AN OVERVIEW OF THE GENERAL PARTNERS OF MASTER LIMITED PARTNERSHIPS

Transcription

1 AN OVERVIEW OF THE GENERAL PARTNERS OF MASTER LIMITED PARTNERSHIPS

2 MLPs and GPs Master Limited Partnerships, or MLPs, are tax pass through entities that derive 90 percent of their income from the exploration, development, mining or production, processing, refining, transportation, or the marketing of minerals and natural resources. Their ownership consists of one or more General Partners (GPs), which have managerial and administrative control over an MLP, and many Limited Partners (LPs), which provide capital to an MLP and are entitled to periodic distributions, but have no control over operations. The GPs typically hold an initial stake of 2% in an MLP, while LPs hold the other 98%. Investors can access an MLP by buying LP common units on an exchange or by purchasing shares of publically traded General Partners. General Partner Carried Interest ¹ A General Partner is compensated for its management efforts through incentive distribution rights (IDRs), which are a form of carried interest. The structure of IDRs incentivizes a GP to increase the MLP s distributions to its common unit holders. As the General Partner raises the nominal amount of distributions made by the MLP to predetermined thresholds, the GP receives an increasing percentage of the distribution. The IDR schedule occurs in a staggered manner and as the distribution target at each stage is reached, the cash flow available to the GP increases up to 50%. This tiered system aligns the GP s interests with the LP unit holders as they both reap the benefits of increasing distributions. IDRs can be explained by analyzing a typical compensation structure for a General Partner: Tier 1: When an MLP s quarterly distribution is $0.275 per unit or less, the GP receives 2% of the payout through its ownership stake, but no additional income from IDRs. The Limited Partners receive the remaining 98% of the distribution. Tier 2: When the quarterly distribution is between $0.275 per unit and $ per unit, IDRs entitle the GP to 13% of the payout within this interval, in addition to the GP s 2% payout through its ownership stake (for a total of 15%). The LP unit holders receive the remaining 85% of the total distribution. Tier 3: When the quarterly distribution is between $ per unit and $ per unit, GPs receive a total of 25% of the payout within this interval (23% from IDRs, 2% from ownership stake). The LP unit holders receive 75%. Tier 4: When the quarterly distribution exceeds $ per unit, GPs collect a total of 50% of the payout in this interval (48% from IDRs, 2% from ownership stake), while the LP unit holders receive 50%. As the LP s distribution increases and reaches higher IDR tiers, the GP s earnings will grow disproportionately faster than the LP s. Figure 1: Role of IDRs in GP Earnings Growth (Hypothetical example. For illustrative purposes only.) As a GP increases an MLP s distributions and reaches higher IDR tiers, the GP s earnings will grow disproportionately faster than the LP unit holders take. Figure 1, to the right, illustrates the relative earnings growth of a GP versus the cash flow available to LP unit holders. Graph Source: Midstream Energy MLPs Primer 3.0, Morgan Stanley, April 2013 FQ = Fiscal Quarter ¹ Source: MLP Basics: Incentive Distribution Rights Explained, Energy & Income Advisor, Master Limited Partnerships 101, Latham & Watkins LLP 2

3 Figure 2: Distribution Growth of Largest GPs and Their Associated MLPs 30% 25% GP LP 25.40% 20% 20.19% 16.54% 15% 13.68% 10% 9.67% 11.43% 10.81% 8.34% 5% 4.30% 5.62% 3.32% 6.55% 0.00% 0.00% 0.31% 0.00% Alliance Holdings Cheniere Energy Energy Transfer Kinder Morgan NuStar OneOK Targa Resources Williams Cos Distribution growth between 2012 and 2013, Sources: Bloomberg 2014, Factset 2014 If a GP elects to return a portion of its earnings to shareholders, having a higher earnings growth rate than its corresponding LPs will often translate into having a higher distribution growth rate. Figure 2, above, demonstrates that between 2012 and 2013, 7 of the 8 largest GPs had higher annualized distribution growth rates than their corresponding LP units. A security with a high distribution growth rate can be attractive to investors as rising distributions often leads to stock price appreciation². Despite the fact that GPs often have lower yields than their related LPs, increasing distributions and the resulting price appreciation can result in higher total returns (yield + price appreciation) for investors. Over the last year, GPs have experienced a total return of 50.96% between December 2012 and December 2013, as compared to 28.77% for their corresponding LP units. Table 1: Total-Return Comparison of Largest GPs and Their Associated MLPs ³ MLP Name GP- 1 Yr Total LP- 1 Yr Total GP- 3 Yr Total LP- 3 Yr Total GP- 5 Yr Total LP- 5 Yr Total Alliance Holdings 29.97% 41.34% 12.50% 11.77% 39.68% 31.68% Cheniere Energy % 43.31% 98.42% 18.87% 72.17% 67.12% Energy Transfer 87.72% 43.29% 34.93% 11.28% 46.93% 19.76% Kinder Morgan 6.19% 7.42% % % NuStar 9.75% 31.80% -1.87% -2.08% 17.32% 13.08% OneOK 49.66% 2.79% 34.81% 15.47% 38.57% 25.55% Targa Resources 71.97% 48.52% 53.30% 22.90% % Williams Cos 22.78% 11.65% 28.59% 9.13% 30.77% 43.69% Average 50.96% 28.77% 37.24% 12.32% 40.91% 34.95% from 12/31/2012, 12/31/2010, & 12/31/2008 to 12/31/2013 Source: Bloomberg 2014 Performance quoted represents past performance and does not guarantee future results ² When a security increases its distributions, its yield (distribution amount divided by price) will initially increase. Since the yield is now higher than before, investors are more attracted to the security. They will theoretically buy shares until the security s price rises to a level where its yield is no longer attracting additional investment. ³ The top pure-play GPs based on market capitalization and their corresponding MLPs have been included in this analysis. Due to insufficient data, Western Gas Partners has not been included. 3

