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Published
May 25th, 2015

Category:
MLP Market Post

Week Thoughts: MLPs Pause for Annual Beauty Contest

MLPs were flattish this week, along with the stock market, oil prices, and interest rates. Natural gas prices and propane declined sharply, however, which helped upstream MLPs and small caps under-perform. There were no significant midstream announcements this week, but plenty among upstream MLP activity, including equity and more consolidation.

Weekly Review_5-22-15

The Last NAPTP Conference Ever

NAPTP announced this week that it will change its name from the National Association of Publicly Traded Partnerships to the MLP Association (press release). That means next year, when management teams, investors, bankers, attorneys and research analysts mix in Orlando at the annual conference, it will be called the MLPA Conference.

The highlight of the conference for me was the excitement of the crowded bar packed with plenty of Houstonians watching the Rockets’ James Harden fail to get a shot off at the end of game 2 of the NBA Conference Finals against Golden State. The collective frustration was something you might see at a crowded sports book in Vegas on the first weekend of the NCAA tournament. Would have been better had the Rockets pulled it out, but it was probably the biggest collection of pro Houston fans in the state of Florida on that particular night.

Mixed Sentiment on Commodities, Focus on Backlogs

Perhaps appropriately, the weather this week oscillated between heavy rain and blinding sunlight. MLP investors seemed focused on the status of backlogs and execution of announced projects, and less focused on the impact of lower commodity prices on current results. There are still wide gaps of opinion on whether we see $70/bbl or $40/bbl first.

In that uncertain environment, the MLP sector should continue to provide opportunities for stock picking. Also, the current environment is the most competitive I can remember among MLPs vying for attention from investors, and I expect certain MLPs to see renewed investor interest in the next few weeks after their appearance at the annual MLP beauty contest.

There were less conversations about who might be the next to try to collapse their IDRs than I would have expected, and more discussions about which hyper-growth drop-down MLP would be the first to use their cost of capital advantage to aggressively pursue acquisitions of lower multiple MLPs.

Panels Instructive

The tax panel was interesting, and provided excellent color and detail on the state of the proposed IRS rules. The main takeaways I had from that discussion was that there are far more questions than answers and the process to reach the final regulations could take a year. That uncertainty doesn’t help some MLPs, and might slow the IPO market for non-traditional MLPs in the meanwhile.

The buy-side panel focused on midstream MLPs’ history of maintaining distributions in past commodity down cycles, and their history of bouncing back hard from prior corrections. Also, there were IDR apologists on the panel that seemed to believe these recent IDR collapsing consolidations (KMI, WMB, CEQP) as simply the inevitable final chapter for a successful MLP, rather than a reason to pressure new MLPs to curb the self-imposed problem of IDRs limiting growth over time. That’s logical, given how well many institutions have done by owning publicly-traded GPs over the years.

Finally, it was great to mingle among readers of mlpguy.com, thanks for the ongoing support and feedback.

Winners & Losers

WLKP rallied hard this week, with management at the conference outlining all the efforts the MLP is taking to change the proposed regulations and outlining its intention continue with business as usual in the meanwhile. EROC rallied Friday on the buyout announcement, but not close to the price implied by the buyout. CAPL (mis-labeled as LGP below) rallied despite not attending the MLP conference.

Top5Bottom5_5-22-15

On the downside, upstream MLPs were pushed lower by equity issuance from LINE and ARP this week, and probably weren’t helped by weaker natural gas prices. Despite the pipeline rupture and oil spill, PAA did not make the bottom 5, and was down less than 2% on the week.

Top5Bottom5_5-22-15_chart

Year to Date

Year to date, WLKP climbed up a few spots this week after a disastrous few weeks. CAPL climbed out of the bottom 5 altogether this week, replaced by ARP. On the upside, DKL popped into the top 5, displacing EXLP, but no other changes at the top.

Top5Bottom5_5-22-15_YTD

Top5Bottom5_5-22-15_YTD_chart

General Partner Holding Companies

GPs underperformed the AMZ this week overall, dragged down by weakness in the more commodity sensitive GPs. EXH led the way after under-performing last week. EQGP showed strength late in the week after their first public appearance since the successful IPO a few weeks ago.

