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May 19, 2018

Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

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Week Thoughts: MLPs Outperform in the Simplicity War

Midstream overall outperformed and MLPs again led the way, up another 3.1%.  The MLP Index is now up 14.4% the last 8 weeks, rallying in 6 of those 8 weeks.  Energy and oil prices continue to trade well, with MLPs tryng to keep pace with broad energy stocks.  News flow was light until Thursday’s simplification party.  Weaker Canadian and utility performance dragged down the broader AMEI midstream index performance.

Energy stocks in the S&P 500 have seen a massive rebound in relative strength, as shown in the chart published by Bespoke Investment Group this week.  Midstream continues to play catch up in a broad energy rally, which should be an ongoing tailwind for the sector as lingering issues around structure and leverage get cleaned up.

Mergers: Simplicity War
Williams Partners (WPZ), Spectra Energy Partners (SEP) and Enbridge Energy Partners (EEP) announced blockbuster mergers into corporate parent companies this week.  Like in the latest $1bn blockbuster movie Avengers: Infinity War when the end of the film saw major characters pixelate out of existence at the snap of a finger, these large MLPs are going to disappear.

These transactions have more similarities to the end of Old Yeller than the end of Infinity War, but we like to keep the movie references somewhat relevant to current pop culture.  In any event, the fallout from these announcements will have implications across the MLP universe.
Universe Contracting
In 2017, we’ve seen 8 transactions announced that will result in elimination of the following MLP tickers: NS, APLP, TEP, WPZ, EEP, SEP, CQH, RMP.  In addition, speculation is for the following tickers to possibly go away in the next 12-18 months: AM, BWP, DM, ENLK, EQM, ETP, TCP, WES, ANDX and possibly PAA.  That’s a staggering 18 total MLP tickers that could exit the structure near-term.
If some of the above dominos start to fall, other large MLPs like EPD and MMP may begin to face pressure to convert if institutional investors avoid buying MLPs, because they are content to choose among the many corporate midstream companies.  The structure is clearly under fire, primarily from a shift in the investor base, but also due to poor financial positions and FERC uncertainty.
I plan to re-assess the universe of MLPs and post an update in a few weeks.  Last time we looked at it, it was 64 midstream MLPs, but after recent announcements (and maybe another couple next week?), the universe of midstream MLPs will be closer to 50-55 after the dust settles.
Index and Fund Impact
WPZ, EEP and SEP combined to represent 10.7% of the AMZ as of the last re-balance.  KMP and EPB represented 10.2% of the AMZ back in 2014, when the index represented more companies and more market capitalization.  This was still big news and the Alerian MLP Index continues to decline in relevance within the midstream universe of stocks.  Traders might point to the weight increases that remaining MLPs will see when these MLPs leave, but for that to matter, funds would have to be flowing into MLPs.  The bigger picture evolution of the sector requires a different index that includes corporations and Canada.
Negative Income Impact – How fast do the rest need to grow to keep Index distributions flat?
All in, the moves announced Thursday represent approximately $400mm in annual distribution savings by the acquiring companies.  Said another way, aggregate distributions to midstream universe investors will be reduced by $400mm ($100mm from WPZ, $360mm combined from SEP/EEP/EEQ/ENF and $40mm from CQH).  That’s another bitter pill for income-focused MLP investors, worse when coupled with a taxable event for WPZ, EEP and SEP owners.
10.7% of the index is effectively cutting distributions 24% (weighted average of the 3 cuts).   Adding in NS and TCP cuts, and the total is 13.4% of the index that will see a reduction in income of 27.5%.
Simple math says the remaining 87.6% of the index must grow distributions on average 4.3% to keep the index distribution flat.  Growing that fast should prove challenging, and it won’t happen if ETP does a stealth cut of its own this year.

So, can we please stop talking about how distributions are at an inflection point?  Yield cannot be relied upon as a valuation metric, or as part of your argument for MLPs being cheap, no matter how enticing an 8% yield looks on paper.
MLP Manager Impact
Over time, the corporatization of MLPs will have major implications for large MLP asset managers, for managers with large fund products structured as corporations, and for fees charged to manage such vehicles.  It also likely has implications for correlations between midstream and the broad stock market (i.e. correlation probably goes up) as the friction costs of owning midstream stocks (K-1s) are removed.
Historical Context
The first time Williams announced they were simplifying (May 2015), I wrote about my early history with the company, how I was on the roadshow team led by Rob Pierce that in August 2005 travelled around selling the IPO with CEO Steve Malcolm, COO Alan Armstrong and CFO Don Chappel.
It was right in the middle of the most hectic period of my banking career, immediately after the Inergy Holdings IPO in June, almost coincident with the IPO of Natural Resource Partners subordinated units, and before the IPO of Boardwalk Pipeline Partners in November of that year.  I was on the deal team for each of those transactions, all led by Lehman Brothers.  In that time period, the Lehman banking team was also lead manager on the IPOs of Enterprise GP Holdings (EPE) in August and Global Partners (GLP) in September.
At IPO, WPZ had just $20mm in distributable cash flow from a hodge podge of assets, a far cry from the expected $5bn 2019 EBITDA.  It was several years before the gas pipeline assets would migrate over to WPZ after the IPO of the gas pipeline business in Williams Pipeline Partners (WMZ).  That original WPZ doesn’t even exist anymore, because back in 2015 it was acquired by the Access Midstream Partners (ACMP), which then changed its ticker to WPZ.
There have been 109 MLP IPOs and 16 GP IPOs since WPZ’s IPO in June 2005.  Spectra Energy Partners (SEP) didn’t IPO until 2007.  It followed the WPZ model of starting small on EBITDA with the intent of growing over time through drop-downs.  It wasn’t until years later than SEP would execute the mega drop-down of its gas pipeline assets into SEP.
EEP is the second oldest MLP still trading today, having come public in 1991.  Buckeye (1986) remains the oldest living MLP.  Since the IPO of EEP in 1991, there have been 146 MLP IPOs and 19 GP IPOs.
Winners & Losers
WPZ was the big winner this week, rallying before and after the simplification announcement to finish the week up 10%.  NBLX made it 2 straight weeks in the top 5, gaining traction after a bad few months.  Smaller MLPs make up the rest of the top 5.  3 of the bottom 5 this week were among the top 5 YTD performers before this week: CCLP, TOO and CNXM.

