Energy Transfer Offering Exposes Pipeline Parent Trap: Gadfly

(This column does not necessarily reflect the opinion of Bloomberg LP and its owners. The views expressed are his own)

(Bloomberg Gadfly) -- Investors gave a thumbs up on Tuesday to Energy Transfer Partners LP's decision to raise as much as $1.16 billion by issuing new units. They just happened to express their enthusiasm by driving up the price of a different stock, Energy Transfer Equity LP:

Energy Transfer Equity is, of course, the parent of what is variously called the Energy Transfer group, complex or empire. The reason the parent's units finished Tuesday up 4 percent is the same reason Energy Transfer Partners fell by 5 percent. Therein lies another cautionary chapter in the continuing saga known as the overhaul of the master limited partnerships sector.

Energy Transfer Partners announced late on Monday it was selling 54 million new units (or 62.1 million if underwriters exercise their right to buy more) at $18.65 each. That's dilution of a potential 5.6 percent at a discount of 5 percent to Monday's closing price. Hence, no wonder Energy Transfer Partners' units took a hit Tuesday.

Yet that only tells half the story.

As an MLP valued for its distributions (the equivalent of dividends) a key metric for Energy Transfer Partners is its yield. This stood at 11.2 percent just before the offer was announced -- or, put another way, Energy Transfer Partners' cost of equity was 11.2 percent.

Except it's actually much higher than that.

Energy Transfer Partners still kicks up payments to the parent, Energy Transfer Equity, via incentive distribution rights. These are a legacy of when MLPs were young and vibrant and, above all else, trying to grow as quickly as possible. Essentially, they award an escalating cut of cash flow to the general partner of the MLP -- Energy Transfer Equity in this case -- as distributions to limited partners (ordinary investors in Energy Transfer Partners) go up. For a more detailed explanation, click here.

This worked well for a while; limited partners weren't bothered by the general partner's rising cut as long as distributions were going up along with cash flow and unit prices. But when MLPs hit a wall in the oil crash and the hangover of high debt from all that growth came into focus, it became an issue.

So in considering Energy Transfer Partners' latest issuance, the ordinary distribution of 55 cents a quarter equates to a cost of equity for the new units -- priced at a discount, remember -- of 11.8 percent. Add in the incentive distribution rights that will have to be paid on them, though, and the total cost rises to a private equity-like level of almost 20 percent.

Effective Cost of New Units


That's a problem for a couple of reasons. First, the business of operating pipelines -- a relatively utility-like function -- is not known for generating sustainable returns on equity in the neighborhood of 20 percent. The yield on the Alerian MLP Index is less than 8 percent. The whole point of MLPs is to raise financing relatively cheaply, so the fact that Energy Transfer Partners is doing so at this cost is a bad sign.

Second, a big reason why Energy Transfer Partners' yield is so high -- regardless of the incentive rights -- is the well-founded sense that the limited partners' second-fiddle status is particularly pronounced in this case.

There was the "heads-I-win-tails-you-lose" convertible preferred issued in the depths of the crash in early 2016. Then there was the stealth dividend cut delivered via the merger with fellow Energy Transfer subsidiary Sunoco Logistics Partners LP, announced in November (Energy Transfer Equity's units jumped in contrast to its subsidiary's that day, too). And the background to all this has been years of expansion and a debt-to-Ebitda ratio that was still 5.6 times at the end of June, according to CreditSights.


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