Top5Bottom5GPs_5-22-15

Top5Bottom5GPs_5-22-15_chart

News of the (MLP) World

No significant midstream transactions this week on the equity or M&A front, but don’t expect that to continue next week. MLPs generally like to keep bankers busy on long weekends, and I’m sure there are junior bankers working right now on a few things we can expect to hear about next week, including at least one IPO.

News-of-the-World

Equity

  • Linn Energy (LINE) priced public offering of 16.0mm units at $11.79/unit, raising $188.6mm in gross proceeds (press release)
    • Overnight offering, priced at 5% discount to prior closing price, and traded down an additional 4.2% in the session following pricing
    • Use of proceeds: to reduce borrowings and for general purposes
  • Atlas Resource (ARP) priced public offering of 6.5mm units at $7.97/unit, raising $51.8mm in gross proceeds (press release)
    • Overnight offering, priced at 5.1% discount to prior closing price, and traded down an additional 4.6% in the session following pricing
  • MPLX filed equity distribution agreement to sell up to $500mm worth of common units at the market (filing)
  • Western Refining Logistics (WNRL) filed S-3 to register up to $1.0bn worth of debt and equity securities (filing)
  • Global Partners (GLP) filed equity distribution agreement to sell up to $50mm worth of common units at the market (filing)

M&A / Growth Projects

  • Vanguard Natural Resources (VNR) announced acquisition of Eagle Rock Energy (EROC) for approximately $614mm (press release)
    • VNR will acquire all common units of EROC at an exchange rate of 0.185 VNR units per EROC unit ($3.05 implied value), and VNR will assume $140mm of EROC debt
    • Purchase price implied premium of 24%, EROC units traded up 11.8% on the next session
    • This deal comes just a months after VNR acquired LRR Energy (LRE) for $539mm, and represents a continued consolidation trend among troubled upstream MLPs
    • There are only 8 E&P MLPs remaining, down from 14 at the peak
    • I will not be writing a post-mortem on EROC’s history and contributions to the MLP sector, but maybe when there are only 5 left, I can recap the history of this corner of the MLP space
  • Atlas Resource (ARP) announced acquisition of Arkoma assets from sponsor Atlas Energy Group (ATLS) for $35.5mm (press release)

Other

  • A pipeline in California owned by Plains All American (PAA) ruptured and released 2,500 barrels of oil, including 500 barrels into the Pacific Ocean (Wall Street Journal)
  • Magellan Midstream (MMP) announced resignation of CFO Michael Osborne (press release)

Published
May 17th, 2015

Category:
MLP Market Post

MLP Week Thoughts: Incentive Compensation

MLPs bounced back this week based on the Alerian MLP Index, which was up 1.3%, but a significant portion of those gains were from WPZ (+20.5%).  The equal-weight version was still positive, but only +0.2%, because it is balanced by weak performing upstream MLPs.  Natural gas prices showed strength, but every other macro factor was roughly flat week over week, including interest rates, the broader stock market and oil prices.

Weekly Review_5-15-15

The NAPTP conference this week should have no shortage of topics to speculate over amongst MLP friends, including: the IRS proposed MLP tax clarification, the new age of counter-intuitive IDR solutions, potential M&A, potential GP IPOs, and PIPEs.  In the midst of all that financial engineering and regulation noise, it’s easy to forget that despite stabilized oil prices in recent weeks, the fundamentals of oil and products storage plus resilient U.S. production are serious challenges to a full oil and NGL price recovery.  So there might be some discussion over prices and project opportunities in a $60/bbl world as well…

Rights Management

Incentive distribution rights (IDRs) have near-mystical qualities.  We have seen examples of IDRs creating massive value for TEGP and EQGP in the last few weeks.  We have seen two examples of sponsors opting out of their right to receive IDRs (CEQP and now WMB).  The main factors that determine when IDRs can create value vs. when they can’t are (1) maturity of the IDR tiers and (2) strength of the underlying MLP’s business.

If an MLP is deep into the top IDR tier, the overall enterprise (MLP and GP) can be challenged to grow.   Great project returns and acquisitions can help keep the plates spinning for a while (like KMP did), although eventually the burden catches up and the IDRs need to then be reset or taken out, it seems.   Weakness in the underlying MLP’s business can also drive GP transactions, as was the case with CMLP.

