This 4.5%-Yielding Pipeline Stock Just Made a $4.4 Billion Acquisition. Here's What It Means for the Dividend.

Oneok (NYSE:OKE) is buying Brazos Midstream's Permian Midland Basin assets for over $4.4 billion. It's funding the deal through a $9 billion minority equity investment from funds managed by Apollo (NYSE:APO). These two deals will have major implications for the pipeline giant's roughly 4.5%-yielding dividend in the coming years.

Here's a look at Oneok's needle-moving acquisition and unique financing arrangement.

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Drilling down into the deal

Oneok is buying Brazos Midstream's Permian Midland natural gas gathering and processing assets for over $4.4 billion in cash. The acquired assets will include 700 miles of gathering infrastructure and 1.2 billion cubic feet per day of processing capacity following the completion of the Cassidy II plant in the third quarter of next year. The assets span 600,000 dedicated acres secured by long-term, fixed-fee contracts with an average of 12 years remaining with producers that include ExxonMobil and Diamondback Energy. The assets are highly complementary to Oneok's existing position and will double its processing capacity in the Midland Basin. The deal will strengthen its integrated Permian-to-Gulf Coast strategy by expanding its scale in the rapidly growing Permian Midland Basin, while adding long-term, fee-based contracted growth with leading producers.

The pipeline company is funding the deal with a unique structure. Private equity giant Apollo and its affiliates are making a $9 billion minority equity investment in Oneok through a Class B interest. Oneok will use the additional funds to retire $5 billion in debt, enabling it to reduce its leverage ratio to around 3.25 times next year. The Apollo investment carries an internal rate of return (IRR) capped at 7% for the first nine years, with all the value created above the cap flowing to shareholders. This investment has a lower cost of capital than Oneok's stock, and it offers the option to redeem it in the future.

While this deal structure is unique, this isn't the first time Apollo has used it to help a public company fund its investment strategy. Real estate giant Realty Income (NYSE:O) agreed to a very similar deal with Apollo earlier this year. Apollo made a $1 billion investment for a 49% stake in a joint venture holding 500 existing retail properties. Apollo's investment in Realty Income has a capped IRR of 6.875%, and the REIT can redeem it in the future. This investment provided Realty Income with low-cost capital to make new investments to support its growing high-yielding monthly dividend. It also provides a repeatable framework for future investments.

Why this matters for Oneok's dividend

The deal for Brazos Midland and the financing arrangement with Apollo will enhance Oneok's financial profile and growth trajectory. The pipeline company expects the acquisition to be immediately accretive to its earnings and free cash flow per share. The energy company noted in the press release announcing these agreements that the "acquisition increases momentum toward the high end of ONEOK's mid- to high-single-digit adjusted EBITDA growth target over the next five to seven years." Meanwhile, the funding will accelerate its deleveraging timeline and more than achieve its previous leverage target without needing to issue common equity. That will give it additional financial flexibility to support its growing backlog of organic expansion opportunities, especially in the Permian Basin.

Oneok also noted that the deals will accelerate its "flexibility to increase capital returns to shareholders, including through potential dividend increases and share buybacks." The company was already targeting 3% to 4% annual dividend growth. That would further build on its legacy of more than 30 years of dividend stability and growth. While Oneok hasn't increased its dividend every year, it has nearly doubled its payout since 2014, significantly outpacing its pipeline-stock peers.

However, the deal doesn't guarantee that Oneok will increase its payout or accelerate its current dividend growth plan. It still needs to execute its expansion strategy, including closing these deals (which it expects to occur in the fourth quarter) and completing its current slate of expansion projects within reasonable timelines and budgets.

A potentially winning transaction combo

Oneok is making a needle-moving acquisition funded with a non-dilutive investment from Apollo, which will also help it reduce debt. While it's using a unique funding strategy, it's in good company, with Realty Income recently completing a similar deal with Apollo. These transactions will put Oneok in the position to return more cash to investors in the future, potentially through even faster dividend growth. As a result, it should enhance Oneok's appeal to income investors.

Matt DiLallo has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends Oneok. The Motley Fool has a disclosure policy.