Chevron – The Merger Wave in the Oil Patch Starts Heading Midstream
A merger wave washed over the oil patch last year. Oil giant Chevron (NYSE:CVX) kicked things off in July by agreeing to acquire Noble Energy for $13 billion. That spurred a flurry of similar deals as oil producers paired up to drive down costs.
The oil industry‘s current M&A wave has now splashed into the midstream sector. Chevron again opened the floodgates by offering to acquire Noble’s former MLP Noble Midstream Partners (NYSE:NBLX) for an additional $1.13 billion earlier this month. Brookfield Infrastructure (NYSE:BIP)(NYSE:BIPC) then followed with an offer to acquire Inter Pipeline (TSX:IPL), while Energy Transfer (NYSE:ET) sealed a deal to merge with Enable Midstream (NYSE:ENBL). More activity seems likely as the pipeline industry seeks to reduce costs as the global economy shifts to cleaner fuel sources.
A closer look at the recent flurry of activity
Each recently proposed transaction has a slightly different spin and strategic rationale. For example, Chevron made a no-premium, all-equity offer to acquire the rest of Noble Midstream. A deal would give Chevron full control of Noble Midstream’s assets, increasing its flexibility while reducing costs. While they haven’t agreed to a transaction, the likelihood that they’ll reach one is high. Chevron is Noble Midstream’s largest customer and investor at a 62.5% interest in the MLP.
Meanwhile, Brookfield Infrastructure and its deep-pocketed institutional partners see value in Inter Pipeline. Brookfield built up a nearly 20% stake in the Canadian Pipeline operator in hopes of leveraging that interest into a larger deal. Despite offering a 23% premium with the potential to go higher, though, Inter Pipeline’s management team hasn’t engaged in negotiations with Brookfield. They believe it has even greater upside potential as the oil market continues to recover. The value-conscious Brookfield and its institutional partners could walk away and pursue a different target.
Chevron and Brookfield Infrastructure made public acquisition proposals, but Energy Transfer signed a merger agreement with Enable Midstream. This contract comes after the MLP’s two largest investors, utilities OGE Energy (NYSE:OGE) and CenterPoint Energy (NYSE:CNP), agreed to exchange their nearly 80% stake for units of Energy Transfer in a no-premium, all-equity deal. The transaction will enhance Energy Transfer’s midstream footprint and credit profile while enabling it to capture an estimated $100 million in annual cost savings.
More merger overtures seem likely
The midstream sector seems ripe for consolidation. The oil industry’s growth prospects are dwindling as the global economy accelerates its shift toward cleaner alternative energy sources.
Two catalysts will likely spur additional M&A activity in the sector. First, smaller midstream companies appear poised to partner up with larger energy companies. Those moves would increase scale and reduce costs, so the combined company could generate more cash. That would give the merged company greater financial flexibility to repay debt, repurchase equity, and boost its dividends.
In addition, more utilities will likely follow OGE and CenterPoint in exiting the midstream sector. That will allow them to focus on their core electricity generating and distribution activities, which will require significant reinvestment in the future to clean up carbon emissions. Pipeline giant Kinder Morgan (NYSE:KMI) recently noted that gas infrastructure asset acquisitions from utilities could help offset its dwindling organic growth prospects. It’s getting tougher to build new pipelines due to the oil industry’s volatility and increasing environmental and legal challenges.
Most corporate mergers will follow the Chevron and Energy Transfer blueprint as all-equity, no-premium deals. Paying a high price for their target will enable acquiring midstream companies to preserve cash without diluting existing shareholders.
It also wouldn’t be surprising to see the purchasing company use equity to fund most future gas infrastructure acquisitions. That would also preserve their balance sheet flexibility while allowing the sellers to participate in the upside and cash in those shares, when market conditions permit.
Finally, it’s also possible that there could be a few more private equity deals like Brookfield’s bid to take Inter Pipeline private. Financial investors can squeeze a lot of value out of midstream assets even if they have to pay a premium to gain control.
The midstream M&A wave appears to be in the early innings
The pipeline industry seems to be in the beginning stages of a consolidation wave. With the sector’s growth prospects dwindling, mergers can enable companies to reduce costs so that they can generate more cash. That cash can, in turn, increase their ability to pay off debt, repurchase shares, or boost their dividends. Utilities also need money to fund their decarbonization programs.
Meanwhile, private equity funds have money to put to work. All of this suggests that there’s a flood of deals coming down the pipeline. This merger wave catalyst makes the midstream sector worth watching.