In its second quarter earnings call, management at Occidental Petroleum (OXY) reiterated its commitm...
A Trio of MLP Takeover Targets
10/02/2013 11:00 am EST
Master Limited Partnerships (MLPs) in the energy sector offer numerous opportunities for income-oriented investors, says Peter Staas, editor of the Energy and Income Advisor.
Steve Halpern: We're here today with Peter Staas, managing editor of both Capitalist Times, as well as the Energy and Income Advisor. How are you doing Peter?
Peter Staas: Great, thanks for having me, Steve, I appreciate it.
Steve Halpern: You recently released a fascinating research report on takeover targets among energy MLPs, but before we look at some specific names, could you first explain what master limited partnerships are and what type of investor should be looking at these vehicles?
Peter Staas: Sure Steve. Master limited partnerships, they trace back to the early 1980s, and there's basically pass-through entities, so they pass-through the majority of their cash flow to investors, as quarterly distribution, and because of the way that they're structured, there's some significant tax deferral advantages associated with these names.
Traditionally, the space has appealed to income seeking investors, especially people looking to turn lifelong savings into a steady income stream when they retire.
But more recently, with sort of the American energy renaissance going on and the massive development of shale oil and gas in the US, production has grown considerably of oil and natural gas, and it's sort of overwhelmed the existing pipeline, processing plant, all the things that oil and gas pass through to get them ready-bring them to market and get them ready for sale.
So there's actually been a huge growth opportunity for a lot of these names, so I would say that they definitely appeal to income-oriented investors, but growth investors should also pay attention to this space I think.
Steve Halpern: Now, you know that there's been increase in takeover activity within the Energy MLP sector and you forecast that the trend will continue in coming years. Could you expand on the reasons behind that?
Peter Staas: Sure Steve. Well, actually, mergers and acquisition activity has always been a big part of the MLP stage. Because they pass-through the majority of their cash flow, to investors, they definitely rely heavily on acquisitions to drive distribution growth. It's a big part of it.
Obviously, there's a lot of organic growth opportunities also, but I would say over the past five-four or five years, we've definitely seen an uptick in deal volume.
Most of it has been focused on specific assets, so buying a pipeline, buying a system of gathering pipelines and processing plants in a specific area, but really, over the past two to three years, we've seen a real uptick in whole company takeovers, and part of the reason for that is, within the MLP space we've had three names-well, there's a handful, like four or five.
The four or five largest by market capitalization have really driven this activity, three names in particular; Kinder Morgan, the Kinder Morgan Family, companies that include Kinder Morgan Inc. (KMI), which is the general partner, and then Kinder Morgan Energy Partners LP (KMP), which is the limited partner.
And also the Energy Transfer family of companies-Energy Transfer Partners LP (ETP) and Energy Transfer Equity (ETE)-and Williams Companies (WMB), and Williams Partners (WPZ), those two are associated.
Basically, what's happening is these really, really, really large MLPs, sort of blue chip MLPs, if you will, they've grown so large, that in order for them to move the needle to grow their distributive cash flow, I mean, it's a fairly considerable amount.
Like, for example, Kinder Morgan Energy Partners, which is the second largest MLP by market cap, they need to grow their cash flow by about $81,000,000 in order to increase their distribution by 10%. I mean, that's a considerable amount.
I mean, you compare it to a newer MLP, one that IPO'd about a year ago, ETP Midstream Partners. They only require about $1,000,000 to produce 10% growth, and so what we've seen, I mean, we've really seen an uptick in deal volume.
Kinder Morgan Energy Partners, they've acquired-well, their general partner-acquired El Paso Corp., which is a lot of natural gas pipelines, that sort of thing, and they've been dropping that down to Kinder Morgan Energy Partners.
They also recently acquired a company called Copano Energy (CPNO), which owns gathering and processing assets in the Eagle Ford Shale. We've seen Williams Partners take a 50% equity stake in Access Midstream Partners, general partner, so we're just seeing a lot of movement in that space.
Another trend that's occurring too, so you've got these larger guys that need to-they're relying on acquisitions to drive growth, because they're so large, and then you've got some smaller guys where they don't have the economy of this scale that these larger companies do.
These larger companies have asset bases that are nationwide. A lot of these smaller players, they have assets that are specific to one region, which brings a lot of challenges with it. There's been a lot of growing pains with the American Energy Renaissance, where you'll have, like a huge uptick, like huge production.
For example, in Cushing, the delivery point for crude oil, West Texas Intermediate Crude oil, you had a lot of pipeline infrastructure going in there, but you only had, like, one or two pipelines going out to the gulf coast.
So that really depressed the price of WTI, and so people that need higher WTI prices, I mean, they were really struggling, and so there's been a lot of sort of growing pains like that.
So, you've got some smaller MLPs, but they're facing some challenging environments in their regional areas, and so they're looking for a capital infusion from largely private equity companies.
This is sort of an interesting story. So, private equity firms, they own a lot of midstream energy infrastructure, stuff like pipelines, gathering and processing assets, that sort of stuff, and they're looking to monetize those assets.
