Shell Midstream Partners (SHLX) – Expected Higher Offer – Upside TBD

Current Price: $13.80

Offer Price: $12.89 (likely to be increased)

Upside: exp. up to 10%

Timeline: 2-3 months

 

This is a buyout of midstream MLP by its general partner. At this point, the idea is rather widely known – 3 months ago the thesis has been published on VIC. We’ve also been pitched this idea a number of times over the last few months but kept it on the side due to the limited remaining upside. Now that shares retraced amidst the market turbulence and several positive developments have rolled in – shareholders voiced opposition, one more MLP recently received a huge price bump, and the remaining timeline got shorter – we are highlighting the situation to our members. Below you will find a quick summary of the VIC thesis updated with the latest developments.

Shell Midstream Partners is an MLP that operates key crude oil pipelines and terminals in Gulf Coast and Midwest. On the 11th of Feb’22, the company received a preliminary proposal from its general partner Shell Pipeline, which owns 68.5% of SHLX) to acquire the remaining units at $12.89. Special committee was formed and has been reviewing the proposal since. Shareholder approval won’t be needed, so everything depends on the special committee’s review/negotiation process. Multiple aspects point towards the bid getting renegotiated higher. The situation somewhat resembles our previously covered takeover of another MLP – BKEP. The downside looks limited at 7% to both the current offer price and pre-announcement price. While potential upside is not super enticing, there’s a good chance of pocketing up to 10% returns over the next 1-3 months.

Overall, MLP is an outdated structure that has lost its relevancy after Trump’s tax changes in 2017. Prices of MLPs tumbled and dividend yields skyrocketed to double-digit levels. The whole operational business model of growing the asset base by issuing new shares at low equity cost issuance became no longer rational. Therefore since 2018 MLPs started to disappear – in large part through buyouts by their GPs or PE firms. Aside from a straightforward argument that MLPs no longer have any reason to exist, the other reason for these buyouts are strong financial incentives. MLP buyouts are highly accretive as the buyers are basically getting a very high-yield stock and funding it with low-cost debt. Some operational synergies are usually there as well. The same rationale is present with the SHLX buyout. One example is that Shell (the GP) has recently signed a major/world’s largest CCS project, where SHLX will be able to provide midstream solutions (as commented by the CEO during Q3 conf. call):

One potential opportunity in this space would be Shell’s recent announcement to explore potential CCS project in the Gulf Coast, where we could be well positioned to provide the midstream solution.

Interestingly, several recent MLP buyouts all have played out rather similarly. The initial bid usually comes in at a very minimal premium to pre-announcement prices and then after several months of review by MLP’s strategic committees, a definitive agreement is signed at a higher price:

• NBLX – an initial bid from Chevron at $12.47/share in Feb’21. Two months later, the price was raised to $14.27/share. 14% increase.
• PSXP – first bid at $32.57/share in April’21 followed by two raises and a final offer at $43.85/share. 35% premium in 10 months.
• BPMP – initial proposal in Aug’21 was at $13.01/share. The price was raised in 4 months to $14.75. 13% premium.
• BKEP – the initial proposal came at $3.32/share in October’21. In 6 months, it was adjusted to $4.65/share. 40% premium.
• And the most recent one is HMLP. Received a bid at $4.25/share in Dec’21. At the end of May’22, the deal was revised to $9.25/share. A slam dunk of +117%. This was mostly driven by the gas price explosion (also around 2x since the offer announcement until the definitive agreement).

So it’s quite likely that the SHLX buyout will follow a similar scenario:

• The bid for SHLX came at absolutely no premium to the share price at the time;
• Just a few months before the proposal (Q3’21 conf. call) SHLX management stressed that the “market is undervaluing our units and ability to deliver over the long term”. Shares were trading at the same price levels as GP’s bid.
• Multiple shareholders/fund managers have recently expressed dissatisfaction with the offer price saying the offer substantially undervalues SHLX: “Shell’s offer is substantially below its intrinsic value […] Shell’s “rock-bottom” price values units at nearly half of what they were worth in January 2020 despite oil prices doubling since then”. Springhouse Capital (ownership not clear) says the fair value is closer to $20/unit.
• The offer is also somewhat opportunistic as it came just half a year after the SHLX share price took a dive following a material dividend reduction in Q2 2021. The distribution was cut from $1.84/year to the current $1.2/year due to one of SHLX subsidiaries – Colonial Pipeline – undergoing a litigation process with its clients, which demanded lower pipeline rates. A bit more background on the situation can be found here. FERC (rate regulators) decision timeline is not clear. Due to uncertainty regarding the potential outcome, Colonial has decided to stop distributions, which alongside several other headwinds led to the SHLX dividend cut. However, Colonial’s distribution clearly will not be frozen forever (even if the rates are cut).
• The offer comes at 9% SHLX dividend yield. This seems cheap, especially taking into account the earnings power of the business as indicated by the previous dividend level ($1.84/year), at which the offer would stand at 14.2% yield. The offer also undervalues SHLX relative to peer yields – MMP (8.4%), PAA (7.4%), MPLX (9.7%), and larger/more diversified competitors – ENB (6.4%), EPD (7.8%).
• Lastly, oil price has increased +17% since the proposal was announced – albeit SHLX is not directly exposed to oil prices, higher overall industry profitability is likely to have an impact on valuations of midstream companies as well;

GP owns a controlling stake – might have high influence over the special committee and could push the current offer through resulting in 7% loss on the investment. However, given the arguments outlined above it is difficult to believe that Shell/GP will play the bad guy and push forward a bid with no premium to pre-announcement prices.

If the takeover fails completely, the downside should be limited. US midstream ETF currently trades at similar levels as back at the beginning of Feb’22. For SHLX, that would be a 7% drop to pre-announcement levels.