Late last month, Plains All American Pipeline announced that its general partner planned to go public, trading on the New York Stock Exchange under the ticker symbol "PAGP." I wrote earlier this week about why a GP would go public, so today we're going to take a look at why some master limited partnerships do away with their general partners altogether.
MLPs merge with their general partner pretty much for one reason and one reason only, and that is to lower their cost of capital.
In the case of master limited partnerships, cost of capital is not simply the cost of equity averaged with the cost of debt. Instead, it is the weighted average of the cost of limited partner equity, the cost of general partner equity, and the cost of debt. There is a significant difference in the cost of LP equity compared to GP equity, which is why we bother making the distinction.
Think of it this way: Investors who want to purchase limited partner units have a required rate of return that is more or less equal to an MLPs next four quarters of distribution payouts, or the forward yield, and expected distribution growth. That is the cost of limited partner equity.
The general partner, on the other hand, is expecting four quarters of 2% of the MLPs cash flow and the expected growth in incentive distribution right payments, which can balloon up to 50% of the MLPs incremental cash flow.
An MLP with no general partner does not have to worry about generating returns to cover IDRs or the GP's 2% equity stake; it only needs to cover the cost of limited partner equity. This, in turn, gives it a competitive advantage against other MLPs that have general partners when vying for assets and acquisitions.
Hungry no more
Magellan Midstream Partners merged with its general partner in 2009. The following year, there was a rash of MLP/GP mergers as other partnerships followed Magellan's lead, seeking out a lower cost of capital and a simplified organizational structure. Here are the four MLPs that ate their general partners in 2010:
- Enterprise Products Partners (NYSE:EPD) -- November 22
- PVR Resources (UNKNOWN:PVR.DL) -- September 21
- Buckeye Partners (NYSE:BPL) -- June 11
- Inergy (NYSE:CEQP) -- August 9
In addition to the four MLPs listed above, Natural Resource Partners (NYSE:NRP) eliminated its IDRs in 2010, but allowed its general partner to maintain its 2% equity interest in the partnership. The first reason listed in NRP's press release, and all of the press releases for the above mergers, was, in fact, lowering cost of capital and increasing competitiveness.
Many investors like MLPs because of their high yields. When an MLP lowers its cost of capital by eliminating incentive distribution rights, it is able to support a faster distribution growth rate, and that is something every MLP investor should keep in mind.