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Take Your Capital and Shove It

By Igor Greenwald on June 28, 2017

It’s an honest mistake but often a painful one for income investors. Buying a stock to generate regular income, we often wrongly assume that regular income is what the stock is there for, because that’s how it looks from our end.

The issuer, on the other hand, sold stock to obtain our capital. It doesn’t matter whether it’s to build an oil pipeline, develop a cancer cure or buy the CEO a third jet. What matters is that for the issuer the distribution is a cost of doing business, not the reason for doing it. At best it’s a transparent profit-sharing arrangement; at worst a marketing gimmick.

Amid the protracted downturn in energy prices some midstream partnerships cut their payouts in order to preserve their credit ratings, and others in order to finance investments.

Sometimes the distaste is mutual. A high yield can indicate that equity investors are no longer willing to provide capital on commercially useful terms. And once that’s the case the issuer can quickly come to see the distribution as useless.

Shipper Navios Maritime Partners (NMM)  cut its payout in 2015 largely because the huge yield was no longer helping it sell equity. More recently Energy Transfer Equity (ETE) has tried to conserve cash by consolidating its affiliated MLPs around the one with the lower yield. It remains to be seen what it will do about investors’ continued reluctance to buy into the restructured Energy Transfer Partners (ETP) at a distribution yield below 11%.

And a punitive yield isn’t the only thing that can sour a sponsor on an investment vehicle. A more attractive source of capital can also do the trick. That’s what happened last week to Rice Midstream Partners (RMP) when sponsor Rice Energy (RICE) sold itself to rival natural gas producer EQT (EQT).

EQT has its own affiliated master limited partnership in EQT Midstream Partners (EQM). And after agreeing to pay $6.7 billion for Rice to become the nation’s largest gas producer it naturally wishes to funnel the bulk of Rice’s midstream assets to its own offspring, EQM. RMP, which expected to buy these assets to support ambitious distribution growth plans, was effectively disowned overnight by its parent’s sellout.

So while RICE shares surged 26% on June 19 in response to the deal with EQT, RMP sank 24% that day. As recently as May, Rice Midstream partners was reiterating plans to increase distributions 20% annually through 2023. Now, despite strong distribution coverage and low leverage, unitholders will be lucky to see any distribution increases.

From the sponsor’s perspective, there is nothing to be gained by these now that the midstream assets once earmarked for RMP can be sold to EQM. Based on the fate of other MLPs recently orphaned when their sponsor was acquired, RMP can expect to be eventually merged with EQM at a price above the current one but below what it fetched before its world turned upside down.

That’s obviously not the expected outcome for Rice Midstream investors. But as the fine print in the annual securities filings of every MLP warns, there is no requirement that management act in the best interest of the public unitholders. Buyer beware.

A current yield approaching 5.7% and the potential for a modest markup in a future cleanup merger still weren’t enough to earn Rice Midstream a spot in the Income Millionaire portfolio following its plunge. Join us to discover better opportunities.

 


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