Should You Buy the MLP or the General Partner?

Master limited partnerships, or MLPs, are a hot topic in the energy investment world, but that raises a question. When is buying the general partner, or GP, right for an investor?

Take a company like Oneok  (NYSE: OKE  ) , which acts as the GP for Oneok Partners, LP (NYSE: OKS  )  Yes, it's essentially all one company, but these two stocks have widely differing market performances, returns, effective yields, and tax consequences.

The MLP advantage
An MLP trades like any stock, but has the tax advantages of a partnership. A regular corporation pays taxes on its earnings at the corporate level, but then shareholders must pay tax on their dividends too. An MLP, however, pays no tax at the company level, thus avoiding this double taxation. Instead, all revenues and expenses pass through to the unitholders, who pay tax only at that point.

Courtesy of Morgan Stanley

MLPs also generally distribute any cash flow not required for capital maintenance, and unitholders pay no taxes on those distributions until the units are sold. Basically, each distribution is a return of capital, which reduces the cost basis of the units. If the unitholder dies and passes the units to their estate, the cost basis is reset. This is an attractive tax saving feature for estate planning.

So MLP investors are generally interested in current income and/or tax advantages. However, filing tax returns can become complex, and MLPs are generally not suitable for tax-deferred accounts like IRAs.

The case for GPs
Investors in the corporate general partner may be more interested in total return than current income. A case study by Global X Funds notes that while MLPs offer high tax-deferred current yields, the total returns of the GP's shares are often much higher due to superior price appreciation. That's because the GP usually has incentive distribution rights, or IDRs, which allow it to receive a greater percentage of the MLP's distributions at certain target levels. This allows the GP to increase its dividends at a rate greater than that of the increase in MLP distributions.

Higher levels of institutional sponsorship may also make the corporate GP shares more attractive. According to Global X Funds, mutual funds and ETFs with more than 25% of their portfolios in MLPs must pay taxes at the fund level, so they prefer to hold shares in the GP instead. The study also notes that GPs may often be attractive acquisition targets for their own MLPs.

Let's compare
A comparison of Oneok to its MLP provides an example. Oneok,, the GP, has a 5-year average yield of 3.30% vs. a tax-advantaged 5.40% for Oneok Partners. But the total return picture is different. Over the past 52 weeks, Oneok, has appreciated by about 68% vs. only 9% for Oneok Partners.

Digging into Oneok Partners' annual report may provide a clue to the difference in market performance. The IDR schedule shows that the GP, Oneok,, is entitled to 50% of the quarterly distributions in excess of $0.4675 per unit. At $2.98 per year, or $0.7450 quarterly, the MLP's distributions are well above this target, so the GP is entitled to the maximum incentive. The GP also has more institutional sponsorship, with 70% of Oneok owned by institutions vs. only 39% for Oneok Partners.

Should Fools rush in?
The buzz around MLPs often ignores the advantages of owning the GP instead. When looking at an energy company like Oneok, you should first know your own objectives. Do you want current income or higher potential for total return? Are you comfortable with the tax complexity of MLPs? If not, the GP might be a better choice. As always, do your homework and check with a tax advisor. 

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