Aug 17th, 2014
MLP Market Post
Kinder Morgan’s big Sunday announcement sent MLPs into a tizzy, read more about the deal here. The MLP Index was up 5.3% this week, with much of that attributable to just 2 MLPs (EPB and KMP) that make up more than 10% of the Alerian MLP Index. 5%+ weeks are very rare. There was a period of 6 years from 2002 to 2008 that the MLP Index had no such weeks. This was only the 4th such week for the Index in the last 5 years.
Yield on the U.S. 10 year rates crossed back over the 2.40% threshold again, stocks are up, and MLP consolidation is driving speculation among smaller MLPs. All is right for MLPs…except for weakening energy commodity prices. The U.S. is clearly having an impact on the global supply picture when an aggressive Russia and (that old standby) tension in the Middle East don’t stop oil prices from falling.
Updated Distribution Aristocrats
A few years ago, I published my list of MLP Distribution Aristocrats (see original post here). As part of my work on KMP this week, I updated the list. MLP “Distribution Aristocrats” are MLPs that have raised their distribution in each of the last 10 years. To qualify, the MLP also needs to have been trading for 10 years. There are only 10 MLPs that meet both criteria. After KMP goes away, there will only be 9, but as more MLPs reach the 10 year trading mark, the list will grow.
Winners & Losers
EPB led all MLPs with a 27.7% pop earlier this week. The unitholders that held on even after EPB announced earlier this year its intention to have no distribution growth until 2017 were handsomely rewarded with a white knight. No matter that the savior (KMI) was the company that was responsible for EPB’s slowing growth rate since the 2012 purchase of EPB’s GP.
MMLP also had a nice pop related to an acquisition this week, up 12.0%, after a bottom 5 showing last week. Speaking of the bottom 5, HCLP was down after issuing equity this week, and after being up 8.0% last week. Also, there were 2 upstream MLPs in the bottom 5, perhaps taking cues from weaker commodity prices. Growth is back en vogue as low yield, high growth MLPs were up sharply this week, epitomized by PSXP’s big gains.
Year to date, PSXP is still out in front, although SUSP jumped HCLP to take second place. MMLP climbed out of the bottom 5 this week, replaced by recent coal IPO FELP. CMLP had a positive week, but remains in the bottom 5, until its white knight appears.
News of the (MLP) World
There were a few interesting deals outside of the Kinder Complex this week, including a series of equity deals and announcements. It was a flurry of capital markets activity that I don’t expect we’ll see again until after Labor Day, although there’s always time for M&A.
- Buckeye Partners (BPL) priced public offering of 2.6mm common units at $76.60/unit, raising $199.2mm in gross proceeds (press release)
- Overnight offering, priced at 2.6% discount to prior close
- Hi-Crush Partners (HCLP) priced 100% secondary offering of 3.3mm common units at $62.91/unit, raising $205.1mm in gross proceeds to selling unitholder Hi-Crush Proppants, LLC (press release)
- Overnight offering, priced at 4.2% discount to prior close
- Viper Energy Partners (VNOM) files S-1 to sell 3.5mm common units in an equity offering (filing)
- VNOM also disclosed an acquisition of Permian acreage for $90mm in cash
- Cheniere Energy Partners LP Holdings (CQH) files S-1 to sell 10.1mm common shares in an equity offering (filing)
- GasLog Partners (GLOP) files F-1 to sell up to $125mm of common units in an equity offering (filing)
- Rice Energy announces plans to form a midstream MLP for its gas gathering and water sourcing assets (press release)
M&A / Growth
- Kinder Morgan, Inc. (KMI) to acquire KMP, KMR and EPB
- Click here to peruse around 2,000 words on this deal
- MMLP acquisition of remaining interest in Cardinal Gas Storage for $120mm (press release)
- MMLP to acquire 57.8% interest owned by Energy Capital Partners
- Accretive to distributions by $0.15/L.P. unit by end of 2015, and MMLP expects to increase distribution by $0.02/unit in 4Q14
- Transaction increases MMLP’s coverage to above 1.05x
- Over 90% of working gas storage capacity contracted with 5 year weighted average contract life
- Improves fee-based contract mix and reduces seasonality
- GLOP $328mm acquisition of two vessels (press release)
- Vessels have 5.5 and 6 years remaining on contracts
- Acquisition value represents 9.5x next 12 months EBITDA
- Announced intent to raise distributions by 15%
Aug 15th, 2014
MLP Market Post
In the media, there is the concept of a pre-written obituary. News outlets (TV and print) prepare segments and obituaries in advance of a celebrity’s death, so they have facts straight and are ready to publish when the famous person dies. The New York Times apparently has a database of more than 1,200 pre-written obituaries, with the oldest one written in 1982 (according to this article on the subject).
