ONEOK, Inc. (OKE) Earnings Call Transcript & Summary

Good morning and welcome to the ONEOK to Acquire Magellan Midstream Partners Conference Call and Webcast. [Operator Instructions] Please note that this event is being recorded today. I would now like to turn the conference over to Andrew Ziola, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Joe. And good morning, everyone. Thank you for joining today's call to discuss last night's announcement of ONEOK acquiring Magellan Midstream Partners. Along with our press release, we provided a presentation deck for this call on both ONEOK and Magellan's IR websites that describe the highlights of the announced transaction. A replay of this call will be made available as soon as it's available. Our speakers today will be Pierce Norton, ONEOK's Chief Executive Officer; Aaron Milford, Magellan's Chief Executive Officer; and Walt Hulse, ONEOK Chief Financial Officer and Executive Vice President, Investor Relations and Corporate Development. Statements made during this call that might include ONEOK's and Magellan's expectations or predictions, including this transaction, should be considered forward-looking statements and are covered by the safe harbor provision of the Securities Acts of 1933 and 1934. Actual results could differ materially from those projected in forward-looking statements. Please refer to the legal disclosures in the press release and on Page 2 and 3 of the presentation as well as a discussion of factors that could cause actual results to differ in our SEC and regulatory filings. After our prepared remarks, management will be available to take your questions. [Operator Instructions] With that, I'll turn the call over to Pierce.

Thanks, Andrew. And good morning, everyone, and thank you for joining us. Let me start by saying this transaction combines 2 great companies with 2 great workforces. I want to thank both of our companies' employees who have enabled these companies to become what they are today. I'm looking forward to seeing what these 2 groups of employees can do together. Today is truly a historic day for both of our companies, as we have announced a definitive merger agreement to acquire all outstanding units of Magellan Midstream Partners in a cash and stock transaction valued at $18.8 billion, combining the premier midstream energy infrastructure businesses of ONEOK and Magellan, with a total enterprise value of $60 billion. ONEOK, a member of the S&P 500, has a long history and track record of being at the forefront of transformational transactions, especially in the last 20 years. In 2004 and 2006, ONEOK made a series of transactions marking its entry into the master limited partnership structure, acquiring interstate pipelines and gathering and processing businesses in the Williston Basin by purchasing Northern Border partners which became ONEOK Partners, setting the company up for what would become a transformational platform for exponential growth. In 2005, ONEOK acquired the natural gas liquids businesses from Koch industries that created our NGL business segment, with assets and systems that link the NGL supply in the Mid-Continent with the Conway and Mont Belvieu market centers. This acquisition was followed by significant organic growth creating natural gas liquids connectivity from the Canadian border all the way to the Texas Gulf Coast. In 2014, ONEOK spun out its regulated natural gas utility business, resulting in a more efficient and flexible capital allocation and growth strategy. In 2017, ONEOK merged with ONEOK Partners, resulting in a simpler corporate structure with broader access to the capital markets and supporting future growth. And now in 2023, this announced transaction introduces 2 additional platforms, refined products and crude oil transmission, further diversifying our business mix and generating incremental free cash flow to provide more flexibility for capital allocation to return more value to our shareholders. This transaction marks the fifth transformative transaction in the past 20 years. Each of these transactions were contemplated from the standpoint of looking through the lens of what's next and finding opportunities in sustainable businesses for future growth. This acquisition continues the legacy of ONEOK in finding new platforms then finding future organic growth opportunities to create value for its stakeholders and specifically for the shareholders. We've said before that we have a high bar for M&A, and this transaction clears that bar. Our intentional and disciplined approach has resulted in growing ONEOK through this accretive and diversifying transaction. The addition of new business lines and diversification of cash flows will improve the resiliency of our businesses and provide new growth opportunities. Included in our presentation are the benefits to both ONEOK shareholders and Magellan unitholders that I will briefly discuss. And then I'll pass the call on to Aaron, who will provide his perspective on the transaction. And then Walt will take you through the transaction terms and financial benefits. As we point out in the press release, there are 4 key points to highlight for the rationale of this transaction. First off, this deal will combine 2 premier and diversified energy infrastructure businesses with top-tier and industry-leading returns on invested capital that generate significant and diverse free cash flow. Adding Magellan's stable, primarily demand-driven fee-based business to ONEOK will create an even more resilient energy infrastructure company designed to generate stable cash flows through various commodity cycles. Number two, this transaction will provide immediate financial benefits, including cost, operational and tax synergies; and is expected to be financially accretive. Walt will provide more details on the financial specifics in a moment. And three, we believe this is a compelling long-term value proposition to current and future investors, driven by a consistent and disciplined capital allocation philosophy. The combined company is expected to generate significant average annual free cash flow after dividends and growth capital. And we will remain committed to growing EPS and the dividend by reinvesting available cash into high-return organic growth projects. As we said -- our recent earnings call, we will continue to pay a highly attractive dividend while targeting a dividend payout ratio of less than 85%. Other uses for capital will be debt reduction and/or share repurchases. Number four, on a combined basis, we'll own nearly 50,000 miles of pipeline assets, primarily in the Central U.S., of which are 25,000 miles of liquids-oriented pipelines. As a result, we see value and significant potential for enhanced customer product offerings and export opportunities. Given ONEOK's and Magellan's assets and operational expertise, we have forecasted at least $200 million of base annual synergies and believe that the activities could result in a -- total annual synergies of exceeding $400 million within the next 2 to 4 years. What is also important to point out: By combining our companies, it's not just the high-quality assets, but it brings together 2 companies and employee workforces that share a commitment and a culture of safe, reliable and sustainable operations and involvement in the communities where we work and live. The transaction is subject to approval by both ONEOK shareholders and Magellan unitholders, regulatory clearance and other customary closing conditions, with the expectation of closing in the third quarter of 2023. I'm pleased to report that the transaction has been unanimously approved by the Board of Directors of both ONEOK and Magellan. I want to thank Aaron and his team for their hard work. We see tremendous value for ONEOK shareholders and Magellan unitholders in combining our 2 organizations to become part of a leading North American diversified infrastructure company across the hydrocarbon value chain and look forward to welcoming Magellan's employees to becoming a part of ONEOK. I'll now turn the call over to Aaron to provide his perspective on the transaction announcement.

