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December 14, 2012

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Western Gas Equity IPO Hindsight

Western Gas Equity (WGP) priced its GP IPO last Thursday at $22.00 per unit, above the range of $19.00 to $21.00, and at a 3.0% IPO yield.  On its first day of trading, WGP opened trading on Friday at $27.00 and closed at $28.00 per unit, up 27.3% in its debut.  It wasn’t the lowest IPO yield ever for a GP (AHGP at 2.96% in 2006), and it wasn’t the highest first day pop of any GP (XTXI popped 30.3% in 2004), but it was close on both counts, making it probably the most successful launch of a GP IPO ever, especially considering the offering was upsized 14%.  All of this during a time when the trading activity in the MLP space has been mostly negative since election day.  WGP wasn’t impacted at all by being structured as a partnership, despite some claiming recent MLP action is a result of MLP-specific taxation fears.
WGP was also a unique transaction in that the proceeds went to buy more units in WES, which no doubt helped its trading performance on day one.  GP IPOs have traditionally been a way for management of private MLPs to take money off the table (e.g. NRGP and AHGP) or for private equity investors to get liquidity (e.g. KMI, TRGP, MGG and BGH).  Below is a chart of GP IPO yields on the 14 GP IPOs since XTXI in January 2004 and a chart of the corresponding IPO pops (the shaded GPs no longer exist).

GP IPO Yield


Western Gas is no stranger to having success during times of MLP volatility.  WES was the last MLP IPO to price before the MLP IPO market closed for nearly two years from May 2008 to April 2010.  Since its IPO, WES has produced total returns for IPO investors of 219%, compared with 75% for the Alerian MLP Index.  WES has executed its drop down story well, and has grown its distribution at an annual rate of 16.4% the last 3 years, near the top of the list of distribution CAGRs for MLPs.
Total Return
WGP’s GP Paper Popular
WGP’s IPO is the clearest example to date of the power of incentive distribution rights and their ability to generate immense value for MLP sponsors in a short period of time.  There have been other successful drop down MLPs, Williams has created 3 at this point (WEG, WPZ and WMZ), El Paso was very successful with EPB until things got muddled with its sale to KMI, and there have been several other good examples of GP value creation with clear exits.  This IPO is also another example of why MLPs keep including IDRs at IPO, just too much money to leave on the table for something that investors don’t mind that much given how well the alignment has worked for LP investors in most cases in the past.
But WES is the simplest example of a clear drop down strategy executed successfully, with a clear valuation marker in such a short time since its IPO.  WES has grown mostly from drop down acquisitions from its parent, Anadarko (APC), and by executing growth projects around those acquired assets.  In just 4.5 years, the cash flow stream to the GP interest and IDRs of WES went from $1.3mm at IPO to approximately $44.9mm, and the value of its GP went from $17.9mm based on its 2% stake of the original IPO to approximately $3.8bn today after stripping out the value of LP units held by WGP.  My math for this is shown below, based on 12/13 closing prices.
WGP Math
The way the math works, if the value of WES common units owned by WGP stays flat or goes down while WGP’s unit price rises 25.7%, the value of the GP interest increases 50.3%, which is what happened since WGP priced its IPO.  Unless my math is wrong (the numbers certainly don’t pass the eye test), the GP is now valued at 84.1x current annualized cash flow, which is the highest of any public GP, by a wide margin.  WGP will likely grow its distribution at a much faster pace than other GPs, if WES keeps up its historical distribution growth rate.  But it is still an amazing multiple.  The GP value created in the last 5 trading days is roughly half of what was created in the last 4.5 years, which is staggering, but kudos to WGP and WES for getting that done in a very challenging market for MLP equity.
The other public GPs whose sole assets are equity interests in public MLPs subsidiaries include: ATLS (ARP/APL), AHGP (ARLP), NSH (NS), TRGP (NGLS), and XTXI (XTEX).  KMI and ETE have other assets beyond their interest in multiple subsidiary MLPs.  There are a few other nearly pure MLP holding companies, like NRGY and WMB out there as well.
Disclosure: I am long WES in some client accounts, no position in WGP.  I am not giving an opinion to buy or sell WGP, just recounting the publicly available facts about the IPO and some historical tidbits.  I do own some other MLP GPs trading at significantly lower multiples (and they probably trade that way for a reason, whether it be slower growth or less certainly of growth than WES / WGP).
Why Don’t Majors Do MLPs?
I’ve been asked this question before several times: why don’t the majors launch MLPs for their midstream assets?  What you hear from companies like Chevron and Exxon regarding MLPs is that (1) they don’t believe an MLP will move the needle or (2) they like having total control of their midstream operations.  The latter reason doesn’t really apply, because the MLP structure still gives all of the control to the MLP sponsor via its general partner interest. To debunk the first reason, that a subsidiary MLP won’t move the needle on their larger business, look no further than the WGP IPO.  Even a company with a market cap of $100bn can’t look down their nose at creating an additional $3.8bn in value out of thin air.  And that value doesn’t include the additional cash that gets sent to the GP as proceeds from drop down acquisitions and as annual cash flow distributions on its stake in the MLP.
Large corporations have clearly caught on to the magic of the MLP drop down model.  Tesoro is well down the path on its drop down midstream MLP, MPLX successfully launched its midstream MLP earlier this year, and PSX made headlines this week with its plans for a midstream MLP.  With WGP’s successful GP IPO and with the copy cat nature of the MLP space, expect to see a few more of these in the next few years once some of these PE backed and drop down MLPs reach their respective 50% IDR tier.  It doesn’t make much sense to IPO before fully ramping distributions to the 50% tier, although Hiland Holdings did just that back in 2006.
Who might be next?  Well back in January, I predicted we would see one GP IPO this year, but WES wasn’t on the list of potential GPs.  Back then I listed the 5 MLPs in the 50% IDR tier with a private GP.  That list included PAA, CMLP, TLP, DPM and MMLP.  With this new concept of taking the GP public even if its owned by a public corporation, we can add other 50% IDR MLPs BWP, OKS, EEP, WPZ, NRGM, SEP and TGP to the list.  That makes 12 candidates in the near term for a GP IPO.  The alternative to a GP IPO for a sponsor is to sell its GP to another company.  Of those 12 MLPs listed in the 50% tier, CMLP seems like the most logical GP IPO candidate given its private equity owned GP, but BWP may be a candidate as well, just to get that public marker for the GP stake owned by Loews.  Keep in mind this is total speculation and in no way is a recommendation to buy those MLPs.
Additionally, there are a few other MLPs with GPs that may change hands in the next year.  ACMP, SXL and EPB all got new parents this year.  There will probably be at least one smaller MLP that gets its GP bought out by a large investment grade MLP.  Also there are at least two MLPs that could be consolidated into their affiliated MLPs.  Ethan Bellamy at R.W. Baird has an outperform on RGP based on the premise that it gets taken out by ETP at some point.  It looks like ACMP could at some point be gobbled up by the Williams complex, and EPB might some day be bought by KMP.   Again, all speculation, but the trend is clearly towards consolidation as public GPs of large MLPs look for new growth avenues (see ETE, KMI and WMB).
More reading on GPs from

  • GP math and discussion of GP historical out-performance (link)
  • MLP GPs: the Parasite Trade (link)
  • General Thoughts on General Partners (link)
  • Chesapeake: When 100x Cash Flow is a Fire Sale (link)
  • Distributions and IDRs (link)
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