A Dream Acquisition for This High-Yield Investment

By Markets Fool.com

Any energy company with a decent balance sheet should be salivating at the idea of making an acquisition or two right now. With oil prices down as much as they are today, many assets out there are trading at huge discounts -- even the ones that shouldn't be. Magellan Midstream Partners has never been one to shy away from making a few small acquisitions here and there to enhance its extensive refined products pipeline network, but there's one massive opportunity out there that would be the talk of the energy world if the company could pull it off.

Continue Reading Below

Let's take a look at why Magellan should consider buying its competitor, Colonial Pipeline, and why Magellan might actually be in a position to do it.

Go East, young man, go East and grow up with the country
The boom in oil and gas production across the United States has made a huge impact on not just the economics of oil, but also the logistics of oil. The Gulf Coast is awash with crude, and the refineries that transform that crude need customers. To get all of that product to America, Magellan has built the nation's largest infrastructure to move petroleum product from refiners in the Gulf Coast and Mid-Continent to customers across the midwest and Rocky Mountains.

Source: Magellan Midstream Investor Presentation.

While this impressive system gives Magellan access to more than 50% of the refining capacity in the U.S., it operates almost exclusively west of the Mississippi. The company does have a large amount of refined product storage terminals, but it relies on other companies to move product to them.

Continue Reading Below

Source: Magellan Midstream Investor Presentation.

These pipelines have been an incredibly stable cash generator for the company, but a large part of those pipes and terminals are in what the Federal Energy Regulatory Commission have deemed non-competitive regions, and therefore, rates for transport are regulated similar to a utility. This means revenue growth -- and in turn distribution growth for shareholders -- comes more from the expansion of its pipelines system through new projects and bolt-on acquisitions.

One way Magellan could really move the needle in terms of expanding its refined product system and increasing distributable cash flow would be to acquire Colonial Pipeline. The reason for this move is that Colonial has the one thing Magellan doesn't: east coast pipelines.

Source: Colonial Pipeline.

Not only would this give Magellan access to a larger client base reaching from New Orleans to New York City, but it would link up its existing pipeline network with more than 85% of its independent terminal system, as well as add Colonial's own terminal network that would greatly expand Magellan's 130 million barrels of storage in the region. To top it all off, it would also serve as a critical link to another 30% of the nation's total refining capacity.

While the revenue and earnings numbers are not available for Colonial since it's a private company, let's just use Magellan's margins as a rough guide for what this system could mean to the bottom line. Between transportation and storage, Magellan makes an operating profit of $1.67 per barrel transported. Colonial's system handles about 2.4 million barrels per day of product, which means the system could generate as much as $1.4 billion in operating profit annually -- about double what Magellan's current refined product business pulls in annually today.

In a position to take a big bite
Knowing the size of Colonial is difficult, but if we were to use that estimate from above and assign an EBITDA multiple of 8-10 times, then it would probably take somewhere between $11.5-$14 billion range to make this kind of purchase. This would be an awful lot to swallow for Magellan since the company stands at a total enterprise value of $21 billion itself. However, based on the company's balance sheet, it's in a better position than ever to make a move of this scale.

Thanks to strict capital discipline and a conservative distribution payout that frees up some free cash flow for growth, Magellan has greatly whittled down its debt levels, and today it stands with a debt leverage much lower than both its target and the target that ratings agencies look for to give out an investment-grade rating.

Source: Magellan Midstream Investor Presentaion.

This wouldn't be enough to make the deal happen with just debt, but it could be enough to make a combined debt/equity acquisition palatable.

What a Fool believes
Magellan Midstream has built a reputation as a solid midstream company that has become an income investor's dream. Over the past decade, it has grown its distribution at a reasonable clip and has beat the broader market on a total return basis by 30 times. Adding the Colonial pipeline could be just a dream considering the size of Colonial, but if the market conditions were just right, Magellan may have the financial flexibility to pull it off.

The article A Dream Acquisition for This High-Yield Investment originally appeared on Fool.com.

Tyler Crowe owns shares of Magellan Midstream Partners.You can follow him at Fool.com under the handle TMFDirtyBird, onGoogle+,or on Twitter@TylerCroweFool. The Motley Fool recommends Magellan Midstream Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.