Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Investors in MarkWest Energy Partners should know a sweet-enough deal when they see it.

Marathon Petroleum, whose pipeline partnership MPLX is trying to buy the natural gas processor, has already sweetened its offer twice to stave off shareholder opposition before a Dec. 1 vote on the transaction. The latest of the boosts came Tuesday when Marathon increased the cash portion of its offer for the master limited partnership to $6.20 per unit, bringing the total value of the stock-and-cash proposal to about $51.74 based on Monday's closing prices.

Tracking The Spread
MarkWest's discount to the MPLX offer narrowed on Tuesday before widening back out.
Source: Bloomberg

Even as a drop in MPLX units erodes the value of the offer, the additional one-time payments should be enough to win over lingering holdouts. Some traders are betting that's the case. The spread between the offer price and MarkWest's units stood at about $5, or roughly 12 percent, as of early afternoon in New York. Earlier, it narrowed to the lowest since the former head of MarkWest's general partner, John Fox, criticized the deal.

Marathon clearly wants this asset badly to twice boost a bid that wasn't that bad to begin with. Another bump could be possible, though it probably won't tack on more than another $1 or so. Ask for anything more than that and MarkWest unit holders start to look a little greedy.

One of the biggest criticisms of a deal with MPLX is the accompanying obligation to make payouts to Marathon. The refiner has so-called "incentive distribution rights," meaning Marathon takes a disproportionate slug of MPLX’s cash flow, leaving less for regular investors. Understandably, MarkWest holders aren't thrilled about handing over cash that could have otherwise been theirs. But it's not like MarkWest gets nothing in return. 

MarkWest was forced recently to cut its guidance for how much distributions to shareholders will grow over the next several years. Based on a consensus estimate of $3.70 a share for this year, the top end of the new guidance implies MarkWest's unit holders would receive a total payout of $23.54 per share between 2016 and 2020 on a stand-alone basis. 

Using the consensus estimates for MPLX, and adjusting for the exchange ratio of 1.09 common units per MarkWest unit, the implied payout if the deal goes through is $18.82. So the new cash portion of $6.20 more than covers the shortfall of $4.72 -- and that is cash upfront,  not discounted over the next five years. 

The Cash Gap
Marathon's sweetened terms will help cover the distribution shortfall MarkWest investors will face should they accept a deal.
Source: Bloomberg, MarkWest presentation

Investors in MarkWest should also be somewhat wary of how secure its distribution guidance is, given the company's leverage and how tight the sector's access to public equity and debt markets has become.

MarkWest's coverage ratio, which measures how far its cash flow goes in covering distributions to unit holders, has been deteriorating over the past year and has been running below 1 for the past two quarters, according to data from Bloomberg Intelligence analyst Michael Kay. Total debt, meantime, has risen from about 4.1 times Ebitda in 2014 to about 5.2 times, according to data compiled by Bloomberg.

Undercover
MarkWest's cash flow doesn't cover payouts like it used to.
Source: Bloomberg Intelligence

Marathon's size, investment-grade credit rating, and pipeline of assets to drop into MPLX would help MarkWest weather the storm and finance the future growth on which those promises of distributions rest. Sometimes you've got to take a little bad with the good. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net