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March 11, 2011

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MLPs: Quick Weekly Recap

MLPs Drop on Global Issues and Are Reminded: There is a Limit to Investor Demand for More MLP Paper

The MLP Index closed down 3.7% for the week, the largest weekly drawdown since May of last year, and the first significant drop week over week since January.  Some of the weakness this week definitely had to do with the several equity offerings that came to market last week and this week.  It typically takes a few weeks to digest a massive equity offering spree like this, even in the best of market conditions.  But, as anyone with an iPad, TV, computer or twitter account knows, there were significant headwinds this week, both geopolitical (driving oil up and stocks down), and natural (earthquakes, tsunamis, end of days), although MLPs made a small comeback on Friday along with everything else.

Just  anecdotally, MLPs seemed to be much more correlated this week around these larger issues than they have been since August 2010.  That hurts the case for MLPs as defensive investments at least for the short term, although longer-term MLP fundamentals proved their strength in the 2008 downturn, and in an end of days scenario would perform better than in 2008 relative to the market.

The net result this week was MLPs underperformed broadly in a bad week and offered patient investors with some buying opportunities, particularly for investors who had been patiently watching the MLP Index hit new all time highs daily in spite of generally rising interest rates.  MLPs that reported less than stellar earnings (GLP and BBEP for example) and MLPs that issued equity (EPB and PAA) were off more than others.  Fund flows into the sector are clearly not as strong as they were last year, and issuers will find it a little harder to get their equity deals done, particularly equity just to pay down debt.

There was one major acquisition announced this week, EPB’s acquisition of more assets from EP for a total of $613.7 mm, continuing to execute its drop down strategy. EPB also announced a 5% distribution increase quarter over quarter.  The market is clearly onto EPB’s game, and knocked down the price 6.0% on Monday and Tuesday in anticipation of the equity deal that would follow and knock down the price an additional 3.2% for an all in acquisition announcement to pricing decline of 9.1%. EPB began to recover and traded very well after pricing, yesterday it was the only MLP that closed positive.  Investors and analysts still clearly believe EPB is a core holding poised for continued growth from drop downs over the next few years, but traders are taking advantage of EPB’s now very predictable process.

In the go go days of 2006 and 2007, EPB could have very easily gathered a group of institutions together to do a PIPE with a pre-announcement negotiated price, and then announced their acquisitions with no equity overhang.  A serial issuer like EPB could have gotten PIPE deals done at a 4-5% discount to the market price back in 2007, like PAA routinely did.  But that sort of PIPE market (using third party institutions rather than just the sponsor taking back equity) is probably still closed for now.  I can imagine that many bankers in the Houston area are going to take the stats of 9% cost of an equity deal and put together a nice pitch book touting their ability to get a PIPE deal done for EPB at much less than 9% discount.

10-Year US Treasury Rate closed at 3.49% last Friday (3/4), closed at 3.39% this week
MLP Index Yield finished last week at 5.95% last Friday (246 bps above 10yr rate), closed this week at 6.18% (widening to 279 bps above 10yr).

Disclosure: Curbstone has positions in EPB and GLP.  Curbstone is a financial advisor, but we are not your financial advisor.  Any content on this website is for information only and is not meant to be a recommendation in any way.


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