Deals

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.

One thing's for sure: Elliott Management ruined Christmas for a lot of folks.

Marathon Petroleum Corp., the oil refining and marketing company that has been the subject of Elliott's attentions since at least the fall, kicked off 2017 by mostly caving to the sometimes abrasive fund's demands. On Tuesday, Marathon said it would accelerate the sale of logistics assets to its master limited partnership, MPLX LP; swap its general partner interest in MPLX for more limited partner units; and conduct a review of its Speedway gas-station business with a view to potentially selling it or spinning it out.

Pity the poor souls who had to crunch all the numbers and draft the slides over the past few weeks.

Elliott, having demanded all this, approves -- as did other investors: Marathon's stock jumped as much as 8.4 percent on the news. In contrast, MPLX managed a gain of 1.8 percent, most of which fell away by the time the analyst call ended later on Tuesday morning.

MPLX is what gave Elliott its opening with Marathon in the first place. Like many other MLPs, it fell out of favor with investors amid the broader energy sell-off. MPLX made things worse by announcing a bid for MarkWest Energy Partners and then upping the cash part of it -- twice.

Buyer's Remorse
MPLX really started to lag behind its peers once the MarkWest acquisition tussle got going
Source: Bloomberg

Barely two months after that deal closed, MPLX slashed guidance. MarkWest's customers, chiefly companies drilling for natural gas in the Northeast, were cutting back due to weak prices. Meanwhile, the precipitous fall in MPLX's price sent its cost of capital soaring, cutting off funding for new projects.

MPLX was supposed to be a source of cheap capital for Marathon by issuing new units to raise money to buy logistics assets from the parent. Instead, it became a strategic question mark, separated from its peers by a vicious circle of a high cost of capital and weak growth prospects:

Odd One Out
MPLX offers roughly half the growth of its peers and, consequently, its cost of capital is significantly higher
Source: Bloomberg
Note: Indicated dividend yield as at close of December 30th, 2016. Forecast growth as per the consensus estimate of distributions per unit for 2017 versus 2016.

After some nudging from Elliott, Marathon in October attempted to jump-start MPLX by announcing it would ramp up the pace of selling assets to the company, thereby boosting growth, and get rid of its so-called incentive distribution rights, which would cut the cost of capital for MPLX (for an explainer on incentive distribution rights, see this). Investors weren't impressed.

Elliott Necessary
Marathon's stock fell after the company announced its new strategy and only perked up again once Elliott's involvement became widely known
Source: Bloomberg
Note: Performance indexed to October 26th, 2016, the day before Marathon announced its initial strategic plan for MPLX.

Rather than sell assets generating roughly a third of its Ebitda to MPLX over three years, Marathon now aims to do it in one. It will also swap its incentive distribution rights, or IDRs, for more limited partner units. In essence, Marathon will lever up the balance sheet of MPLX in order to give itself a slug of cash -- estimated at $4.5 billion -- most of which will likely get paid out to shareholders.

More importantly, Marathon hopes these moves will force a reappraisal of its valuation overall. If it gets $10.5 billion for the IDRs and $11.2 billion for the assets being sold to MPLX -- the midpoint of its guidance -- then that leaves an implied enterprise value for the refining and marketing business of less than $15 billion, which looks low. That's especially so if you factor in a spun-off or sold Speedway, which could be worth $10 billion or more on its own.

Management refused to speculate on Speedway's future on Tuesday's call, pending the strategic review. Yet, given that only in October CEO Gary Heminger was saying a retail business was "a valuable differentiator" for Marathon, announcing the review was a major capitulation in itself. Barring a spectacular increase in Marathon's share price between now and the summer, it seems likely Speedway is destined to separate.

After a year to forget for refiners in general, and with 2017 shaping up to be unpredictable on both the market and regulatory fronts, Marathon's ability to pull levers of its own should mark it out from its peers in a more positive way this year. 

Which leaves MPLX and its muted reaction. This actually makes sense. On the positive side, the accelerated drop-down of assets from the parent should roughly double MPLX's Ebitda within a year or so, addressing the growth deficit quickly. Along with getting rid of Marathon's IDRs, this ought to reset the cost of capital at a lower level.

On the other hand, the legacy of MarkWest means moves in gas prices continue to play an outsize role -- and expected warmer weather sent those tumbling by more than 10 percent on Tuesday. MPLX will also end up carrying more debt.

More importantly, high up-front growth will make it harder to grow off a bigger number beyond 2018 (one rationale for having assets trickle rather than flood down from Marathon). And, on a pro-forma basis, Marathon's limited partner interest in MPLX will jump from about a quarter to a stake of more than 66 percent; and it will retain the powers of the general partner.

A banker might say that leaves the two companies' interests closely aligned; an investor might well regard the parent's embrace as stifling. For MPLX to fully join the race against its MLP peers, Marathon will have to reopen some distance between the two.

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

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net