Magellan’s midway carriers face a heavy toll from the Oneok deal

Oneok (OKE), a pipeline operator organized as a corporation, has reached a $18.8 billion deal, including assumed debt, to purchase Magellan in a cash and stock transaction at an initial value of $67.50 per unit. That represented a 22% premium to Magellan’s closing price on Friday. The deal, which was revealed Sunday, is set to close in the third quarter.

Shares of Magellan were up 14.3% at $63.28 Monday, which is just under the current value of the deal. Oneok shares fell 8.2% to $58.57. Magellan owners are set to receive $25 a share in cash and 0.667 Oneok shares for each of their units.

Magellan operates a large network of pipelines carrying gasoline and other refined products. It also transports crude oil.

Barron He wrote positively of the company three years ago, describing it as “the best-run, financially savvy pipeline operator in the country.” Due to its high yields, Magellan and other pipeline operators have been popular with retail investors. Prior to the deal, Magellan was making close to 8%.

Both companies said the deal would be a “taxable event” for Magellan holders, New York tax expert Robert Wellens said. Barron That bill can be significant. For starters, the equity portion of the merger payment is taxable because while companies can participate in tax-free reorganizations, partnerships like Magellan cannot. The monetary portions of acquisition deals are always subject to tax.

“Not only is the transaction fully taxable, but it is certain that most of the gains made by the MMP Partners will be ordinary income, not capital gains,” Wellens wrote. Barron in a letter. “This is because MMP has what are called ‘hot’ assets, and the portion of a partner’s gain from selling his interest that is attributable to the partnership’s hot assets is ordinary income,” Willen wrote in an email. Hot assets are taxed at ordinary income rates, not capital gains, when sold.

Holders of Magellan, like holders of other MLPs, receive distributions, which are the partnership’s equivalent of profits. Dividends are taxed slightly or not at all initially, which is favorable for investors. The catch is that the distributions reduce the owner’s cost basis in the units, deferring taxes until the units are sold.

Due to the tax structure, many MLP investors refrain from selling their units, which end up in their estate, as the tax treatment becomes advantageous due to the increase in the cost basis at death. The Oneok transaction disrupts this because the acquisition represents a sale of those units.

In an email reply to Barron On the tax issue, Magellan writes: “The tax implications of the transaction will be unique to each investor depending on when they purchased their MMP investment. The $25/unit down payment was specifically negotiated to help with the tax impact for our investors.”

Willens writes that it is complex for unit owners to calculate the cost basis. “The basis is increased to reflect the partner’s distributive share of the company’s taxable income; and it is decreased to reflect distributions made by the partnership to the partner,” Wellens said. “Thus, a long-time MMP unit holder is likely to have very little basis with the result that the gains from the sale of partnership units will be correspondingly large.”

Further, the owner must reflect the “non-recourse obligations of the partnership” from which the holder is relieved.

“When it comes time to sell the units, the diminution of their basis in the units results in a gain so great, and to add insult to injury that profit is so much ordinary in nature rather than capital. We always have this account when a ‘pool’ is made,” Wellens wrote. “MLP”.

MLPs go from being tax efficient to tax inefficient when they are sold. The result is that Magellan investors could face a tax bill that wipes out much of the premium they receive in the transaction.

Write to Andrew Bary at [email protected]