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May 17, 2015

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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.
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.
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).
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…

  • 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)


  • 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%
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