.4 billion with a coverage ratio of 1.4 times, and a debt/EBITDA ratio of about 4 times. These numbers would make it one of the largest midstream firms we cover, and broadly would be very healthy metrics. Incentive distribution rights for both entities have already been eliminated, yet they retain master limited partnership status versus a c-corp.

Both firms also reported first-quarter results at the same time as the merger announcement. The results generally matched our expectations and management guidance. We do like the announcement that MPLX is now participating with a 15% equity stake in the Wink-to-Webster pipeline project, as part of a joint venture with ExxonMobil, Plains, and Lotus Midstream. This pipeline plans to move more than 1 million bpd (up to a max of 1.5 million bpd) from Wink and Midland to the Gulf Coast and is due in service in the first half of 2021. We see this as an acceptable replacement for the Permian Gulf Coast pipeline joint venture, which would have followed a similar route, but collapsed in late March after it was unable to generate enough shipper interest to move forward. At the time, we also highlighted that the Wink-to-Webster pipeline was a natural alternative for shippers and MPLX to become involved in.