Thank you, Pierce. I'm pleased to be with you today to address Magellan's view on this next logical step for our company. For those of you who have followed Magellan, you know that we have remained focused on safe and responsible operations, financial discipline and long-term investor value throughout our more than 20 years as a public company. And I can assure you those priorities remain important to us today. As Pierce noted, we believe ONEOK shares these same priorities. And we are pleased to join them in creating a stronger, more diversified midstream company with more opportunities that neither of us could pursue on our own. I believe our ultimate goal is to deliver value for our investors and to consider all opportunities to unlock incremental value. We believe the premium value offered and as part of this transaction, along with the combined company's prospects for the future, will do just that. While the MLP structure has been beneficial for Magellan and our unitholders, we've always been open minded to considering organizational alternatives that we believe would enhance value. We have also through the years explored possible ways to diversify our portfolio in order to enhance our growth opportunities and create an even more resilient business. We believe this transaction accomplishes these goals. As part of our process, we carefully considered, among other things, the tax implications of this transaction and the impact on Magellan unitholders. We recognize this transaction will be a taxable event for Magellan's unitholders; and understand the tax impact could be quite meaningful, especially for the investors who have been with us a long time. Ultimately we believe the value opportunity more than offsets this tax impact, and we negotiated a cash and stock transaction to ensure unitholders will have cash available to meet any tax obligations. At an implied price of $67.50 per Magellan unit, the transaction values Magellan at a 22% premium to the closing price of Magellan units on Friday, May 12, the last trading day prior to this announcement. Beyond the implied premium and cash consideration, however, the transaction also provides Magellan unitholders with the opportunity to participate in future upside through approximately 23% ownership of the combined company. The combined company's greater scale and earnings diversity positions it for growth and value creation across industry cycles and as the broader energy economy continues to evolve. The combined company will also remain committed to returning significant capital to shareholders, a key priority for Magellan. Although in the near term, dividends will be somewhat less than the amount Magellan unitholders have been receiving, importantly, the combined organization will have both an attractive yield and enhanced prospects for growth and therefore more long-term dividend upside. In addition, the combined company may also return capital to shareholders through share repurchases. We were pleased that Magellan unitholders will be able to continue receiving compelling quarterly cash dividends while also benefiting from the upside potential of an even stronger and more diversified combined organization. I'd like to thank our talented team for their hard work and dedication to our customers and our company. As Pierce previously mentioned about both of our workforces, our people are the foundation of our success and one of our competitive advantages. And I know they will capitalize on the opportunities provided to them for growth and development as part of the ONEOK team. Bottom line, Magellan's Board and management share ONEOK's confidence in the future of our combined companies. We believe joining our companies together will create a stronger, more diversified, resilient business to serve the essential energy needs of our nation and create long-term value for our investors. Magellan looks forward to working with the entire ONEOK team to achieve a smooth path to closing and integration at the appropriate time. Until then, we will operate as 2 separate companies and remain focused on safe operations and delivering value for our investors. I'll now turn the call over to Walt to address more of the financial components of the transaction.

