Magellan Midstream Partners LP

NYSE:MMP

Earnings Call Transcript 2023-Q4

[Jeremy Tonet, J.P. Morgan]

My name is Jeremy Tonet, and I cover the midstream and utilities universe for J.P. Morgan, Equity Research. And for our final presentation of the day, we are extremely excited to be joined by Magellan's CEO, Aaron Milford. Very exciting developments with the Magellan story. So thank you very much for taking the time to join us today. And maybe I'll just lead off with a question on everyone's mind. Starting off, if you could just discuss the factors that went to Magellan's decision to sell to ONEOK, how long had there been conversations between the two companies and the Magellan hold a full process? How did potential C-Corp conversion back in? A lot of the elements to this decision if you could walk us through.

[Aaron Milford, Chief Executive Officer]

Well, Jeremy, thanks. First of all, thanks for having us this afternoon. It's been a great conference. It's great to talk with you all. So starting with the first part of your question about, why would Magellan think about selling the company or combining with ONEOK in this instance? And for us, it actually goes back strategically for some period of time. We would often get asked the question, would Magellan think about diversifying into other products or other parts of the energy industry? And our answer was, sure, we're open minded anything that creates value and the idea of having a more diversified company with more product exposure to things like NGLs and natural gas in particular is something that we'd be interested in doing. If we could find a way to do, and this is the important part that creates value.

So through the years, we have spent time studying that. What options are available to us to find a way to enter the NGL business or natural gas business and other commodities, frankly, to add to our already strong refined products and crude business. So how do we go by doing that? So there's just a lot of background work that we've been doing for the years searching for a way to do that. One of the things that happened is, you'll recall or see in the preliminary as foreign proxy statement we filed yesterday morning, our first conversation with ONEOK was in 2019. And that conversation essentially comes from the work that we do, making sure we're evaluating strategic alternatives.

The other part of that conversation, Jeremy, that we always mentioned was that, whatever we were going to do in the NGL and natural gas space was most likely going to be inorganic or an acquisition. And the reason we were of that opinion was that, historically as a company, we've built things. If you go all the way back to really, 2004, 2009, we've been a company that has grown organically. The crude oil business is an example where we sort of built the assets and built that business for us. So we have a natural inclination we want to build things, because we think there's value in it, but we knew in the NGL space just the -- you need the full value chain in order to be successful in that, and that would probably lead us to an acquisition.

What you don't know, even though you've come to that conclusion is, which side of that coin might be beyond, and a lot of that has to do with just what's happening in the market and what the opportunities are available. So the idea of combining with ONEOK is not a new idea. The idea of wanting to have a diversified portfolio is not a new idea. It just so happens that everything came together in this particular instance with ONEOK to combine and create the stronger, higher growth, more resilient company that we sort of had in mind. It just so happens that we're on the being acquired side of that rather than the acquiring.

But I think that also speaks to just our mentality, which is, we're all about creating value for our unitholders. That's what we're supposed to do. And you can't get too hung up on which side of an equation you're on. So long as when you look at that equation, it's accomplishing your strategic objective and you believe that it's maximizing value for your unitholders. If that's -- if you end up on one side of the coin or the other, well, that's the goal, that's what you're supposed to do, and that's what we're doing. That is our objective. So that's why we're be thinking about selling. We weren't necessarily thinking about selling, but we wanting to create a much more diversified company, and that's what this transaction does. So it's just really an extension of a strategy we've already been employing.

[Jeremy Tonet, J.P. Morgan]

Got it. That's very helpful. I know we had multiple questions packed in there. So I didn't know if there's any other thoughts you were able to share at point in this juncture as far as conversations, how broadly with other companies. And Magellan talked about C-Corp analysis in the past, and I guess how those factored into this process?

[Aaron Milford, Chief Executive Officer]

Yeah. I just didn't keep up with all the questions. So thank you for that. So in terms of what did the process look like? As you'll see in the preliminary proxy statement, it was a heavily negotiated process. For -- with ONEOK, what's important to understand is what I sort of led with, which was, we done a lot of background work, we pay constant attention to the strategic alternatives that are available to us. Things that we think are actionable, things that could create value, whether those are acquisitions or different combinations or joint ventures or selling assets or buying assets, it's a continual process for us at all times. So it creates a good background for us where we're current at all times about what our options might be so that when you do get an opportunity that comes in, you're not starting from zero. You sort of understand the playing field and the background and that was the case here. So we have that background work. We understand what's sort of possible for us, and then we start our discussions with ONEOK at the end of 2022.