When Robin Williams died earlier this week, the NY Times may have had a pre-written obituary ready to go, but most news outlets probably didn’t. If it were my policy to have pre-written obituaries on MLPs that could potentially be consolidated and go away entirely, KMP would not have been at the top of the list.
It wasn’t a surprise to see KMP announce a transaction that fixes the IDR burden on a permanent basis. The first post I wrote on this blog asked the question, can KMP sustain distribution growth of 5%+ per year given its huge GP take? It’s a question that’s been around a long time. But Kinder endured with the El Paso acquisition, which allowed KMP to continue its growth for a few more years, while sucking EPB’s coverage dry.
Eventually, KMP needed to fix itself, and certainly the expectation was that it would someone make it happen. But the market (and KMP investors in particular) was surprised at the structure of the transaction that would leave no publicly-traded partnerships bearing the Kinder name. We’ve always seen IDR buyouts where the MLP buys out the parent and continues on as a public company (e.g. EPD, MMP, BPL), even when the GP was held in a corporate structure (e.g. MWE’s buyout of Markwest Hydrocarbon, Inc.).
What follows is my post mortem on the deal announced this past Sunday, after lengthy discussion and reflection on the transaction.
Transaction Review: A Simpler Kinder Complex
Kinder Morgan, Inc. (KMI) is acquiring all of the outstanding units of KMP and EPB, and all of the outstanding shares of KMR, in a cash and stock transaction valued at $71.0bn (press release).
- KMI will have a stepped up tax basis on the acquired companies, and will use higher depreciation from that basis (and from accelerated depreciation) to reduce the effective tax rate at KMI and grow distributions at 10% per year for the next 5 years.
- KMI announced that the combined entity will have target leverage of 5.0-5.5x EBITDA, and that it would be investment grade.
- KMI announced that its lower cost of capital and size would enable it to be an acquirer of other midstream companies.
What will Kinder Look Like in the Future?
KMI may be advantaged relative to MLPs when it comes to buying assets outside the U.S. KMI will be able to buy non-qualifying assets abroad more easily than MLPs. Does this mean they will buy Canadian pipelines, LNG regasification terminals in Asia or Europe, or terminals in Latin America? I don’t know, but it seems like this transaction sets them up to be able to do that.
Kinder will have another MLP someday, whether it’s a spin out of existing assets in 2016 or 2017, or it’s an MLP acquired as part of buying an existing MLPs G.P., I don’t know. But the flow through tax advantages are still there.
Other Open Questions Asked this Week
- Who are the acquisition candidates for KMI?
- Is a 5.0×-5.5x levered company really investment grade?
- How will the new MLP compete on a cost of capital basis against other MLPs when the depreciation and coverage at KMI burns off?
- Doesn’t KMP have an advantage not paying taxes vs KMI over the long term?
- Maintenance capex looked at differently going forward?
- Kinder said this somewhat circular comment on conference call: “Maintenance capex is less relevant with all the extra cash we have, we think it becomes a lot less important given our size”
Impact on the Sector
MLP Structure: Neutral Impact
I don’t think this will lead to other MLPs leaving the MLP structure. EPD is much larger than KMP, with a market capitalization of roughly $70bn. EPD is under no pressure whatsoever to convert its MLP to a corporate structure. EPD solved its cost of capital issues long ago by eliminating the IDRs, as others have done.
- The traditional MLP structure continues to work as is, and if an MLP’s cost of capital becomes a drag because it becomes too big, there are a number of solutions to that, a KMI-type deal being just one of them.
- Shell’s MLP IPO, Dominion’s MLP IPO, Hess’s MLP IPO, and the large shadow backlog of unannounced MLP IPOs should still move forward
- There are MLPs that have high IDR burdens, but none of them is as large as KMP was. The top 5 MLPs that have the highest percentage of cash flow being paid to the GP/IDR interest (excluding KMP and not counting IDR givebacks/waivers): ETP (38.1%), PAA (34.9%), WPZ (32.2%), OKS (31.2%), and ARLP (31.2%). KMP is paying 46.0% to its GP (gross, not counting waivers), and EPB is paying 28.1%.