If the MLP is challenged to pay its distribution and is paying IDRs, removing those IDRs will allow the MLP to more easily maintain its distribution.  At some point along the IDR spectrum and along the MLP’s distribution coverage spectrum, the GP value is dramatically impacted to the point where the GP is willing to get rid of them altogether.

It all seems sort of circular, and if you think about it too much, what you thought was a given starts to unravel a bit.  It reminds me of what is known as the Penrose Staircase (pictured below), an impossible staircase that never ends or leads to nowhere, depending on your perspective.

Penrose Staircase

Winners & Losers

WPZ (+20.5%) grabbed headlines and will now trade as a large-cap lame duck MLP until its merger with WMB and exit from the MLP sector are finalized in the fall.  CNNX rekindled investor interest with much improved management rhetoric on its conference call.  SHLX’s big drop-down combined with a PIPE deal that removed equity overhang helped send its units higher this week.

Upstream MLPs didn’t fare well this week with 3 representatives in the bottom 5 (MEMP, LRE, LGCY), despite strength in natural gas prices and flat oil prices that have a direct positive impact on the operations of those MLPs.

Top5Bottom5_5-15-15

TLP rebounded from last week’s 10% decline.  WLKP continued its slide as the proposed IRS regulations remain in limbo for the next few months until finalized.

Top5Bottom5_5-15-15_chart

Year to Date

CNNX climbed out of the bottom 5 this week (replaced by CAPL), but remains down 13% for the year, even after its big week.  On the positive side, contract compression MLPs are the best performing MLPs this year with all 3 in the top 5 (EXLP, USAC, CCLP).

Top5Bottom5_5-15-15_YTD

GPs

Last week’s GP IPO was outdone by this week’s GP IPO.  Now that we have two more publicly-traded GPs, it makes sense to look at the weekly performance of GPs, starting this week.  Early in the week the focus was on EQGP’s debut, but the market shifted focus to WMB on its announcement and OKE as the market’s consensus pick for the next IDR solution transaction.  As the GP of a coal MLP, AHGP caught a bid today on natural gas price strength.  Also, several GPs underperformed the MLP sector this week.

GP Top5Bottom5_5-15-15

News of the (MLP) World

Hot GP IPOs, big PIPE deals, feels like we hit a 2006 time warp this week.  Except for that very contemporary reverse GP buyout merger that emerged out of Tulsa…

News-of-the-World

Equity

  • EQT GP Holdings (EQGP) priced IPO of 23mm units at $27.00/unit, raising $621mm in gross proceeds (press release)
    • Priced $3.00/unit above the high end of the range, and the deal was upsized by 3mm units (1.36% yield)
    • EQGP owns the 2% G.P. interest, IDRs and 21.8mm L.P. units of EQT Midstream (EQM) and will be treated as a partnership for tax purposes
    • Opened at $32.00/unit and closed at $32.92/unit in its first trading session, up 21.9%
    • The biggest IPO pop belongs to the first one back in 2004 (XTXI), and results have been mixed since then. Below is a list of the GP IPOs over the years.

GP IPO pops

  • Shell Midstream (SHLX) announced private placement of 7.7mm common units to a group of institutional investors for $300mm in proceeds (press release)
    • Goldman Sachs, Prudential Jennison, Kayne Anderson, Center Coast, Baron Asset Fund, Swank/Cushing, Eagle Global
    • This is the biggest PIPE transaction in the last few years, and harkens back to the days when upstream MLPs went public and were in such a hurry to do acquisitions, they sold equity to fund acquisitions via PIPEs to avoid issuing an S-1 in the first year after going public
  • Empire Petroleum Partners (EPLP) filed initial registration statement for an MLP IPO to raise up to $100mm (filing)
    • EPLP’s GP is controlled by American Infrastructure MLP Fund and its affiliated funds
    • EPLP is a wholesale distribution of motor fuel under long-term, fixed-margin supply agreements
  • Rose Rock Midstream (RRMS) filed equity distribution agreement to sell up to $150mm worth of common units at the market (filing)