And then through the process, as you're evaluating before you actually agree to do something like this, you think about, well, who else might be interested in doing this? And we did that work. We talked to our financial advisers. We talked amongst the board. We took the time to look at, well, who else might be out there and what else might that look like and what's actionable. And so, we did that work sort of during the process to make sure we really understood what the potential might be. But then most importantly, we're getting a full value from ONEOK in this transaction. We think it fully values our company. But we also asked our self the question, what if we're wrong? What if there is somebody out there, even though we've done the work to determine that it's unlikely. What if there is somebody out there that might have a superior or better deal?

So what we focused on then was making sure in the merger agreement that we had terms that while we can't go solicit, while we're pending the closing, we can't go solicit. If someone has a better idea or a better deal, they can bring it. And we think we did a good job getting the hurdles of the breakup fee that someone might have to overcome in order to do that at the low end of the range. It's still in a reasonable range but is at the low end. So we removed impediments, we believe, that could keep someone of interest that has a better deal from approaching us. So the idea was, we think we have a pretty good idea of what's actionable. We think [indiscernible] we know in this deal, we have a full value in front of us. But if we're wrong, someone else can at some point prove it by showing up with a better deal if they choose to.

So that's how we thought about the process. So rather than running sort of a more traditional auction, we think we ended up in the same place in terms of being able to feel good that we got a clearing value when you look at the totality of the deal, including the terms. Now in terms of a C-Corp, the last part of your question. We did some work a few years ago where we put some analysis out of how we looked at C-Corps. So we were -- and C-Corp has always stayed sort of on the back burner for us in the sense that we're always aware of what that might look like. And for us, if you look at -- so let's just look for a moment and think as we're just standalone. And let's just say we decided that we wanted to convert to a C-Corp. Well, we already traded a healthy multiple as an MLP. And if you look at the delta between where we trade and C-Corps today or even back then, there was at one point, a little bit of a gap where C-Corps were more valuable. It may be a little different today. But we already traded a really good multiple.

So one of the -- some of the logic behind converting to a C-Corp would be -- convert to a C-Corp, and that would open up Magellan to a broader set of folks that are willing to hold C-Corps and they are MLPs, also open you up for passive investments, index inclusion, and those things. But those are all unknown. In other words, what value uplift will you get when you convert? What you do know is, if you convert you're going to pay taxes as a corporation. So when you put that together with what is an unknown uplift, it becomes a difficult decision to make on a standalone basis because you really don't know how to measure the gives and gets. Was it a good decision or not a good decision, and you won't know it until you do it. Right?

Well, now juxtapose that as a stand-alone approach to converting to C-Corp and look at the combination that's in front of us. Let's think about the unknowns in the first instance and think about the knowns here. The knowns here are the combined company will be an S&P 500, so you know you're in the index. The known here is you're getting a premium and a full value for your business, that's known. So there are a lot more knowns in this transaction in terms of -- versus the conversion, and it's all about the premium value we're delivering for our unitholders in the process. So this converting on the unilateral basis, the C-corp has a lot of unknowns. This transaction has much fewer, and it has a value that we can all see.

[Jeremy Tonet, J.P. Morgan]

Got it. That's very helpful there. And so it sounds like a lot fed into the valuation analysis. Were there any other elements to thinking about proper fair value with the partnership that went into your process? Or is that going to cover the process as a whole?

[Aaron Milford, Chief Executive Officer]

Well, for us, it's a key thing to understand. The first one is we've been very vocal over the last few years that we believe that we have been undervalued in the market. We haven't been shy about it. And not only do we believe that we have been undervalued in the market, but we've been buying back units. Over the last three years, we bought back 12% of our outstanding units, a little over $1.3 billion buying units back. We were doing that because we felt we were undervalued.

So how does one determine they're undervalued, right? And that's where that dovetails into this process, how we determine whether or not we felt were undervalued. It was did through traditional math. We looked at our firm, we looked at what we thought it was going to earn, we did that over a very long period of time and came up with a discount in cash flow, unlevered for the technical folks in the room, the value of what our firm is. And we've kept that updated for three years because you can't have a buyback program without having some view of value if you're only going to buy back if you think that there's value in it, right?