Capital Flows: Positive Impact
- The retail investor base of KMP includes big pool of investors that have been long-term holders and never wanted to sell for tax purposes, and were probably planning to die and get a step-up in basis on their KMP units. Now those investors are forced to sell and will have to pay out massive taxes. The end result is that that big pool of retail investor money is now free to diversify into other MLPs.
- Combined between EPB and KMP, retail ownership is approximately $21bn. Some portion of the after-tax proceeds of that has a good chance of finding a home with other MLPs, which is good for MLPs.
- With this transaction, KMP will essentially graduate from the Alerian MLP Index up to the S&P 500. KMP and EPB represent more than 12.5% combined in the Alerian MLP Infrastructure Index, which is tracked by the ETF AMLP (and its $9bn).
- The weights of the other large cap MLPs should go up (ETP, PAA, MMP, WPZ, etc.) in this index and others, which has positive implications for their stock prices.
Consolidation / M&A Premiums: Positive Impact
Other MLPs are likely to carry consolidation M&A takeout premiums for a while, given how vocal KMP has been about consolidating the sector. KMP buying other natural gas pipeline MLPs is a challenge given HSR anti-trust issues, but gathering & processing MLPs and liquids-focused MLPs would be logical targets. Also, this transaction may increase pressure on other large MLPs to grow even larger, and could lead to consolidation outside of KMI.
Tax Impact: Turn in Your Deferrals
KMI is basically forcing a huge step up in basis on its largely retail investor base and then will be using that new step up to have higher depreciation and save on taxes at KMI, which is the key driver of KMI’s ability to grow at 10% a year for the next 5 years.
KMI put out an estimated tax cost for the average KMP unitholder of approximately $12.39/unit. But that is going to vary wildly. Newer unitholders will do better on an after tax basis than older ones. I personally know someone who has owned KMP since 1993. His CPA has estimated that he will owe around $27/unit in taxes. In the hypothetical, illustrative example below, I show you what that will mean (using a round number of 10,000 units) to the income he is used to receiving. He will need to sell shares of KMI to pay taxes and the net result is 44.5% less take home cash on an annual basis. This is an extreme example, but you see why long-time KMP investors, who rely on KMP for income, might be a little upset that this transaction messes up tax planning and also actual cash flow.
KMP first went public 22 years ago as Enron Liquids with a market capitalization of approximately $150mm and a 9.5% yield. At the time, there were only 9 MLPs. By the time Rich Kinder took over in 1997, 4.5 years later, Enron Liquids hadn’t grown very much. KMP was only a 3.5% weight in the Alerian MLP Index (Amerigas was the largest at 12.5%). But less than 3 years later, at the end of 1999, KMP had grown its market cap by 10x to $2.4bn, making it the largest MLP of all at the time, a title it carried for several years more before EPD overtook it. At the end of 1999, KMP represented a 22.4% weight in the MLP Index. That was KMP’s peak relative size. As the number of MLPs grew, and the index eventually reached its 50 stock maximum, KMP’s weight in the Index slid down to 8.5% at the end of July.
Before Rich Kinder took over Enron Liquids, MLPs were all about yield. Investors bought them in the early 90s as an alternative to bonds and utilities because of their high yield and stable cash flows, not their growth prospects. Today, annual distribution growth has become as prominent as yield when reviewing the MLP sector. The CAGR-ization of the MLP space began with KMP.
15 years ago, in July 1999, there were 21 MLPs in the Alerian MLP Index (it wasn’t until 1Q 2006 that the AMZ reached its maximum number of 50 names).
- 12 were midstream, 9 were other (including 7 propane MLPs)
- Of those 22, 12 are still trading today, 9 of which are midstream MLPs
- EPD, KMP, PAA, ETP, EEP, OKS, BPL, GEL , TCP
- Of those 9 midstream MLPs, KMP has grown distributions at a faster rate than all of them at a 9.6% annual rate
- The fastest growth for KMP came in its most active dealmaking period, when it grew distributions 15.1% annually from 1999-2004
Landmark Kinder Deals
So, how did KMP grow so big so fast early on and maintain its growth over the years? Well, it wasn’t a single transaction that did it; it was the growth machine that KMP management built, first through acquisitions and later through organic growth. In all, in 17 years, KMP executed 88 acquisitions for a total of $26.5bn. It was a combination of large acquisitions and small bolt-on acquisitions, see below (click to enlarge).
