Normally, acquisitions go fairly smoothly. Sometimes things get complicated.
ONEOK's (NYSE: OKE) proposed acquisition of Magellan Midstream Partners(NYSE: MMP) is increasingly uncertain. Here's what investors need to understand, with Magellan's management team providing very clear examples of how bad it could get if the deal falls through.
Acquisitions follow a rhyming path
When a company offers to buy another company, it generally provides a premium to the current market price. That's intended to entice the shareholders of the target to agree to the deal. Wall Street reacts to this development as you would expect, bidding up the price of the target toward the offer price.
However, the price usually doesn't reach the target price, unless a competing offer is expected. The discount between the market price and offer price exists because there is always a chance that the deal will fall through. In fact, merger arbitrage attempts to take advantage of this discount by trying to figure out the deals that will get consummated while avoiding those that don't. This is a very unique style of investing, however, that's best left to specialists.
So, for most investors, the situation in which you'll most likely find yourself is owning a stock that has appreciated because of an acquisition offer. Thus, there will be a quick stock price advance, but there could be just a little more upside if you hold out for the deal to be completed. As a shareholder you have to decide if sticking around makes more sense than selling, recognizing that the share price will drop to pre-acquisition announcement levels if the deal falls apart.
This is the big issue facing shareholders of Magellan Midstream Partners today.
Some unitholders are going to say no
To sum it up, midstream energy company Oneok offered to buy Magellan for $67.50 per unit. The units currently trade at around $66.50 or so. But there are prominent unitholders that have openly come out against the deal, which increases the chance of a negative outcome.
Part of the problem is that Magellan is a master limited partnership (MLP). It's complicated, but the acquisition will trigger a tax event for Magellan unitholders that could be fairly substantial (it will be different for each unitholder, so it is impossible to accurately quantify the full impact.) Magellan is telling unitholders that the benefits of the deal outweigh the hit they'll face and that the outlook for the future is much improved by joining forces with Oneok. The dissident unitholder believes the opposite. Individual unitholders have to decide if the roughly 1.5% upside from current prices is worth the risk of sticking around. Magellan, meanwhile, recently quantified the downside if the deal falls apart.
According to Magellan, if the deal is scuttled, the value of the units would be around $55.40 or so assuming historical valuation multiples. From recent prices that would mean a price decline of nearly 17%. But the story doesn't end there. Management also provided a price of $48.66 if Magellan's units decline toward the average peer multiple. That would equate to a roughly 27% decline, which is a lot uglier.
So the question that investors have to ask themselves is whether or not a 1.5% gain that is uncertain is worth the risk of losing between 17% and 27%. Note that selling or waiting both lead to a tax hit, so that issue isn't really relevant in this specific situation. The only way to avoid the tax implication is for you to sit tight and for the deal to fall through, but that still leaves you with the likely drawdown in the unit price.
The best of a bad set of options
Most acquisitions and mergers are not nearly as tense and uncertain as the one that's happening between Oneok and Magellan. But every so often you get something that requires you to make a tough choice. Given the small potential upside from here, it seems like conservative investors will probably be best off taking their money and running. Just know that taxes will be a bit more complicated because of that decision. And remember that you can always buy Oneok outright after the dust settles if you want to.
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