So we have all this work we've done over three years about what is our firm work. It's current. So this transaction comes along. And sure, there's a comparison that you make to where you're trading in the market, where there's also a comparison you have to do or we felt we had to do to the intrinsic value of our firm regardless of what the market value is put on it. What is the value of the firm? And we think this combination change that bar or is better. That's when we say full value, we say we fair value it's that intrinsic value that we're focused on because in our mind, that's the real value.

So that's how we determined it. It's work we've been doing for three years, and we know what the firm is worth in this combination just on a present value basis, chin that bar. But beyond that, if you look at the combined business, it's not just the value today, the fair value. It's also what is the combined company going to be worth because the deal here is $25 of cash plus 23% of the combined entity. That's really the deal. And if you look at what we think the value of that pro forma company can be, we think it's going to be higher than what we can achieve on our own. So it's not only the value you get and you have to make sure that's fair, but it's also the value you see in the pro forma company that we're very excited about, frankly.

[Jeremy Tonet, J.P. Morgan]

Got it. That's very helpful there to think three year analysis. Tax is an area where we've received a lot of questions. In tax basis, especially for long-term unitholders. Could you walk us through, I guess, how that factored into your analysis?

[Aaron Milford, Chief Executive Officer]

Well, it was -- there were a lot of discussions about taxes Jeremy, during this whole process. Anyone that's followed the MLP space for a while knows that whenever you're looking at a transaction like this, you're going to talk about taxes. It's just part of the MLP structure that you have to understand and evaluate. We're no different from an MLP, so we need to understand it. So we took the time to literally look at the trade groups that own our units. And I don't want to get too technical, but the tax position you're going to be in will depend up on when you bought your unit and for how long you held it. Those are the two really important things to understand.

And what we wanted to understand was we had this fair value of the firm. What happens if you take that fair value of the firm and then you sort of tax effect it and then you compare that to essentially the combination that's on the table? And how do those stack up? And the conclusion we reached was that, this combination, we believe, is in the best interest of all of our unitholders even on an after-tax basis. And part of the reason we reached that conclusion was that, the taxes that will be realized on closing are taxes that our unitholders for the most part already owe. The part that's incremental to this is only the part of the capital gains that's related to the premium that we're getting.

So if you just step back, the taxes that our unitholders will owe are taxes they already owe. So let's use an example, if I could, for a moment. If you looked at May 12 of this year, so that's the last unaffected price before we announced this combination. We were trading for around $55.41. And so if your tax -- if you wanted to realize that as one of our unitholders and you sold at $55.41, you're going to pay these taxes depending on which trade group you're in and will determine how much that is you're going to pay. Let's just say, for example, it's $20. Let's pick a high number, $20. You've held us a long time. So you'd only realize $35, $35.41 in this example. Compare that to this transaction, which at announcement was $67.50. Do the same math, take out -- instead of $20, take out $24 because we're getting a premium, and you get a number that's higher than what you could otherwise realize by around $8 or $9. You're better off under the transaction after the transaction than you are selling at the previous market price. So that's the reality, is that our unitholders already owe it.

The second thing about taxes that's important, and this is probably the most difficult piece of the equation for our unitholders to really grasp, and that is, if you don't want to sell the unit and you want to just essentially defer these taxes, so don't sell it. I don't want to pay the $20 that I already owe. But I want to -- I know I owe it, but I want to pay it in the future. So I'm just going to hold my unit and pay those taxes in the future.

What needs to be understood and what we're trying to make sure really clear is that, our unitholders from this point forward are going to face higher taxes each year. The taxes that we're going to owe on the distributions that we pay will be increasing. So the idea of holding and avoiding a tax burden isn't really an option. And an example of that would be for some of our longer-dated or longer tenured unitholders say they owned this for 10 years or longer. The tax that they owe could be as much as 60% of the distribution that we pay them in 2026. So the idea that I'm going to avoid paying these taxes by simply not selling my units in any event, frankly, and holding it and avoiding taxes along the way, just doesn't -- that's not how this is going to work. The taxes are going up. But you have to understand both of those things. And at the end of the day, the taxes will be owed.