Below are two press releases from two of the larger deals KMP did early on. Reviewing those press releases takes you back to a time when competition for assets wasn’t as great and capital wasn’t as easily obtained, such that KMP could buy another publicly-traded MLP and its GP and still have it be 12.5% accretive to distributions per unit, or could buy a $750mm pipeline asset at 7.5x EBITDA.
Aug 10th, 2014
MLP Market Post
The Alerian MLP Index broke its 7-day losing streak in a big way on Monday with a 2.1% pop, the best day for the MLP Index all year. That huge day was followed by the first day of the year that all 50 MLPs were down on the same day, resulting in a 1.8% decline overall that erased most of Monday’s gains. The rest of the week was much less volatile, with the MLP Index finishing up 0.7% for the full week. The broad market was volatile as well, finishing up 0.3%, while utilities were flat. Interest rates were lower, and the US 10 Yr now yields 2.42%, 61 basis points lower than at year end 2013.
Within the MLP Index, large cap MLPs outperformed the smaller ones, as evidenced by the disparity between the 0.3% price change for the Alerian MLP Index and 0.3% decline for the Equal Weight version.
On the commodity front, WTI oil price dropped to a six month low on Wednesday, before recovering to close out the week roughly flat. Natural gas prices bounced 4.5% this week, but that wasn’t enough to pull up ethane (down 2.7%).
Earnings: Exports in Focus
It was another busy week of earnings releases, with more than 40 MLPs reporting. Results were mixed, but when results failed to meet the Street’s expectations, research analysts were able rationalize the weaker than expected results in various ways. Below are some paraphrased examples of what analysts wrote about earnings.
- Despite miss, growth story intact
- Thesis unchanged despite miss
- Drop down timing issues lead to miss vs. expectations
- EBITDA miss, but DCF beat on lower than expected maintenance capex
- Miss, but guidance maintained as volumes are expected to ramp in 2H14
- Growth backlog building, giving us comfort despite weak quarter
On the conference calls, the clear focus was trying to figure out which MLPs might have the ability to join the condensate exporting party that Pioneer and EPD started last month. The consensus seems to be that PAA is closest to joining the party. Also notable, analysts pressed management for details on DPM’s small Chesapeake export terminal project to export butane from the Marcellus Shale.
The investment community is eager to identify future potential beneficiaries from exports of abundant U.S. resources, and with good reason. Firms that have the ability to provide export outlets today produced strong results in 2Q (EPD, NGLS, OILT and SXL all handily beat expectations). Further conflict in Iraq escalated over the weekend. Increased geopolitical conflict could potentially provide cover for approving further condensate exports under the rationale of providing secure supply to the global market. Worth monitoring, but likely something for the next administration to tackle.
There are a few final earnings announcements to come next week. Beyond earnings, and potentially an overnight offering or two between now and the end of the month, I expect the news flow to slow substantially by the end of this coming week. The IPO window is closed until after Labor Day, but it should be a very crowded capital markets calendar in the Fall.
Winners & Losers
LGP was the runaway winner this week after it announced the latest transformative M&A transaction in the MLP space. Read about the transaction below, but it was a combination of the ETP/SUSS deal and the DVN/XTEX deal that dramatically changed the expected growth profile of LGP. IPO HMLP was the second best performer for the week, which is consistent with last week when the 3 IPOs led the MLP sector’s returns. DKL popped 11% after posting results that blew away expectations and that included 2.0x quarterly coverage. HCLP and ENBL round out the top 5.
HCLP went from bottom 5 last week to top 5 this week. GLOP and BKEP went the other way, from the top 5 to the bottom 5.
For the year to date, BWP has caught and passed EROC, which means we have a new biggest losing MLP this week. MMLP joined the bottom 5 after its rough week. On the upside, GLOP dropped from 2nd to 5th, but the other top performers remained intact.
We had another successful MLP IPO launch this week, making it 10 MLP IPOs for 2014 so far. 9 out of those 10 closed their first day of trading up from IPO price. The one broken IPO of 2014 was coal producer Foresight Energy (FELP). Also, while MLPs didn’t get the cover of Barron’s this week, there were two articles relevant to MLP investors. One was the annual round table MLP discussion, which this year featured two research analysts (Michael Blum from Wells Fargo, Becca Followill from US Capital), one tax attorney (Tim Fenn, whose middle name might be MLP), and one buy side representative (Doug Rachlin of Neuberger Berman). The second article covered the topic of yieldco renewable spin offs from utilities, and how they were similar to MLPs.