Debt

  • Rose Rock Midstream (RRMS) priced $350mm offering of 5.625% senior notes due 2023 at 98.345% of par to yield 5.875% (press release)
    • Offering was upsized from $300mm originally offered
  • Genesis Energy (GEL) priced $400mm 6.00% senior notes due 2023 at par (press release)
    • Proceeds to be used to repay 7.875% senior notes due 2018

M&A / Growth Projects

  • Williams Companies (WMB) announced acquisition of Williams Partners (WPZ) in $13.8bn transaction (press release)
    • WPZ unitholders to receive 1.115 WMB shares for each WPZ unit, equal to a 14.5% premium to 10-day average closing price for WPZ prior to the announcement
    • WMB believes that accretion from the transaction from valuation differences, plus the tax benefits from the step-up in tax basis (courtesy of the unitholders) will enable WMB to extend 10-15% dividend growth guidance through 2020
    • Transaction solves the disparity in valuation between WPZ and WMB, solves the issue of the potential IRS rules impacting WPZ’s chemical operations, and solves the IDR drag on cost of capital
    • WMB plans to raise dividend by 6.7% in 3Q 2015, after the transaction, which is expected to close in the Fall of 2015
    • WPZ currently represents 5.0% of the Alerian MLP Index and represents 7.5% of the Alerian MLP Infrastructure Index (tied to the biggest MLP ETF)
    • At NAPTP this week, I expect the topic of taking MLPs out of the market will dominate conversations, along with speculation over who might be next, but the list of potentials is rather short
  • Shell Midstream (SHLX) announced first drop-down acquisition for $448mm (press release)
    • SHLX will acquire additional interests in Zydeco Pipeline Company and Colonial Pipeline Company from sponsor Shell Pipeline Company
    • Acquisition will increase SHLX’s interest in Zydeco to 62.5% from 43% initially and will increase its interest in Colonial from 1.612% to 3.0%

Published
May 17th, 2015

Category:
MLP Market Post

WPZ: Back to the Future

I hit the road with the Williams Companies (WMB) management team in August 2005 on the IPO roadshow for Williams Partners (WPZ), an MLP with a plan to start small and grow by acquiring assets from its parent company (see original prospectus here).  WPZ was one of the first MLPs to explicitly launch with a long-term drop-down strategy, and the first to hold back such a massive dowry of assets.

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The IPO went very well, pricing above the range at 6.51% yield, at the time a record low yield for an MLP IPO (US 10 year yielded 4.25% at the time).  By comparison, the latest record low IPO yield for an MLP is Antero Midstream at 2.72%, achieved in late 2014.  Less than 10 years later, WPZ would announce its exit from the MLP sector entirely to rejoin its parent company.

WPZ was WMB’s second MLP.  WMB had spun out Williams Energy Partners (WEG), now known as Magellan Midstream (MMP), in 2001.  Williams then ran into financial difficulties in 2002 and nearly went bankrupt, before obtaining an emergency loan from Lehman Brothers and Berkshire Hathaway.  Then Williams began shedding assets, including the Mid-America Pipeline Company and Seminole Pipeline to Enterprise Products for $1.2bn (at a 6.7x EBITDA multiple) in 2002, and its GP and LP interests in WEG to private equity funds Madison Dearborn and Carlyle/Riverstone in 2003.

Once WMB stabilized again, plans began to establish another MLP.  I took my first ever business trip down to Tulsa in early 2005, and spent many hours developing the financial and tax shield model for the newly formed partnership.  The summer and fall of 2005 was a very busy and innovative period in the MLP capital markets, and the busiest time for me in my brief investment banking career.  See below for a list of key deals during that 6 month period.

