What are some alternative capitalization strategies MLPs can employ in this environment?
Anyone who’s ever had to pinch pennies understands that there are a variety of ways to make ends meet. Ask any financial planner and they’ll tell you the three ways to increase your wealth are: earn more, save more, and invest. In our personal finances, we may take on a side hustle, refinance our mortgages, stop going out to eat, or cut the cord on cable. Similar concepts apply to MLPs: they sit down with a calculator and figure out the best way forward. In January, we discussed alternative financing options available to MLPs. Today, we’ll look at a few other creative ideas for keeping the boat afloat in the form of alternative capitalization strategies (“save more”).
When I was about five years old, I managed to pick up a tick after a long day of playing in our neighbors’ garden. I vividly remember my dad pulling the little parasite off of my chin with tweezers. “Be careful,” he said, “parasites are not our friend.” Now, we love GPs at Alerian and would never call them ticks, but there are times when they can be a bit of parasite to MLPs. What I mean by this is that many GPs receive incentive distribution rights (IDRs) from the MLPs they sponsor. IDRs can make a ton of sense, as they incentivize the GP to grow LP distributions by entitling GPs to receive a higher percentage (generally up to 50%) of incremental cash distributions when the distribution to LP unitholders reaches certain thresholds. However, given current conditions, transferring cash to GPs makes MLPs about as happy as I was to transfer a portion of my blood supply to that tick. In an effort to simplify the structure, combining the two entities could make sense. In late September of last year, for example, Crestwood Equity Partners (CEQP) folded in its MLP, Crestwood Midstream Partners (CMLP). Also, these consolidations can occur in reverse. One illustration of this occurred in 2010 when Enterprise Products Partners (EPD), bought its GP, Enterprise GP Holdings (EPE).
GP/LP mergers can also take place when the GP is private. For instance, Genesis Energy (GEL) effectively rolled in its GP in 2010. The general partner interest was converted into a non-economic interest and IDRs were eliminated when GEL issued approximately 20 million common units to the stakeholders of their GP. Genesis Energy LLC became a wholly-owned subsidiary of GEL as a result of the transaction.
Similarly, corporations may also absorb their MLPs. Lowering the cost of capital, improving credit profiles, and removing the drag of another public company have all been cited as reasons for this move. When Kinder Morgan Inc. (KMI) announced its intention to purchase Kinder Morgan Energy Partners (KMP), Kinder Morgan Management (KMR), and El Paso Pipeline Partners (EPB), speculation swarmed that the end of MLPs as we knew them was near. Obviously, this fear was a little over dramatized. We did, however, see Targa Resources Corp. (TRGP) roll in its MLP, Targa Resource Partners (NGLS), last month.
Equity recapitalization is another option for MLPs. Think of this like refinancing your mortgage. In the same way that the terms of your mortgage change to be more beneficial to you during a refinance, the same is true during a recapitalization. Just like you have to pay lender, appraisal, and title fees upfront in a refinance, MLP recapitalization comes at a cost. The question to ask is if long term savings more than compensate for the upfront costs. Niska Gas Storage Partners (NKA) is an example of a company that has recapitalized. The 2013 plan combined NKA’s subordinated units and previous IDRs owed to their sponsor, affiliates of Carlyle/Riverstone Funds, and restructured them into “new” IDRs. The cost to NKA was that instead of owing increasing percentages of incremental cash distributions after quarterly distributions hit $0.4025 (from 13% to 48%), they now owed 48% of any quarterly distributions after common unit holders received the minimum quarterly distribution of $0.35. With the subordinated units eliminated, NKA will save about $12 million per quarter, however, which is a worthy long-term benefit.
If we had it our way, we’d always have so much excess money that careful planning and wise financial strategies wouldn’t be necessary. Unfortunately, for most of us, this is not reality. Many MLPs likely identify with the family trying to make ends meet during a difficult time. And like all savvy families who’ve found a way to survive a job loss or temporarily reduced income, MLPs may very well not only endure the tough times, but come out stronger.