This MLP Game Changer Is Seeing Its Game Changing

Last year Vanguard Natural Resources (NYSE: VNR) changed its distribution policy and in so doing changed the game for oil and gas producing MLPs. The new monthly distribution policy enabled the company's income-seeking investors to better match their monthly cash outflows with monthly inflows from Vanguard. It was such a unique strategy that the company even trademarked the tag line that the company is "The Monthly Distribution MLP."

It's time alone at the top didn't last long; its industry peer LINN Energy (LINEQ) recently announced that it too was moving to monthly payouts. LINN Energy basically created the oil and gas MLP space when it went public and it has been delivering both income and returns to investors ever since. Last fall while Vanguard was implementing its monthly distribution policy, LINN was busy creating LinnCo (NASDAQ: LNCO) which has really become a game changer for its business model.

In fact, it's changed the space so dramatically that now Vanguard is starting to consider creating one of its own. The company is looking at options to fund an increase in its growth capital budget, and in order to do so it's giving some serious consideration to creating a separate entity. Internally dubbed VanCo, the entity, if chosen, would force the company to change its strategy to start including a lot more growth capital.

The appeal of such an entity, however, is hard to deny. CFO Richard Robert specifically pointed out that the premium that LinnCo is trading at versus LINN is hard not to notice, considering that investors are willing to "leave 100 basis points on the table" to get a 1099 instead of a Schedule K-1. With both LINN and LinnCo now switching to monthly payouts, it's going to make it tougher for Vanguard to compete for investor attention and capital in order to grow.

First, Vanguard must overcome its reluctance to switch strategies. CEO Scott Smith says that "from our perspective it's really a change in strategy that's overcoming that philosophically to have growth CapEx is not something that we've done in the past. And that's what's necessarily to make that structure work." The real question is if a switch in strategy is in investors' best interests.

The other consideration is how necessary a dramatic strategy switch is. When you look at LINN Energy's growth, it went from spending $45 million on growth capex in 2009 to $700 million last year. It has plans to spend over a billion dollars on capital projects this year. Meanwhile, Vanguard's capital budget is just $55 million this year. While it's a much smaller company, this is still a smaller percentage, which is where the strategy change would come into play if it went to a VanCo model. LINN's been a very active acquirer along the way, often picking up assets with embedded growth opportunities.   

Its success has not gone unnoticed by its peers which is why a strategy shift might not be limited to just Vanguard. I'm interested to hear what BreitBurn's (BBEPQ) management has to say when it reports earnings on May 3. The company has already declared its first-quarter distribution so a switch to monthly payouts probably isn't on the table just yet. However, given its ramp-up in growth spending last year, I wouldn't be surprised to hear mention of a possible BreitCo.

Like its peers, BreitBurn has been a very active acquirer with $950 million of acquisitions closed the past 20 months. Further, the company expects to spend another $500 million this year to go along with a capital budget of $260 million this year. The company's 2012 capital budget began at just $68 million but was increased to $152 million before the year ended. With cost of capital being so critical to growth, if might make sense at some point BreitBurn to also pursue the LinnCo model.

The oil and gas MLP space should be a rather boring model where acquisitions of mature oil and gas assets slowly drive distribution growth. However, LINN Energy changed the game when it decided it could just as easily grow it distribution organically. Now, it's peers are looking to change their game in order to keep up. LINN is still well ahead of the game as it continues to be the trailblazer, even if wasn't the first to issue monthly distributions.