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September 27, 2015

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Week Thoughts: MLP Deflation Escalation

MLPs fell for the fourth week in a row, with this week’s 5.9% decline the worst of the streak so far. The broad market was weak (S&P 500 -1.2%), struggling to find footing after the Fed’s announcement last Thursday, while utilities outperformed.
Weekly Review_9-25-15
Oil futures finished the week up 2.1%, but were again volatile around the weekly inventory report. Oil was stronger late in the week, but MLPs stayed down. MLP investors have been hoping for a decoupling of oil prices and MLP prices, but were probably expecting it to occur when oil prices were flat for some time period and MLPs were up. Not just yet.
Historical Context
With just 3 days left, the Alerian MLP Index has produced -19.4% total return in 3Q. If that holds, it would be the 2nd worst quarter in the history of the MLP sector (4Q 2008 was -20.3%). It’s clear now the current MLP decline has just one comparable: 2007-2008.
Peak to Trough
From last year’s peak to today, the MLP Index total return has been -37.8% over 392 days. On 7/15/07, the index peaked and saw a 50.6% total return decline over the next 497 days to 11/21/08. The index bounced 11.3% the next day and produced 87.0% total return the next 12 months from the bottom. To get that 11.3% bounce in the index, there was a final washout 2 days prior when the MLP Index declined 10.8% in a single day. It should be noted that the S&P 500 was down 6.7% on that big washout day. The broad market hasn’t been strong lately, but it’s not in total panic like it was back then, which makes the MLP action lately all the more frustrating.
With school back in session, weekends are quickly filling up with kids’ birthday parties. It got me thinking about bouncy castles. I set up a bouncy castle for my nephew’s party this year. It’s a simple process: hook the castle up to the fan and plug the fan in. The castle slowly inflates, and if you get inside, you can hear the air leaking out from small holes along the surface of the castle. As long as the fan is pumping air in, it stays inflated, even as air dissipates from the surface.
When the party’s over, shut off the fan, and the castle slowly deflates. When it gets about halfway down, to get the rest of the air out, it helps to jump on it and squeeze out the remaining air.
Bouncy Castle
The party for MLPs ended around this time last year, and the sector has been slowly deflating ever since. But air (funds) continued to flow for a while, allowing MLPs to access the capital markets without much friction. Since June 30th, however, oil’s decline and more vocal concerns about growth prospects for the sector have teamed up to jump on the sector, joined by uncertainty from Yellen last week. At this point, after a horrible September (to cap a horrible quarter and 12 months), it feels like we’ve gotten almost all the air out of the sector.
Winners & Losers
Down 24.7% this week, SMLP led the MLP losers (not counting variable distribution MLP EMES, which was down 42%). The reported unconfirmed rumor of SMLP’s sponsor sale efforts caught the market by surprise. There were amazingly only 4 positive MLPs this week, led by CMLP.
Drop-down growth MLPs have struggled of late, but none more so than CPPL, which made it two straight weeks in the bottom five, dropping like a rock early in the week.
HCLP joined the bottom 5 for the year. VLP announced an accretive drop-down acquisition with no equity needs, and it dropped out of the top 5. FGP climbed into the top 5 for the first time this year. The list of MLPs with positive returns this year is declining rapidly, and there is now just one MLP with more than double-digit returns.
General Partner Holding Companies
All GP holding companies declined this week, and the median underperformed the MLP Index. CPPL’s sponsor CPGX dropped almost as much as it’s MLP, down 14.5% and near the bottom for the second straight week. WMB and ETE performance fell in the middle of the chart below, which is appropriate given the holding pattern their potential merger is in.
News of the (MLP) World
The last few months, we’ve seen more buyback programs than at-the-market equity programs announced, and the results have generally been positive for the MLPs involved. Two more were announced this week. There was 1 actual M&A transaction this week, from a supportive sponsor. There were also 2 reports of rumors related to MLP M&A. No equity offerings, no PIPEs, no debt offerings. But you can be sure bankers are busy behind the scenes, hopefully efforting fixes for broken MLPs.
Capital Markets

  • Dominion Midstream (DM) announced that its sponsor, Dominion, has initiated a program to buy back up to $50mm of DM units over the next 12 months (press release)
    • This is one of several recent buybacks announced, although this is the first of the class of 2014 drop-down MLPs to institute such a program
    • DM units were slow to react to the announcement, but did finish the next trading session up 4.1%
  • CST Brands, sponsor of CrossAmerica Partners (CAPL), announced program to buy back up to $50mm worth of CAPL units (press release)
    • CAPL units were up 5.0% on the day the program was announced

M&A / Growth Projects

  • Valero Energy Partners (VLP) announced $465mm drop-down acquisition of Corpus Christi Terminal assets (press release)
    • Sponsor Valero Energy Corp (VLO) will help finance the acquisition with a $395mm subordinated loan agreement with VLP and by taking back $70mm worth of VLP equity
    • The acquisition price represents a 9.3x EBITDA multiple, based on next year’s EBITDA of approximately $50mm, backed by a 10-year terminaling agreement with VLO
    • VLP reiterated distribution growth guidance of 25%+
  • According to a Bloomberg report citing people familiar with the matter, Energy Capital Partners, the private equity sponsor of Summit Midstream (SMLP) is rumored to be seeking buyer for its midstream assets and stake in SMLP (Bloomberg)
    • SMLP would not comment on the speculation, choosing not to add credibility to what they view as a rumor
    • The market reacted violently to the rumor, sending the stock down 28.3% in two days following the report
    • The market appears to be worried that SMLP will end up as an “orphan MLP” with no remaining drop down acquisitions to drive growth
    • The orphan MLP scenario has not played out well in the past (see El Paso Pipeline Partners and QEP Midstream Partners)
    • SMLP was already down more than 50% in the last 12 months prior to the downdraft this week
    • We have heard the risk of SMLP becoming an orphan MLP from other investors over the last year, and management specifically addressed that question in the past, so even if this were true, this should not have been 28.3% type of news for the market
    • SMLP bounced Friday, but still quite a bit of damage done and the market is ascribing no further growth for SMLP or the potential for a positive outcome if such a sale were to happen
    • There are potential positive scenarios for SMLP if they are indeed seeking a sale
    • Given the MLP IPO market appears closed, it’s quite possible that a potential acquirer would place a premium on buying assets where there is an existing MLP in place (like Devon did with ENLK)
    • On the other hand, there is no shortage of existing MLPs that could be thought of as shell MLPs for a good sponsor, so that in and of itself is not a value driver (just ask CMLP)
    • In any event, Energy Capital is not happy this week, having lost around $160mm in value this week and $1.0bn from 52-week high last week
  • According to a Reuters report, the board of Williams (WMB) will vote on a revised offer from Energy Transfer Equity (ETE) as early as this week (Reuters)
    • The report indicated that the offer could include a cash component of around 15%, up from an all equity offer originally
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