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Dan Dicker

Dan Dicker

Dan Dicker is a 25 year veteran of the New York Mercantile Exchange where he traded crude oil, natural gas, unleaded gasoline and heating oil…

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How to Play the Growing Trend in MLP Spinoffs

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 with Chesapeake Midstream Partners (formally CHKM) – finally selling their holdings to other capital partnerships.  The name of the MLP was changed to Access Midstream Partners (ACMP) upon their exit.  

The big point here:  Chesapeake ultimately realized far more from their MLP spinoff than any straight sale of downstream assets could have possibly accomplished.  Indeed, I think that one reason Chesapeake shares have managed to blunder through their turmoil of 2012 and emerge with a rallying stock now is more than partially due to the big return they managed with ACMP.

So, how do you play this trend?  Here are a few of the takeaways we can say about this new trend of spinoffs of downstream assets into MLP’s.  First, they are almost always aggressively priced into the syndicate – remember, usually the largest shareholder remains the parent company, at least at the start, and a favorable price for their buy-in is a key component in the spinoff plan.  Second, that would indicate that the new IPO’s are the ones we are looking for – mature MLP’s will be much more sensitive to interest rate markets as they’ve reached full independence from their parents.  

You need only look at the recent IPO’s of CVR refining (CVRR) or Phillips 66 partners (PSXP), to name only two of the many I could name, to see the massive profits that can be made if you can get in at the insider price, not counting the massive distributions that such a low initial offering price usually implies.  

What’s the next coming IPO to look for?  Western Refining (WNR) has submitted docs for a MLP spinoff coming sometime in the next week and past that, Devon Energy (DVN) has indicated that it is looking to “MLP-out” it’s downstream assets sometime in the 3rd quarter.

Both of these look as close to a ‘lock’ of a buy as exists not just in the energy space, but anywhere in the market right now.  I think you can buy them almost blindly, almost certainly if you are a member of the syndicate and can get an allocation at the inside price.  

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