  • June 2005: Inergy Holdings (NRGP) priced the first GP IPO structured as a partnership with its $76.5mm IPO at a 4.00% yield
    • This was the first IPO where I traveled with management on the roadshow, Lehman Brothers was the lead bookrunner
  • August 2005: Williams Partners (WPZ) priced its $123.6mm IPO at 6.51% yield
    • Lehman Brothers was lead bookrunner, I traveled on the roadshow
  • August 2005: Enterprise GP Holdings (EPE) priced its GP IPO, raising $352.8mm at a 3.57% yield
    • I wasn’t on this deal, but Lehman Brothers was the lead bookrunner
    • 8 GP IPOs would follow suit in 2006
  • August 2005: Natural Resource Partners (NRP) priced the first (and only ever) IPO of its subordinated units under a separate ticker (NSP) than the MLP
    • I worked on this deal, which required me to travel on a 3 day roadshow almost like a real IPO
  • November 2005: Boardwalk Pipeline Partners (BWP) priced its $336.4mm IPO at a 7.18% yield, with a novel concept of putting FERC regulated natural gas pipelines into an MLP
    • Instead of creating a manufactured drop-down story, BWP put its assets into the MLP from day one
    • This was the largest MLP IPO ever at the time
    • Lehman Brothers was joint bookrunner on this deal, and I traveled on the roadshow, staying at the Loews Hotel in Hollywood, rather than the Beverly Wilshire Hotel where we stayed on previous IPOs
  • December 2005: DCP Midstream Partners (DPM) priced its $222.5mm IPO at 6.51% yield (matching WPZ’s lowest ever IPO yield)
    • DPM was set up in a very similar manner to WPZ, designed as a drop down story

Drop Downs by Design

Williams Partners marked a new era of growth MLPs spun off from much larger corporations.  Large companies had spun off midstream assets before, including GulfTerra (from El Paso), Kinder Morgan (from Enron), Sunoco Logistics (from Sunoco), Holly Energy (from Holly), NuStar (from Valero).  But those deals had been from companies with either smaller pools of future drop downs or companies seeking to put slow growth assets in their entirety into an MLP.

WPZ was designed to start small and grow via a very large pool of drop-down acquisitions.  This model would be replicated many times since then and in increasingly aggressive ways (Dominion Midstream, for example, started with $50mm of EBITDA at the MLP, with more than $1.5bn of EBITDA to drop down).  The reason for starting small is to grow the GP value over time, while providing growth visibility for L.P. investors, which perpetuates a premium valuation for the MLP over time.

WPZ Proves the Model

WPZ’s model worked very well initially.  In its first 3 years, WPZ grew distributions per unit at an annual rate of 22.0%, second only to GEL as the fastest growth rate among MLPs that existing when WPZ went public.  That high growth period was immediately followed by 5 straight quarters of no distribution growth at all, which coincided with the financial crisis.

WPZ Growth Rates

WPZ emerged able to grow its distribution in the 8-9% range annually for another 3 years starting in 2010, after the acquisition of WMB’s third MLP, Williams Pipeline Partners.  Distribution growth slowed considerably in 2013-2015 when higher IDRs and some aggressive acquisition efforts failed to play out well for WPZ.  Over the last few years, WPZ has continued to evolve, and was actually acquired by Access Midstream last year, although the partnership name and its assets live on.

WPZ’s notable contributions to the modern MLP model and the MLP financial engineering playbook:

  • Super drop down MLP strategy
    • Big company with lots of qualifying MLP assets starts small MLP
    • WPZ was the forerunner to others who have perpetuated similar strategy (TLLP, WES, VLP, MPLX, DM, SHLX, many others)
  • Large-scale consolidation within its MLP family whereby higher multiple MLP buys out cheaper one
    • In 2010, WPZ acquired WMZ to simplify its structure and drive accretion for the acquiring MLP
    • This was long before ETP acquired RGP (2015), WPZ was acquired by ACMP (2014),
  • Put chemical plant into an MLP to combine with traditional midstream assets
    • The IRS may nullify this contribution, but EPD and SXL are still pursuing PDH plants and following in WPZ’s footsteps to some extent
  • Established conventions for IDRs
    • Prior to the WPZ IPO, the IDRs were set in an arbitrary way
    • Starting with WPZ, almost all MLPs have IDR tiers set at a specific percentage increase over the minimum quarterly distribution (MQD), such that:
      • Tier 1 is 15% higher than the MQD
      • Tier 2 is 25% higher than the MQD
      • Tier 3 is 50% higher than the MQD
    • DPM and BWP followed that convention later in 2005, and the convention was established that remains the standard today