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Energy sector MLPs are eyeing up their partners

For investors, master limited partnerships (MLPs) are a tried and tested means of gaining exposure to oil and gas dividends. MLPs offer the best of two worlds: They are publicly traded like a stock but structured like a tax-efficient limited partnership, of the kind favored by private equity for their investment funds.

MLPs hold the interests of limited partners (LPs) that participate in the upside from these investments, predominantly in pipeline infrastructure assets as they yield predictable income. LPs put up the money and take the majority of the returns, while a general partner (GP) company takes a share of the spoils for its hard work selecting the best assets in which to invest.

What are the pros and cons of this MLP strategy?

1/ Survival is always the ultimate motivator  

While formerly operating as separate investable entities, MLPs began a wave of restructuring in recent years as a matter of survival. MLPs needed to fix their broken balance sheets and restructuring was an obvious choice. This is because of the GP’s hefty incentive distribution rights (IDR)—essentially their cut off the top for their investment management services.

The problem is this IDR split had become unworkable, with the GP taking upwards of 40% of distributable cash flows from the MLP. For this reason, MLPs sought to merge with their GPs. Not only did this improve the dividend yields for MLPs, it also reduced their cost of capital.

2/ It may have been a matter of “right place, right time” for these mergers

With the oil price having rebounded and dividends on the rise, now may be the time for more MLP-GP mergers. Earlier this year, Chevron kicked off proceedings with its US$1.32 billion purchase of Noble Midstream Partners at a 7.8x multiple of the LP's 2020 earnings.

More recent examples include Philips 66's US$3.48 billion merger with Phillips 66 Partners last month, a deal that has been on the cards for years. The transaction went ahead at a 23.2x multiple of Phillips 66 Partners' 2020 EBITDA. Also last month, Crestwood acquired Oasis Midstream Partners in a US$1.85 billion deal that equated to a 15.5x multiple of Oasis' 2020 EBITDA.

3/ Valuations and quantities of cash will determine future mergers 

The question now is, who's next? That has a lot to do with the current valuations of LPs and how much cash their GPs have at their disposal.

Recent analysis by Mergermarket found that LPs currently have a median enterprise value of US$7.2 billion, whereas their parent companies have median cash on hand of US$1.5 billion and liquidity of US$3.3 billion, a clear mismatch. These deals will not work for everyone, but don’t be surprised if companies in the sector keep considering their MLP options.

The best potential oil & gas merger options based on current valuation