So, what they'll do is, they'll purchase what's called a general partner stake in one of these companies, which gives them exposure to any growth that happens at the LP level, the limited partner level.
And then they'll drop down some of these assets that they have. We've seen two deals like that over the past few months. We had Arclight Capital Partners, it's a private equity firm. They took out a stake in American Midstream Partners (AMID), which is a smaller MLP.
They bought a 90% interest in that company's general partner, and then more recently, we had Alinda Capital Partners. They took out a 50% economic interest in Martin Midstream Partners (MMLP), general partners, so I think we're going to see a lot more deals like that.
And those are something investors should keep an eye on, because both those stocks, American Midstream Partners and Martin Midstream Partners, I mean, they popped significantly after those deals.
So under the assumption that these dropdown transactions would enable the smaller MLPs to grow their distributions, so their payouts, quarterly payouts to shareholders, so it's an exciting time in the MLP space.
Steve Halpern: Now, with that as a background, could you highlight a couple of potential takeover targets that you see continuing this trend that you've just discussed?
Peter Staas: Yeah, no problem, Steve. I mean, I think there are basically two types of transactions that we're keeping an eye out for. The first would be a name that a larger company would be interested in, so like Kinder Morgan Energy Partners, Energy Transfer Partners.
I mean, Energy Transfer Partners CEO, he recently did an interview with Bloomberg Television saying that the MLP is definitely looking for new acquisition to try to grow, so a name that we think that has been rumored to be a takeover target, actually for a long time, would be MarkWest Energy Partners (MWE).
They own a lot of gathering and processing assets in the Marcellus Shale, which is their natural gas play in the Pennsylvania and West Virginia, and they recently formed a joint venture.
Well, they signed a letter of intent to form a joint venture with Kinder Morgan Energy Partners, and so that's prompted a lot of speculation that they could be a takeover target.
Certainly, their assets would be complimentary to Kinder Morgan Energy Partners and, as we've seen with Kinder Morgan's takeover of El Paso Corp, they certainly don't shy away from big deals, so this would definitely be a big deal.
Shares of MarkWest Energy Partners, they're pretty expensive where they are right now, so, I mean, it is a takeover target. I like the names fundamentals, but I think the stocks a little pricy here.
A name that I think is a bit more under the radar and I would say more interesting would be TransMontaigne Partners (TLP), and they own a lot of terminal assets, crude oil storage assets with fine product storage all over the US.
But they've got a really nice presence on the gulf coast, which with all this oil coming down now from Cushing and from the Permian Basin, Eagle Ford Shale, all these other regions, that storage capacity and that terminal capacity is really in high demand, especially for refined products, which the US is exporting at record levels.
And I think what makes TransMontaigne Partners interesting is, like, nobody has really paid attention to this name, because the general partner is Morgan Stanley and, if you've seen what's going on with JP Morgan Chase and their physical commodities business, they've decided to exit it.
Morgan Stanley is under pressure, because they became a bank holding company during the financial crisis to stay afloat, and so they're subject to rules and standards that bank holding companies are, so they are probably going to need to divest TransMontaigne Energy Partners.
TransMontaigne, they have joint venture called Bosco, it's a series of terminals in Texas on the Gulf Coast, and that joint venture is with Kinder Morgan Energy Partners, so it wouldn't surprise us if there was a deal there and that's a name that we think trades at a reasonable valuation. You get a solid yield from it and you get the potential upside from the takeover.
A second type of transaction that investors should be on the lookout for, and we wouldn't allocate a lot of capital from this yield, for this sort of transaction.
This would be something that you take smaller stakes, have it maybe be a basket of stocks, so you're not taking on too much risk, because this would be a play on private equity company, potentially buying a general partner interest in one of these kind of more marginal names.
For a name that's struggling, PVR Energy Partners (PVR) would be one to maybe take a look at. They actually own a coal royalties business and a few years ago, they decided, hey, we're going to downplay our exposure to this, we're not going to grow that business anymore.
It's fairly steady, that business. It has come under pressure over the past three years, but it's reasonably steady.
What they did was, they acquired, like, gathering and processing and pipeline assets in the northeast portion of the Marcellus Shale, and the market really applauded that yield when it went through, but it hasn't really worked out for them.
The volume growth hasn't really been there, so they've sort of disappointed. Their cash flow hasn't come close to covering the distribution, but there have been shortfalls, sort of like a classic name that a private equity company would get involved with, and if that were to happen, really shore up the distribution coverage and provides nice visibility on potential distribution growth.
Again, the payouts to shareholders, which would be a real upside catalyst for that stock. I would say if you already hold that name, something to think about. If you don't, you might want to take a nibble on it, so those would really be, I'd say the three names for investors to think about.
Steve Halpern: Okay great, we appreciate your time and your insights, and again, mentioned that takeover targets always have an added level of speculation, but we appreciate you sharing these really good ideas.
Peter Staas: Well great, thanks again for having me Steve. I really appreciate it.
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