In the 1967 movie "The Graduate," Benjamin Braddock, played by Dustin Hoffman, is a recent college graduate worried about his future. In the movie, he's given one word of advice that was meant to set him on a profitable course in life. That famous word is plastics. He was told that there would be a great future in plastics and was urged to think about a career in the field.
The new plastic revolution
Fast forward nearly five decades, and we stand at the forefront of a future where plastics could yet again represent a great future opportunity. It's a future that even the IRS sees as being an important one for our country. That's why it ruled in October 2012 to allow companies that convert ethane and other natural gas liquids into olefins, such as ethylene could to be classified as master limited partnerships. What that means is that now these makers of the basic building blocks of plastics can now avoid the double taxation of a corporation.
It's almost as if the IRS is now giving chemical companies and investors the same advice Mr. McGuire gave Benjamin Braddock, which is to invest in plastics. While it took nearly two years for the first plastic maker to take advantage of this tax-advantage, we now have a first-mover. Westlake Chemical (NYSE:WLK) is that company as it is the first U.S. plastics maker to take advantage of the IRS ruling as it is now planning an IPO for its MLP Westland Chemical Partners LP.
The Westlake Chemical MLP will own the company's three U.S. ethylene plans as well as a 200-mile ethylene pipeline. The company plans to raise about $272 million in the IPO, which is likely to be the first of many public offerings of units by the new MLP. Westlake said it plans to use the MLP to operate, acquire, and develop ethylene production facilities, so it's likely to use these units as currency to grow the business.
First, but not the last
Westlake is likely just the first of many plastic makers to use the IRS rule change to make more money on plastics. Huntsman (NYSE:HUN), for example, has already stated that it would be open to following Westlake's move and create its own MLP. After that, companies like Dow Chemical (NYSE:DOW) could follow suit. Dow Chemical in particular might not have much of a choice, as it could be forced to bow to activist pressure and create an MLP to house some of its assets in order to benefit from the value differential between a C-Corp and an MLP.
Dow Chemical is currently battling hedge fund manager Daniel Loeb. He's pressuring the company to spin off its slow-growing petrochemical unit and focus on specialty materials. That being said, Dow Chemical believes any move to break apart its business would hurt the value of the company as opposed to enhance its value.
However, if the Westlake Chemical Partners IPO is well received, and the MLP creates value, then both Dow Chemical and Huntsman will at least need to explore the MLP option. Both companies are already spending hundreds of millions of dollars in capital spending to boost capacity to take advantage of America's cheap natural gas. Using the tax advantage of an MLP could help both companies cheaply raise capital to fund the building boom -- and earn a better return in the process.
Petrochemical manufacturers now have two very important catalysts that should yield profitable growth for years to come. First, the North American shale revolution is providing a competitive advantage as it's providing the key natural gas feedstocks these companies need at a big discount to world gas prices. Now, on top of that, the IRS is allowing these companies to have a special tax advantage to more easily raise investor capital in order to take advantage of the natural gas boom. That's a good formula for making profits.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.