There's one very limited exception to how you might not pay these taxes, and that is to pass away and pass them on to your heirs. But the longer that event is, which we all hope everyone has a long fruitful life from where they're at, we're not going to wish sort of death upon our unitholders, the longer that data out is in time, the more taxes you're going to pay along the way, and the less that benefit -- the less value that benefit will have to you.

So our job is to make sure all of our unitholders understand from here looking forward what's their situation. And we think once they understand it, they'll come back to the central premise. There's really two. There's a full value for the firm that we're getting in the combination. It's full value. Second, the combined company, we believe, will be worth more, the Magellan stand-alone. And thirdly, you're not going to avoid these taxes absent passing away, and we don't wish that on any one.

[Jeremy Tonet, J.P. Morgan]

Got it. Mortality is a difficult part of active management. So understood. And so, maybe kind of -- I don't know if you're able to comment, I guess, what receptivity is. It sounds like there's a lot of investor education if that's something that you're able to talk about or we could move on to synergies for the combined entity as you see it.

[Aaron Milford, Chief Executive Officer]

Well, let's talk about the sentiment and how people are receiving this. I think it's important. I think most of our largest shareholders or unitholders are still in very much the assessment understanding phase. We just put the preliminary proxy out. We've just put out the supplemental information that's meant to help them understand at least how we see the world, and we think they're absorbing that. And that's good. That's what we want to have happen.

So we think through time, as people will absorb this information, we have conversations with our unitholders, we're going to be able to sort of cut through some of the fog that is out there around the deal and at least have them see the value proposition through the lens through which we see it. So the reaction has been, thanks for putting it out. We're really going to study it, and we're anxious to talk more. And we think that's a good thing. We have open minds, which is a good thing.

So in terms of the synergies, let's talk about that for a moment as well. I appreciate you bringing it up. Just to put us all in the same page, we expect the synergies from this deal to be between $200 million and $400 million plus. And if you look at the S-4, what you'll see most of our forecasts, we sort of essentially focused on the $200 million, which is the low end of that synergy range. That $200 million on the low end of the synergy range, the deal works from our perspective. The combined company should be worth more going forward, even at the low end of the synergy range. If you want to break the $200 million down, about $100 million of that we expect to come from cost synergies, primarily back office or back office activities, redundancies, things that when you look at the combined company, you don't need too of or things that you can do better. So that's $100 million of the $200 million. The other $100 million, we think, will be commercial synergies. And then there's going to be commercial synergies that get us to the upper end of that range.

So the point I would make is that, even with conservative synergy numbers, I don't think anyone would argue that those are heroic. The deal makes sense. And then to the extent we do better than that, which we expect to, it's really going to start making sense. So what's going to get us to that end where it really starts making sense? And it's really going to be things like optimizing the assets among the two businesses. That's an area. An area that we're really focusing on is as a company today, we buy NGLs, butane in particular, and we blend that into gasoline. We believe that going forward, we're going to be able to find efficiencies through that entire value chain that we couldn't find independently. We're you just going to be more efficient in how we procure store, move, make butane available and then blending it into our system. So that's another area that's going to find synergies.

So between the optimization and the blending and the cost structures, the $200 million is the low end of the range. We think we're going to be able to, through time, get to the upper end of that range. But even if we're wrong, we don't get to the upper end of that range, the deal works.

[Jeremy Tonet, J.P. Morgan]

That's very helpful. And so again, I'm not sure exactly how much you're able to comment at this point, but there's been some public opposition to the Magellan deal. And so, I'm just wondering, to the extent you were able to provide thoughts in that direction and anything else, I guess, on [vote] (ph) in general to the extent you're able to comment.

[Aaron Milford, Chief Executive Officer]

Sure. We're -- I'm not going to get into -- I appreciate the question, and I know I think we should talk about it. We're not going to get into a tit-for-tat with our unitholders. They're entitled to their opinions to view this deal ever on how they want to view it. What our job is, is not to get into an argument with our unitholders, but to explain why we think this is in the best interest of unitholders. And that's what we're trying to do, and that's what the supplemental information that we put out yesterday is intended to do. It's meant to show the reasons why we think this is in all of our unitholders' best interest. Even those who may disagree with this in some respects, we still think it's in their interest. We can agree to disagree.