- Hoegh LNG Partners (HMLP) priced initial public offering of 9.6mm common units at $20.00/unit, raising $192mm in gross proceeds (MarineLink.com)
- Priced at midpoint of filing range, or at 6.75% yield
- Opened at $22.00, traded as high as $22.40, before closing at $22.25 (+11.3% from pricing) on its first trading session
- HMLP’s initial assets consist of 50% interests in 2 vessels, and a 100% interest in a third vessel
- All 3 of the vessels are floating storage and regasification units operating under long-term charter agreements with average remaining contract life of approximately 17 years
- HMLP plans to grow via drop downs from its parent company, also named Hoegh LNG
- Energy Transfer (ETP) sold 1.2mm of its units of Amerigas (APU) for net proceeds of $55mm (buried in earnings press release)
- ETP sold $377mm worth (8.5mm units) in June
- SunCoke Energy (SXCP) files equity distribution agreement to sell up to $75mm worth of common units at the market (prospectus)
M&A / Growth
- Regency Energy (RGP) announces JV with American Energy – Midstream, LLC for construction and operation of RGP’s previously announced Utica Ohio River Project (press release)
- RGP and American Energy Utica, LLC (AEU) will enter into a gathering agreement for gas produced from the Utica
- RGP and AEU will contribute all previously signed agreements to the JV, including volume commitments and acreage dedications
- The project will be upsized to accommodate more than 2 bcf/d of firm volume commitments
- Total project costs expected to be $500mm, with RGP contributing 75%
- Lehigh Gas Partners (LGP) announces sale of GP interest and IDRs to CST Brands for $85mm (press release)
- CEO Joe Topper and other investors to retain subordinated and common units representing 44% L.P. interest in LGP
- Creates a sponsor-backed, growth-oriented MLP vehicle
- CST to pursue long-term drop down strategy of its US wholesale fuel supply business and newly constructed real estate into LGP
- Given the early stage nature of LGP and its IDR tiers, the multiple paid for the GP interest was more than 650x current annualized cash flow
- Allows CST to bypass IPO route and gain control of an existing MLP with some scale in place
- CST has 1900 locations throughout the Southwestern US and Eastern Canada
- LGP operates a wholesale distribution business and owns real estate used in the retail distribution of motor fuels (distributes fuel to more than 1,050 locations and owns/leases 625 sites in 16 states)
- Blueknight Energy (BKEP) announces plans to build $300mm crude pipeline linking East Texas resources to Oiltanking Houston (press release)
- 160-mile, 16-inch diameter pipeline backed by long-term shipper commitments, including an agreement with Vitol, which owns 50% of BKEP’s G.P. and an agreement with SEI Energy, LLC
- EnLink Midstream (ENLK) announces two new growth projects for $200mm+ (press release)
- ENLK to expand Bearkat System in West Texas by constructing a new natural gas processing plant, supported by Devon production, for $200mm
- ENLK to construct NGL pipeline extension from Existing Cajun-Sibon system in South Louisiana in a JV with Marathon Petroleum
- With earnings, DCP Midstream (DPM) announced $160mm of smaller organic growth projects (press release)
- Sand Hills pipeline lateral lines extending DPM’s footprint into new areas of the Permian
- Eagle Ford condensate handling, expanding capabilities at two Eagle Ford plants
- Marysville liquids handling
- Chesapeake terminal upgrade for butane exports
- Linn Energy (LINE) announces $340mm acquisition (press release)
- LINE to acquire assets in the Hugoton Basin from Pioneer Resources
- Details of assets acquired:
- 40 MMcfe/d current production, 60% natural gas
- 6% decline curve, 23 year reserve life
- 340 bcfe of reserves (95% PDP), 235,000 net acres, all held by production
- 51% operating interest in the Satanta natural gas processing plant with 240 mmcfe/d of capacity
- To be partially funded by sale of undeveloped acreage in the Anadarko Basin for $90mm
- Vanguard Natural Resources (VNR) announces $278mm acquisition (press release)
- VNR to acquire assets in North Louisiana and East Texas for $278mm from Hunt Oil
- Details of assets acquired:
- 23,000 net acres, currently producing 17.5 MMcfe/d (67% natural gas)
- Estimated reserve life of 23 years, based on reserves of 150 bcfe, which are 57% proved developed
- Mid-Con Energy (MCEP) announces $19.4mm acquisition of Waterflood reserves in the Gulf Coast region (press release)
- MCEP to acquire oil properties with 658,000 barrels of reserves
- Properties are currently producing 154 bbls/d, with annual decline rates of 8% for the next 3 years