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November 27, 2016

Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

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Week Thoughts: Stepped Over

The MLP Index finished the week flat overall, despite big declines from SXL and ETP (13.1% combined index weight), and a 3.5% gap down in oil prices in brief trading Friday.   The broad stock market grinded higher, interest rates stopped going up, and natural gas prices soared back above $3.00.


If OPEC doesn’t continue to wreak havoc on oil prices next week, and this benign backdrop can continue, MLPs should be well-positioned to finish November positive for the first time since 2013 (up 2.1% month to date).  2013 was also the last time MLPs were positive for December.

Another Arranged Marriage

Investors were caught offside in positioning around the Energy Transfer Complex when the SXL-ETP merger was announced Monday.  On the 3Q ETE call, management commentary seemed to hint more towards permanent solutions for ETP and SXL IDRs, so expectations leaned more towards a buy-in or elimination of IDRs between ETE and ETP.  The market also seemed to expect ETP to maintain its distribution (despite 11%+ yield), predicated on ETE support.

The market was not expecting the complex to use SXL’s lower cost of capital to drive a stealth distribution cut at ETP, although it clearly is a lever to pull (see ACMP/WPZ, MPLX/MWE, other mergers).  ETP investors were surprised by the cut, SXL investors were surprised by dilution to what had been a unique story with concentrated exposure to Permian and Marcellus takeaway pipelines.

I can handle things, I’m smart! Not like everybody says…like dumb!

Growing up, Thanksgiving weekend was always a dead period for TV programming, especially on cable.  Often deep cable channels would run marathons of movies.  TNN (now Spike) would run an entire weekend of James Bond Films, SyFy ran through all the Planet of the Apes films in a row.  And AMC would run marathons of The Godfather films.

This transaction between SXL and ETP reminded me of a few Godfather characters.   Michael Corleone starts off with a small role in the family business than his older brothers Fredo and Sonny.  He gains experience and takes over the family after Sonny’s death.  Michael finds himself cleaning up Fredo’s messes with increasing frequency, until he finally snuffs him out reluctantly.    In this analogy, Michael is SXL, Fredo is ETP.


Fredo: I’m your older brother, Mike, and I was stepped over!
Michael: That’s the way pop wanted it.
Fredo: It ain’t the way I wanted it!  I can handle things! I’m smart! Not like everybody says…like dumb…I’m smart and I want respect!

Expanding the analogy further, Vito is ETE, Sonny is probably Jamie Welch and WMB is probably Connie’s husband who sells Sonny out.

In any event, the Energy Transfer saga continues with a seemingly endless stream of controversial transactions that continue to leave L.P. unitholder carnage and massive banking and legal fees in their wake.

Winners & Losers

No real theme among the winners this week.  RIGP received an improved buy-in offer from its sponsor, which helped push it higher.   The real action was on the downside this week.  The entire Energy Transfer family of MLPs made the bottom 5, including SUN perhaps on expectations of less GP support, then SXL and ETP on the above-mentioned merger.  ENBL did a very rare day-before-Thanksgiving equity deal at a wide discount that landed it near the bottom this week.  FGP announced a larger distribution cut than was expected (80%), earning it the bottom spot for the sector.

Notable that SXL and FGP made it two weeks in a row in the bottom 5.


Year to Date Leaderboard

No change among the top 5 year to date performers.  On the bottom 5, PSXP, SHLX were both higher, along with other sponsor-driven growth MLPs like VLP and DM.  Fading the drop-down MLPs has been a winning strategy for most of the year, but at some point, they become attractive relative to more execution oriented MLPs.  Perhaps the announcements by TLLP (IDR waivers and reiterated 12-15% distribution growth) provided a spark for the group.



G.P. Holding Companies and Midstream Corporations

Despite all the upheaval and violent trading at the subsidiary MLPs, Energy Transfer Equity (ETE) didn’t make the bottom 5 this week, I believe on relief that its IDR (and their option value) remain in place, and that ETE would not need to provide further support to ETP to maintain its under-earned distribution.  Overall GPs outperformed MLPs, and 4 of the top 5 best performers were corporations, maybe an indication that institutional investors (who tend to be more corp-focused) were buyers in midstream this week.



News of the (MLP) World

So much for a quiet holiday week, MLPs are still hard at work trying to solve their financial and fundamental challenges.  Many of those challenges at this stage involve IDRs or leverage.  Neither of the big M&A announcements solved long-term IDR challenges, IDRs were a part of each deal and they bought each some time.  Timing on the ENBL equity deal was surprising – I can’t recall an MLP overnight equity deal pricing the day before Thanksgiving – but showed that the market is there for 10%+ discount deals.


Capital Markets

  • Enable Midstream (ENBL) priced public offering of 10.0mm common units at $14.00/unit, raising $140mm in gross proceeds (press release)
    • Overnight offering, priced at 13.0% discount to prior closing price, and traded up 5.4% the next session
  • Plains All American (PAA) priced $750mm of 4.5% Senior Notes due 2026 at 99.716% (4.535% YTM) (press release)

Growth Projects / M&A

  • Sunoco Logistics (SXL) announced merger with Energy Transfer Partners (ETP) in an all-stock transaction (press release)
    • ETP unitholders to receive 1.5 SXL units per ETP unit, which equated to a 10% premium to ETP’s VWAP over the prior 30 days, but at no premium to the prior day closing price
    • The transaction results in a back door or “stealth” distribution cut for ETP unitholders of 27.5%, but the IDR waivers in place at ETP will continue to be in force for SXL
    • The transaction is accretive to SXL, which (according to management) will allow SXL to grow distributions in the low double digits in the near-term with 1.0x coverage
    • SXL expects $200mm of commercial and cost synergies to be realized by 2019
    • Transaction expected to close in 1Q 2017 and requires unitholder approval from ETP unitholders
    • Smaller MLP buying the bigger MLP but the combined entity will retain the bigger MLP name (Energy Transfer Partners)
      • Just like when Access Midstream (ACMP) merged with Williams Partners (WPZ) a few years ago
  • Tesoro Logistics (TLLP) announced two acquisitions, distribution guidance and IDR waivers (press release)
    • $400mm drop-down acquisition of terminalling and storage assets in California from Tesoro Corp (TSO) at 8.4x EBITDA multiple
    • $700mm third party acquisition of North Dakota gathering & processing facilities from Whiting Petroleum at 6.7x EBITDA multiple
    • TLLP announced distribution guidance of 12-15% for 2017
    • TSO announced $100mm of IDR waivers over the next 8 quarters to help make the acquisitions accretive enough to support distribution growth targets
  • Transocean Partners (RIGP) announced sponsor Transocean has agreed to increase consideration for buy-in of RIGP units (press release)
    • Equity ratio increased to 1.2 shares of Transocean per RIGP unit, up from 1.1427 previously
    • Transocean failed to gain approval for its prior deal at a 11/16 special meeting of unitholders, and is trying again at a 12/6/16 special meeting


  • Activist investor Elliot Management sends letter and presentation to management of Marathon Petroleum Corp (MPC), sponsor of MPLX (press release)
    • The letter called for an immediate drop-down of all MLP-qualifying assets and full strategic review
    • I think I know what they meant (midstream assets only), but almost all of MPC’s assets are MLP qualifying (refineries yes, some of the Speedway assets too)
    • MPC responded with this letter that highlights the aggressive actions management has taken to create value, especially noting the recent accelerated drop down plan (press release)
  • Ferrellgas (FGP) announced 80% distribution cut (press release)
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