Northern Tier Energy: Making Sense Of The Western Refining Acquisition

| About: Western Refining, (WNR)

As I noted in my previous article, Northern Tier Energy (NYSE:NTI) has had a remarkable couple of trading days. NTI's Q3 earnings report and subsequent dividend cut has been totally eclipsed by the news that Western Refining (NYSE:WNR) is to buy a 38.7% limited partner stake in NTI along with 100% of the general partner interest for $775M. NTI's stock has reacted very positively to this development, with shares up over 10% for the week. This is in stark contrast to the 5%+ decline seen in the after market when the WSJ initially reported the rumored transaction. In this article, I will attempt to answer some of the questions left unanswered from the previous article and explain why the stock has surged.

(Click to enlarge)

Why did the PE firms sell at a discount?

In my earlier article about this transaction, I mentioned that the selling private-equity firms TPG and Acon Investments Ltd had likely sold out at a slight discount to the then current stock price for NTI. In essence, the PE firms sold their limited partner stake at a 6.5% discount. This valuation also places a zero value on the controlling GP interest. This discount intrigued many, including myself.

However, the comment section of that article seem to have the answer. One commenter noted that this transaction was more similar to a private placement, or non-public offering, of equity than to an outright acquisition.

This line of thinking makes a ton of sense and easily explains why the PE firms received a discount for their units. As followers of NTI should know, these PE firms had already been unwinding their position throughout the year. In 2013, there had already been three such public offerings of units. Each of these offerings were quite large and priced at similar discounts.

  • January 2013: 10.7M units for $24.46 each
  • April 2013: 12M units for $26.28 each
  • August 2013: 11.5M units for $22.85 each

Basically, this transaction is inline with previous sales of units. The PE firms are to receive $775M for the remaining 36.62M units, implying a price of about $21.15 per unit. A public offering of this size would have likely needed a much larger discount to entice buyers.

What benefit would Western Refining see in controlling NTI?

This is by far the most important and interesting aspect of this affair. In the press release announcing the transaction, Western Refining CEO Jeff Stevens noted the following:

"This investment further enhances our strategic goal of expanding our refining presence in areas with direct pipeline access to cost-advantaged crude oil resources. By adding these strategically aligned assets to our business portfolio, this transaction adds scale to our business and diversifies our operations by adding a new geographic region to our refining platform. Northern Tier Energy's St. Paul Park refinery is a very successful refinery with pipeline access to cost-advantaged crude oil and refined product regions that historically have generated strong product margins. The combined strength and scale of the two organizations will provide future growth opportunities for both companies over the long-term."

For those not familiar with the current North American energy situation, this statement may seem odd. However, it makes perfect sense. NTI has one of the few refineries located close to both the Bakken and to pipelines carrying Canadian crude. Both of these oil feedstocks trade at large discounts to WTI. In essence, NTI has a "location advantage" compared to many of its peers due to its refinery not needing as much WTI priced crude, and basically zero Brent priced crude.

As Western Refining's current assets use other sources of crude, this allows the company to diversify its feedstock and to benefit from more crude oil price differentiations often seen in different regions.

Another substantial benefit Western Refining may see is an improved valuation for its assets. UBS notes that Western Refining trades at only a 3.3X enterprise multiple (EV/EBITDA), way below NTI's 6.7X and CVR Refining's (NYSE:CVRR) 7.8X. Part of the reason for this difference may be due to the difference between Western Refining being a C-Corp while the NTI and CVRR are MLPs. If Western Refining were to dropdown downstream assets directly to NTI, the company would see a massive benefit due to the increased multiple applied.

Western Refining would likely have to ensure these assets are accretive to NTI's EBITDA and FFO per share metrics, as NTI's stock would likely be the "currency" for any such transaction. I can easily see a scenario where NTI issues LP units directly to Western Refining in order to add a refining asset. Or more likely, NTI issuing units to the public to pay for the assets in cash.

Why has NTI's stock increased in value?

Western Refining and NTI are extremely comparable companies, with very similar and aligned interests. With Western Refining as its GP, NTI now has a clear pathway for future growth as well as potential diversification.

A Goldman Sachs note also mentions that the share overhang from the previous PE firm owners is now removed. Basically, NTI unitholders no longer need to worry about massive unit offerings coming to market. A cursory glance at the stock chart shows that these offerings have had a chilling effect on NTI's share price throughout the year.

Final Thoughts and Conclusion

Western Refining controlling of NTI is a classic example of a win-win scenario. Both stocks are up huge on the news, and with good reason. Given this news and that crude oil differentials have recently begun to widen, it is once again a good time to be long refiners such as NTI and Western Refining.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

Disclosure: I am long NTI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.