4 Substantial Management Ownership in GPs 4 In many instances, members of a GP s management team will own considerable equity positions in the GP itself. Insider ownership in many large GPs currently exceeds 10%, while insider ownership in the corresponding LP units is currently less than 1.5%. High insider ownership signifies that the interests of the management are more closely aligned to the interests of the General Partner. Moreover, it also demonstrates considerable conviction among management regarding the prospects of the GP compared to the related LP. Potential for Acquisition 5,6 In a few instances, MLPs have merged with their General Partners in order to reduce their cost of capital 7. The cost of capital for an MLP is the weighted average of cost of limited partner equity, cost of general partner equity and cost of debt. The cost of general partner equity increases with increasing distributions (due to the presence of IDRs), thus making it a very expensive component of cost. By merging with their GPs, MLPs eliminate IDRs, and hence have higher flexibility in growing distributions, as well as in gathering assets and funding future acquisitions. Examples of MLPs which have taken over their GPs include Magellan Midstream Partners, Enterprise Product Partners, PVR Resources, and Buckeye Partners. Additional GP acquisitions are fueled by private equity firms looking to invest in midstream energy infrastructure. High Institutional Ownership ETFs, Mutual Funds, and Closed End Funds are taxed at the fund level when more than 25% of their portfolio includes LP units of an MLP. Additionally, tax deferred accounts like individual retirement accounts may lose tax advantages when investing in LPs, as they can owe an unrelated business taxable income, or UBTI. These factors often restrict institutional investment in LP units. GPs are favored by institutional investors because they provide leveraged, highly correlated exposure to LPs, while avoiding the potential tax obligations related to LPs. Conclusion Despite having lower distributions yields, the General Partners of MLPs have exhibited higher distribution growth rates than their LP counterparts due to the compensation structure established by IDRs. These higher distribution growth rates have been a primary driver for the total return outperformance experienced by the GPs. There are additional factors that make GPs appealing including the high level of insider ownership, their attractiveness as takeover targets, and significant institutional investment. Sources: Current GP / IDR Market Trends. Vanguard Natural Resources, LLC, 11 Oct Web. 18 Nov File?item=UGFyZW50SUQ9MTEwMDM1fENoaWxkSUQ9LTF8VHlwZT0z&t=1 Gue, Elliot H. MLP Basics: Incentive Distribution Rights Explained. Energy & Income Advisor. Capitalist Times, LLC, 15 Nov Web. 18 Nov Maresca, Stephen J. Midstream Energy MLPs Primer 3.0. Morgan Stanley, 17 Apr Web. 18 Nov. 2013, p morganstanleyfa.com/public/projectfiles/4735a09e-c35d-4545-a c8d057f0.pdf Master Limited Partnerships Latham & Watkins, LLP. Web. 9 Jan < Staas, Peter. A Trio of MLP Takeover Targets. MoneyShow.com. 2 Oct Web. 18 Nov article/44/dailyguru-32711/a-trio-of-mlp-takeover-targets/ 4 Ownership data from Bloomberg on October 31, 2013, 5 Source: Current GP/IDR Market Trends, Platts Conference. October 11, Source: A Trio of MLP Takeover Targets, The Money Show. October 2, Cost of Capital represents the expenses associated with a firm s financing methods. Two common financing methods are issuing debt and selling equity. The cost of debt is the rate a firm pays to service its debt. The cost of equity is the returns required by shareholders. 4

5 This information should not be relied upon by the reader as research or investment advice regarding any funds or security in particular. It is not intended to be tax or investment advice, a forecast of future events, or a guarantee of future results. Investors are urged to consult their tax professionals or financial advisers for more information regarding their specific situations. Neither Global X nor SEI provides investment or tax advice. Investing involves risk, including the possible loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Investments in securities of MLPs involve risk that differ from investments in common stock including risks related to limited control and limited rights to vote on matters affecting the MLP. MLP common units and other equity securities can be affected by macro-economic and other factors affecting the stock market in general, expectations of interest rates, investor sentiment towards MLPs or the energy sector, changes in a particular issuer s financial condition, or unfavorable or unanticipated poor performance of a particular issuer (in the case of MLPs, generally measured in terms of distributable cash flow). This information is not intended to be individual or personalized investment or tax advice. Please consult a financial advisor or tax professional for more information regarding your tax situation. The Funds are required to distribute income and capital gains which may be taxable. Buying and selling shares will result in brokerage commissions and tax consequences. Shares are only available through brokerage accounts which may have minimum requirements. Only whole shares may be purchased. Carefully consider the Fund s investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Funds prospectus, which may be obtained by calling GX-FUND-1 ( ), or by visiting www. globalxfunds.com. Read the prospectus carefully before investing. Global X Management Company, LLC serves as an advisor to the Global X Funds. The Global X Funds are distributed by SEI Investments Distribution Co., which is not affiliated with Global X Management Company or any of its affiliates. All numbers are approximate. Securities mentioned, comments made, or charts included should not be considered investment advice or a recommendation to buy or sell any particular security. 5