PAA returned the top 5 YTD, replacing TOO.  CEQP also continues to climb the leaderboard.  CAPL joined the bottom 5 this week, replacing EEP.

General Partners & Midstream Corporations
GPs and midstream corporations underperformed MLPs this week.  SEMG repeated as a top 2 performer, with back to back 5% weeks.  AMGP was the big winner in the group, despite no update or announcement on simplification.  WMB was positive this week, but didn’t have a big move in either direction despite the simplification announcement.

PAGP climbed into second place YTD, in a close race with LNG.  AMGP climbed out of the bottom 5 YTD, and KMI fell back into the bottom 5.

Canadian Midstream
Canadian midstream underperformed sharply this week in USD terms, which was impacted by weaker Canadian dollar.  TransCanada and Enbridge, the largest players in Canada, underperformed most of the group.  ENB seemed to react positive to the simplification news Thursday, then faded Friday in a weak day across Canadian midstream.  The market was surprised and disappointed with Keyera’s announced plan to develop storage terminals in a competitive U.S. market.

ENF outperformed on the buyout news and was one of just two positive performers this week.  Keyera was the best performing stock in the group heading into this week, but finished the week 4th on the leaderboard after an ill-advised development announcement.

News of the (Midstream) World
The week started slow, but ended with fireworks on May 17th, a day that will forever be remembered as Simplification Day.  Also, lost in the merger news was the entrance of WMB into the Permian gas pipeline sweepstakes.

Capital Markets

  • None

Growth Projects / M&A

  • Williams (WMB) announced acquisition of subsidiary MLP Williams Partners (WPZ) in an all-stock transaction valued at $10.5bn (press release)
    • WPZ unitholders will receive 1.494 WMB shares for each WPZ unit, implying a 6.3% premium to prior closing price
    • Pro forma entity is expected to be investment-grade rated with 1.7x dividend coverage in 2019
    • Taxable event for WPZ unitholders; WMB does not expect to be a taxpayer through 2024
  • Enbridge (ENB) announced acquisition of all publicly-traded subsidiaries, including SEP, EEP, EEQ, and Enbridge Income Fund (ENF) in all-stock transactions (press release)
    • Prices implied no premium for SEP (for now), EEP and EEQ and a 5% premium for ENF
    • Results in a single, streamlined Canadian security
    • FERC uncertainty and stark outlook for businesses of SEP and EEP within an MLP wrapper cited as reasons for the mergers
  • Cheniere Energy (LNG) announced offer to acquire 90%+ owned subsidiary Cheniere Energy Partners Holdings LLC (CQH) in an all-stock transaction (press release)
    • Price implies 1% premium to prior closing price
    • LNG attempted to buy in CQH a few years ago, but a deal was not reached after multiple offers
    • The difference this time around is that LNG has a contractual right to acquire the remaining shares of CQH given the 90%+ ownership LNG has in CQH
  • Williams (WMB) announced potential Permian natural gas pipeline, the Bluebonnet Market Express Pipeline in its Analyst Day presentation
    • Pipeline potentially would have 2.0bcf/d of capacity extending from Waha to Katy, TX, and would potentially be in-service by late 2020
    • Would compete directly with other announced, but not yet sanctioned projects by BWP, EPD and NAmerico Pecos
  • Global Partners (GLP) announced acquisition of retail fuel and Jiffy Mart convenience store assets in Vermont and New Hampshire (press release)
    • Assets include 37 company-operated gas stations, 24 fuel sites and fuel supply agreements for 70 gas stations
  • Keyera (KEY-CA) announced development of Wildhorse Terminal, a crude oil storage and blending terminal, in Cushing, OK with an expected in-service date by mid-2020 (press release)
    • Wildhorse will include 12 above ground tanks with 4.5mm barrels of working storage capacity, the majority of which is backed by fee-for-service, take-or-pay contracts ranging from 2-6 years
    • Keyera will invest $185mm to develop the facility
    • An affiliate of Lama Energy Group will own 10% of the project with an option to increase its ownership to 30% by the end of the year


  • Canadian Finance Minister Morneau said Ottawa will compensate Kinder Morgan (KMI) for any financial losses due to delays resulting from British Columbia’s actions (CBC)
    • Expect drama and further negotiating in public ahead of KMI’s deadline at month end