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ONEOK joins MLP simplification trend, on prowl for next deal

ONEOK Inc. joined the crowd of holding companies merging with their MLPs to eliminate the need to push cash upstream as incentive payments to the parent.

Early Feb. 1, ONEOK said that it was buying out the remaining public stake of ONEOK Partners LP it did not already own for $9.3 billion in company stock.

"As we evaluated other investment opportunities at ONEOK, we continued to arrive back at the same conclusion, that the best value for our shareholders would be owning the remaining 60% of the partnership," ONEOK President and CEO Terry Spencer told analysts on a morning conference call to discuss the merger. "Our current structure has performed well in a tough environment, but the much larger entity post-transaction is expected to provide even more financial strength and greater stability."

The move will probably result in ONEOK's debt being bumped up to investment grade, the company said, as the need to for incentive payments to the ONEOK general partner is eliminated, freeing up cash and lowering the combined entity's cost of capital. While not commenting on ONEOK directly, S&P Global Ratings analyst Michael Grande said in a Feb. 1 note that collapsing MLPs is, in general, good for credit quality. "Structural simplification for MLPs is the more transformative fix to their high cost of capital, rather than simply a distribution cut or an IDR subsidy by its general partner, and the next step in the evolution of the sector."

Incentive distribution rights — in which increasingly disproportionate amounts of cash are paid to the 2% general partner of an MLP — become a drag on the MLP's cost of capital as revenues and cash flows increase with the MLP's growth. In the past two years, some of the biggest MLPs in the nation have used a variety of tactics to eliminate IDRs.

"As the dollar per [limited partner] distribution crosses certain thresholds, an increasing proportion of incremental cash flows are paid to the general partner," CreditSights analyst Charles Johnston explained on Feb. 1. "The top level, referred to as the high splits, typically directs 50% of incremental cash flows to the general partner. This increases the equity cost of capital for the [limited partner] and MLPs use equity for around half of capex funding."

Williams Cos. Inc. used $11.4 billion recently to re-position its ownership of Williams Partners LP and eliminate the IDR payments. More simply, midstream and pipeline operator such as Targa Resources Corp. and Kinder Morgan Inc. have merged the MLP into the parent.

CreditSights noted that the one remaining MLP holding company to address the IDR payment issue is MLP holding giant Energy Transfer Equity LP.

ONEOK executives told analysts on the call that the company could use its assumed investment grade status, free cash, and ability to finance more cheaply, do more mergers, primarily bolt-on acquisitions of smaller firms. Spencer also would not rule out taking on a peer.

"We have been historically an acquisitive company," Spencer said. "We're always looking; particularly the bolt-on acquisitions are considerably appealing to us. But also there might be acquisition more on the strategic front."

"We have been very vocal about being interested in pursuing other types of transportation assets in terms of pipeline," Spencer said. "Refined products and crude oil, we're very interested in. Candidly, those assets are hard to find and not many people are out there trying to sell them, but certainly, we're very interested in those."

Under the terms of the Feb. 1 deal, ONEOK will buy the remaining 60% public stake of ONEOK Partners with ONEOK stock at a 22% premium to the Jan. 27 closing price for the limited partner units. In addition, ONEOK said it will cross-guarantee the MLP's debt, which stood at $7.9 billion at the end of the third quarter of 2016, according to S&P Market Intelligence data.

"Upon closing, [ONEOK] intends to up their dividend 21% to nearly $3 (~5.4% yield) and grow 9-11% annually through 2021 at greater than 1.2x coverage," analysts at Tudor Pickering Holt & Co. told their clients. "Deal seems fair for both parties. [Limited partner] holders receive attractive premium (26%) with a modest (7%) distribution cut and relief of IDR burden to offset likely taxable event."