Thank you, Pierce and Aaron. As we detailed in the press release, ONEOK will acquire all of the outstanding units of Magellan in a cash and stock transaction valued at approximately $18.8 billion, including assumed debt of $5 billion, resulting in a combined company with a total enterprise value of approximately $60 billion. The consideration mix is 63% stock and 37% cash and is supported by a fully committed bridge facility. We expect to permanently finance the transaction primarily through a notes offering prior to closing. Total consideration for each Magellan unit will be $67.50, consisting of $25 in cash and 0.667 shares of ONEOK common stock based on ONEOK's May 12 closing price of $63.72. This represents a premium of 22% to Magellan's closing price and 22% to its 20-day volume-weighted average price as of May 12, 2023. This transaction is expected to be earnings per share accretive in 2024, with EPS accretion of 3% to 7% per year expected from '25 through '27 and free cash flow per share accretion averaging more than 20% annually from '24 through 2027. From a tax perspective, ONEOK expects to benefit from the step-up in Magellan basis from the transaction, thus deferring the expected impact of the new corporate alternative minimum tax from 2024 to 2027. The benefit from the basis step-up has an estimated total value of approximately $3 billion, which has an estimated net present value of approximately $1.5 billion. Utilization of the expected tax attributes could increase if additional capital projects are put into service or acquisitions are completed, which may increase the NPV of the future tax deferrals. The combined company is expected to experience a step change in free cash flow, after dividends and growth capital, by generating an average annual amount of approximately $1 billion in the first 4 years following the expected transaction close. The increase in free cash flow will provide additional cash for debt reduction, growth capital and value returned to shareholders through dividends and/or repurchasing shares. We would expect the total combined adjusted EBITDA to approach $6 billion in 2024, with stable and growing volumes from our base businesses among our 5 business segments. The combined company expects pro forma 2024 net year-end debt-to-EBITDA of approximately 4x. We expect leverage to decrease below 3.5x by 2026 as future growth projects are placed in service. Excluding certain large projects that have not yet received final investment decision from the expected net debt-to-EBITDA calculation would accelerate the time frame to achieve 3.5x by approximately 1 year. Pierce, that concludes my remarks.

Thank you, Walt. And thank you, Aaron. Before we move on to the Q&A session, I want to summarize how compelling this transaction is to generate long-term value for both ONEOK shareholders and Magellan unitholders. Our shared deep commitment to our values and our culture of operating our assets safely, reliably and in an environmentally responsible manner remains. This transaction introduces 2 new platforms to ONEOK, which diversifies our earnings stream and generates robust free cash flow to return value to shareholders. We will continue to focus on industry-leading returns on invested capital; execute on high-return organic growth projects, large and small; maintain our strong balance sheet; pay a highly attractive dividend; and be intentional and disciplined with future merger and acquisition opportunities. And finally, our expanded products platform will present further opportunities in our core businesses as well as enhance our ability to participate in the ongoing energy transformation with an increased presence in sustainable fuel and hydrogen corridors. We are excited about the future of our combined companies and look forward to welcoming Magellan's well-respected employees to ONEOK. With that, I'll turn the call back to Andrew.

All right, thank you, Pierce. That concludes our prepared remarks. We're now ready for questions. [Operator Instructions] Operator, please open the lines and begin with the first question.

[Operator Instructions] We will now take our first question, which will come from Michael Blum with Wells Fargo.

I'm wondering if you can provide some more details on what exactly is going to drive the $200 million up to $400 million of synergies. Is this cost synergies, commercial, both? Anything you can do to give us a little more detail on that would be great.

