Many times we think the most important information to glean from quarterly conference calls relates to very specific details about a company’s operations. However, in the topsy-turvy world of energy, conference calls are increasingly providing details on business models and macroeconomic trends that make these group chats a can’t-miss quarterly tradition.
The most recent call at Plains All American Pipeline (NYSE:PAA) is a perfect example, and today we’ll look at what CEO Greg Armstrong had to say about an issue unique to the master limited partnership structure: incentive distribution rights.
Incentive distribution rights, or IDRs, are essentially bonus payments that an MLP issues to its general partner once it hits previously agreed upon performance standards. If, as in the case of Enterprise Products Partners (NYSE:EPD), your MLP doesn't have a GP, then this issue doesn't apply. But in almost all other cases, IDRs increase the cost of capital for MLPs. The IDRs represent that much less money to pay out to investors or retain internally for growth, which is why Enterprise got rid of its GP in the first place.
Some MLPs have a publicly traded general partner. In the case of Kinder Morgan Energy Partners (NYSE: KMP), it's Kinder Morgan (NYSE:KMI), which gives investors a vehicle to cash in on IDRs, oblique though it may be. Others have privately held GPs, as is the case at Plains All American. And because it's private, we don’t get the same insight that we would at Kinder Morgan. Or at least we didn’t before Plains’ fourth-quarter conference call.
On last week’s call, an analyst asked a question regarding the IDR plan in regard to Plains' 2011 acquisition of BP’s Canadian NGL assets. Armstrong took the opportunity to enlighten us all about how IDRs can affect the day-to-day business at MLPs:
As far as what we have always said and would continue to reiterate, our general partners understand the value and the burdens of the IDR and have shown that they'll be very flexible to accommodate larger transactions. Clearly, the IDR burden increases our cost of capital. That's really not an issue at all with respect to organic growth, because there's a huge spread between our returns on our projects and our current cost of capital, even including the GP IDR. But where it really challenges you is on the initial transaction, big transactions. Because acquisition transactions, typically you're having to pay a higher multiple. And it takes time to feather in the synergies or have the commercial benefits that you're forecasting.
Right here we see that size does matter, and GPs do us all a favor by deferring IDR payments in the wake of large acquisitions. Equally important from an investing standpoint, Armstrong continues to elaborate on how things shake out at Plains:
I think it's fair to say that our general partner has steadfastly said they'll support the growth and make whatever appropriate modifications that's been requested of management. I think the longest it has taken us to get approval for an IDR reduction is like 48 hours, when we've got a transaction that's in front of them. So I think what you should walk away from here is that PAA's general partner's going to be very flexible and supportive.
The idea that GPs will be supportive of a temporary reduction in IDRs is not unique to Plains, but it's important to hear nonetheless, especially for unitholders.
Case in point
We can look to the most recent deal over at Kinder Morgan Energy Partners to get an idea of what IDR deferral looks like with a big transaction. When KMP announced its desire to purchase Copano Energy (NASDAQ: CPNO) for $5 billion, KMI announced that it would waive IDRs on a sliding scale over the next few years. It will forgo $120 million in payments in 2014 and 2015 and $110 million in 2016, with a reduction of $5 million per year every year after that.
Again, we see Armstrong’s point about IDRs and big acquisitions hammered home. We all know how it works now, and that knowledge gives us one more thing to pay attention to and evaluate when acquisitions are announced.
Many conference calls come at inconvenient times -- we have lives, after all -- but the transcripts are almost always available online 24 hours later, and investors should make a point of checking them out. The Q&A at the end is especially valuable.