It's not often that an M&A transaction expands a company's present-day business, improves its tax situation, upgrades its growth prospects, and removes operating risk from the business. And yet, Macquarie Infrastructure Company LLC (NYSE:MIC) achieved all of that when it bought its partners' 50% interest in International Matex Tank Terminals (or IMTT)). I liked Macquarie back in December and even after this 30% run in the shares I still believe the shares are an undervalued play on quality infrastructure assets.
Sluggish Q2 Results Not The Big Story
Macquarie Infrastructure reported operating results for the second quarter that came in a little weak, though without any particular problems that should linger on.
Revenue rose 11%, with all of the operating units delivering double-digit growth. Volumes improved at Atlantic Aviation, as did average fuel margins, while terminal revenue at IMTT grew even in spite of lower utilization tied to maintenance outages.
Gross margin improved about 70bp, with a small improvement at Atlantic Aviation and a larger improvement in the power business offsetting weakness at IMTT. EBITDA rose almost 15%, with Atlantic up almost 13%, Hawaii Gas up almost 32%, and power up 46%, while IMTT was up just 2%. On an operating level, Macquarie missed expectations by about three cents, with the misses coming fairly evenly across the operations.
Proportionate free cash flow was more than five cents below expectations, but still up about 9% on a per-share basis. With that, management raised the dividend again (by a little more than 1%, to $0.95/share/quarter).
Owning All Of IMTT Worth More Than Simple Arithmetic
Macquarie Infrastructure significantly improved its outlook and long-term value when it reached an agreement earlier this month to acquire the other 50% of IMTT that it did not own. While already a very familiar business to Macquarie and its shareholders, I believe this can be a transformative acquisition.
Macquarie Infrastructure owned 50% of IMTT, with the founding family owning the other 50% and holding operating control. While the relationship between MIC and that family may not have reached the level of Hatfields and McCoys, it was a contentious relationship and likely about to get worse as deficiencies and shortfalls at IMTT were starting to weigh on Macquarie's valuation and prospects.
Relative to other operators of liquid petrochemical storage facilities, including Kinder Morgan Partners LP (NYSE:KMP), Buckeye Partners LP (NYSE:BPL), and Oiltanking Partners LP (NYSE:OILT), IMTT was spending considerably more on maintenance capex than industry norms. While other storage operators have been spending around 8% of EBITDA, IMTT has been spending closer to 25% even after adjusting for Sandy-related repairs. Macquarie Infrastructure management believed that IMTT was missing opportunities to control spending through better procurement, scheduling, budgeting, and cost control efforts, but IMTT's management apparently wouldn't listen.
Whether due to the capex issue or other factors (including a lack of interest in reciprocating growth investments?), IMTT was also showing a much weaker growth backlog than expected, with 2013 year-end backlog more than a third below some expectations/projections. Given the growth in shale-based production and IMTT's advantaged locations in New York and Mississippi, this was extremely disappointing in a period where many storage companies are unveiling aggressive growth plans that can fuel above-average distribution growth in the years to come.
In buying out its partners, Macquarie Infrastructure can now run IMTT as it likes, and I believe that is a very good thing. First, Macquarie Infrastructure can now invest in growth projects and profitably redeploy capital. Second, management can now look to trim the excessive capex spending and bring the operation's cost structure more in line. Last and definitely not least, consolidating IMTT allows Macquarie Infrastructure to offset growth in cash taxes at IMTT with existing NOLs and avoid the double-taxation of its share of IMTT earnings.
Other Operations Have Their Positive Points Too
With the IMTT transaction, this business now grows to over half of Macquarie Infrastructure's operations, relegating Atlantic Aviation to second place at about one-third. Atlantic is hardly an afterthought, though - BBA Aviation (OTCPK:BBAVY) is still a larger player, but management has been good about restructuring operations and this business is leveraging improving business jet traffic.
Management is also shuffling the deck in its power operations. Management agreed to sell its stake in District Power and intends to reinvest those proceeds into other energy projects; a recent $11 million investment into a 20MW New Mexico wind power facility is likely representative of what the company will do here in the future. Hawaii Gas is more of an "is what it is" business, though future rate cases could reset the contributions to a higher level.
Recalibrating The Value
Between ongoing improvements in the aviation services market and the considerable benefits to owning 100% of IMTT, I'm ratcheting up my fair value estimate on Macquarie Infrastructure. I'm now looking for distributable cash flow to grow closer to 10% a year, lifting the fair value to nearly $75 even with the higher share count. The biggest risk I see to that outlook is the funding environment - relative to energy MLPs, Macquarie Infrastructure will be a little late in committing growth capex to IMTT (assuming they go that route) and many of these other companies have locked in low-cost funding. On the other hand, the tax benefits of the transaction provide a solid near-term boost to the company's overall financial efficiency and should de-risk the operations (which will help the cost of capital).
The Bottom Line
I thought that Macquarie Infrastructure was an undervalued and overlooked infrastructure play back in December and I continue to believe that now, particularly given the benefits of the IMTT deal. Brookfield Infrastructure Partners (NYSE:BIP) arguably has a quality edge on Macquarie Infrastructure, and the business mixes are quite different, but both are quality names and Macquarie looks undervalued enough to be worth real consideration even after this run in the shares.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.