Okay, thanks, Michael. The way that we're going to produce these synergies is by focusing on what I would call the process that's going to produce the desired outcomes that we're looking for. We're going to create a dedicated team to develop a map of what has already been identified in the synergies and more importantly what was going to be identified in the future. This map that we're going to create is actually going to serve its purpose to holding us accountable to deliver these synergies, so there's 2 main categories. And you basically mentioned those, is -- the first one is overhead cost. If you look at the studies of deals that are basically this size, the average savings is around 25% of the total combined G&A cost. In our case, what we've assumed is actually half of that number, which is 12.5% or $100 million. So it's $100 million of the $200 million, so you can extrapolate there what the additional would be. The second thing is commercial. And the way that we have categorized those is we put them into 3 categories. The first one is what we call bundling. The second one is something that we focus on around here a lot, which is demand pull. And the third is export expertise. So kind of going back to this bundling concept. So an example of that would be that we could bundle NGL and crude services working with a single customer, say, in the Permian or the Mid-Continent or the DJ Basins. That actually creates value for the customer. It's more of a one-stop shop. Demand pull, we're always looking for ways to create more demand pull for our NGL products. And we believe this acquisition expands those opportunities for blending and the demand pull of our various NGL products. And then thirdly, the export expertise: We have talked a lot about exporting liquid products. That's something that Magellan does currently. And we think that this expertise is going to pay long-term benefits to our liquids products, along with continued long-term benefits to the assets that we're acquiring. We do believe long term globally that these products are still going to be in high demand because of increased population growth and the fact that there's continued demand for a higher standard of living across the world, and that's going to support that demand. I'll give you just one expertise. All of these things can create more opportunity to move volume through our system, so think about it this way: For every 100,000 barrels of additional product that we can move through these combined systems, say $0.05 per gallon, that's an additional $75 million, so we do believe that the commercial opportunities are what's going to drive the synergies from $200 million to the higher numbers. I hope that helps.

And our next question will come from Theresa Chen with Barclays.

Pierce, I wanted to ask about the export piece long-term benefits contributing to that other $100 million to $300 million of your total synergies. And -- or does this mean that you will be using MMP's [ seasoned ] ship channels to get into NGL, LPG exports? And what are the costs of doing that?

Well, you're asking a very detailed question, Theresa, that -- we're going to be considering all of those kind of things, but at this point, we're not necessarily breaking it down as to exactly how they would be used. But we believe the expertise that Magellan employees brings to the table is what's going to unlock whatever opportunities we execute on.

Okay. And if you could just give a little bit more color just from a high level on the demand pull piece. I understand that now you can blend your own captive produced butane into the gasoline stream, but for the other NGL products, how does this acquisition enhance the demand pull opportunities?

Well, again it's partially on the butane side and we'll be looking at other opportunities to do other things in the future.

And the next question will come from Spiro Dounis with Citi.

First question, on capital returned. One of the big investment thesis behind Magellan was this sort of robust capital return story; big, large yields; somewhat aggressive buyback program. You all have been sort of less aggressive on the buyback side historically. I'm just wondering. Could this deal maybe augment your approach longer term? Walt, I know you mentioned delevering over the next few years. It sounds like that's a priority, but just any sort of sense how this might change your capital return thesis?

Thanks, Spiro. Well, it definitely opens up lots of opportunities for us. Yes, we will in the early stages be using some of the free cash flow to get our debt metrics back towards that 3.5x aspirational area, but clearly, as we go forward, we have room for strong capital investment and growth opportunities, continuing to grow the dividend. And there will likely be opportunities to look further into share repurchases as well.

Got it. Second one, more of a housekeeping, should be a quick one. And sorry if you mentioned it, but was this a negotiated deal or part of a more formal sales process?

What you're going to see -- we'll be filing all of those details in the proxy statement, so I'm going to really refer you to, when that proxy statement comes out, I'd encourage everybody to read it. And they're going to get the full history of this deal in the proxy statement.

And our next question will come from Brian Reynolds with UBS.

Pierce, ONEOK has discussed at length over the past few months its intention to diversify away the base business. There were likely many options that management and the Board considered in this diversification strategy, so curious if you could perhaps discuss perhaps some of the other paths that were considered and why Magellan was perhaps the best option over a longer-term horizon versus perhaps organic growth or value M&A like we've seen recently within the space.

Well, I will start by saying, when we talk about diversifying away from some of the other business that we have, that does not mean that we're not going to continue to be very focused on those base businesses. We just look at this as adding 2 more base businesses to our organization. And again, as far as the strategies and all those stuff that were considered, I'd point you to the proxy. And all that will be discussed as the history of that unfolded.

And our next question will come from Jeremy Tonet with JPMorgan.

I just want to see, as far as potential future synergies are concerned, if you might be able to speak to the potential for conversion of existing assets, if you see that as something that could be meaningful here, such as converting, I guess, Houston pipes to maybe service LPG movements towards the ship channel or anything along those lines?

I'd point you back to my earlier comments on that, Jeremy; is it's just about the things that we actually talk about, which is bundling services, those kind of things. It's not necessarily talking at this point about converting this or that. It's simply by, if we do find some additional capacity to move certain things and products, then that's kind of the magnitude that I would look at is in that. For every 100,000 barrels a day, then it's about $75 million, without getting into the details of what products might be moving on what pipes.