And those things are: it's a full value; the combined company is more attractive, higher growth, more resilient than our business stand-alone; and the taxes are something you're going to owe anyway. We spend a lot of time on that. I'm not going to rehash it. You're going to owe them anyway. And if you believe that, it all comes back to value. And we think the value is there, both in the pro forma company and in the consideration we're receiving. We think as we continue to talk about this, and we help people understand the equation that we see, we're going to be successful with this vote and get to closing.

[Jeremy Tonet, J.P. Morgan]

Got it. So I think we've touched on the deal in many different directions. Are there any salient points that we haven't touched on that we should be thinking about at this point?

[Aaron Milford, Chief Executive Officer]

No, I think the only other salient point, and it's a bit of a soft issue, but I think it's interesting from our perspective, and that is, there's a lot of emotion around this transaction. It's really interesting, frankly. We have a lot of unitholders that have been with us a long time, and we're really appreciative of them. We've tried to run this company as best we could possibly run it. I think we have a really good reputation of being unitholder-friendly, discipline, focused on value, all those things that investors love.

And I think we've done a reasonably good job of that through the years. We've made our investors a lot of money. And I think there's just a sense of sadness in some respective that there's going to come a point in time where you're not going to see a Magellan ticker symbol out there, and I think that that's an emotional thing from a lot of our investors. Frankly, it's an emotional thing from much a management. But at the end of the day, I can look around the room and see like Paula and Jeff, Bruce. We've been here since the get-go, the beginning of this. So there's a little emotional for us as well. But at the end of the day, our job is to create value, to maximize value, and that's what we're doing. That's what we believe this combination does. And at the end of the day, that's our job, that's what we're going to do.

[Jeremy Tonet, J.P. Morgan]

Got it. That makes sense. Well, I think we're down to our last three minutes, and we haven't touched anything fundamental yet. Is there anything fundamental conversation to the Magellan business that we can -- that you want to touch on in the past -- in the final few minutes of our talk here?

[Aaron Milford, Chief Executive Officer]

Yes. This will be a great bridge conversation actually because I think it's a way for us to talk both about the combination and the fundamentals. Our business is doing well. We find product demand stable, slightly growing in certain areas. It's going to be a really good business for a really long time. It's currently a good business and everything is going very well.

If you look at our crude oil business, it's had some challenges just with the overcapacity. That's nothing new, but our team is doing a really good job. We've got really good contracts. Cash flow is really stable. So when you put our business together, it's doing really well. If you look at the commodity environment this year, it's been really favorable for us.

So we're still highly confident in our business. It's going to be relevant for a really long time. It's going to generate, we believe, a lot of cash flow for a really long time. And we're going to take that, and we're going to put it together with another really good business and have a stronger business. So things are going well. This is a great year so far for us. We expect it to continue that way, and we're going to take that, put it together with another really strong business and have an even stronger business.

[Jeremy Tonet, J.P. Morgan]

And on the refined product pipeline side of the business as far as publicly available information is concerned, it seems like things are tracking in line with expectations as set out in the guidance last time around or anything else notable?

[Aaron Milford, Chief Executive Officer]

It's certainly tracking our guidance. We expected this year refined product volumes to grow 1%. So 2023 over 2022 grow 1%, but you also have to keep in mind that 2022 was a record. So as a company, we're continuing to grow. So you have to keep that 1% perspective, certainly not declining. So we're thankful for that.

[Jeremy Tonet, J.P. Morgan]

Well, I think we're down to our last minute here. And so, I don't know if there's any final thoughts that you want to share with the audience on the fundamentals or otherwise?

[Aaron Milford, Chief Executive Officer]

No. At the end of the day, I appreciate being here again. What I would highlight is, we think the [indiscernible] merger maximizes our unitholders' value, including on an after-tax basis. The value that we're receiving is full. The company is going to be stronger on a combined basis and the taxes. We understand it's sensitive. But once you understand you're going to owe them one way or the other, it all comes back to where we began and that's the value, and we think this combination provides it.

[Jeremy Tonet, J.P. Morgan]

Got it. Makes sense to us. We greatly appreciate taking the time.

[Aaron Milford, Chief Executive Officer]

Yes. Glad to do it. Thank you all.