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How to Play the Growing Trend in MLP Spinoffs

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Posted on Fri, 02 August 2013 18:29 | 0

There’s been a recent mania in energy to spin off assets as master limited partnerships. You’ve seen it in practically every refinery, but other E+P energy companies have also repackaged their downstream assets in MLP form.  Let me explain why this is happening and how to trade the trend.

Master Limited partnerships’ main structural superiority is their tax-advantaged status, designed to help shareholders on fixed incomes.  By deferring much of the liability at the corporate level and shifting it to personal income for shareholders, the MLP promises to return virtually all the profits to shareholders.  This equates to high percentage distributions of 5%, 7%, sometimes 10% and more.  

The tax-advantaged nature of MLP’s is particularly powerful in a very low interest rate environment like we have now, when yield-starved investors are searching everywhere for returns.  Energy companies have also taken particular advantage recently by remaining large shareholders in the new MLP themselves.  They first drop downstream assets to the MLP and take the write-downs, while enjoying the partnership distributions from the new entity as dominant shareholders, which they then use to finance further capital expenditures. Finally, when the retail rush for MLP shares sends the stock price higher, they sell their holdings to MLP funds, gaining another big cash infusion.  This is precisely what Chesapeake Energy (CHK) did…

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