Sunset for the MLP Structure?
Income-generating assets have had a challenging time since the pandemic began. Popular income vehicles like real estate investment trusts (REITs) and master limited partnerships (MLPs) have been especially hard-hit. Shut-down orders impacted the ability of tenants to pay rents, which hurt REITs. The plunge in energy prices negatively impacted MLPs, because the majority are pipeline MLPs.
MLPs Take a Hit
Until the oil price crash of 2014, MLPs had long been favored for their above average yields and stable returns. Many MLPs yielded 6%-8% and steadily grew those distributions year after year.
Midstream MLPs are typically viewed as toll collectors for oil and gas producers that use their pipelines. Their cash flows are protected by long-term, take-or-pay agreements. As such, their fortunes aren’t as subject to the ups and downs of oil and gas prices. But the oil price crash was so deep that it ultimately clobbered MLPs as well. That shook investor confidence in MLPs.
More events would follow that would decrease the attraction of the MLP structure versus a corporate structure.
In 2017, President Trump signed a tax reform bill that dropped the corporate income tax rate from 35% to 21%. This is great for corporations, but it significantly reduced the key tax advantage an MLP held over a corporation. This move made MLPs a less attractive option than they had been, because there is additional complexity in tax filing for MLP investors.
Second, a ruling by the Federal Energy Regulatory Commission (FERC) to reverse a longstanding policy on MLP tax costs for interstate pipelines drove up the cost of business for some companies. Several MLPs were significantly hurt by the FERC ruling, again reducing one of the advantages they held over a comparable corporation.
Finally, many MLPs pay incentive distribution rights (IDRs) to their sponsors. Elimination of IDRs has been cited as another incentive driving some MLPs to convert to corporations, because these IDRs can be a drag on growth after a while.
These factors combined to shrink the pool of MLPs as many converted to corporations. That in turn resulted in institutional capital exiting MLPs, which has created net selling pressure on the sector.
Many of the remaining MLPs have publicly discussed the possibility of converting. There is plenty of evidence that the market is now favoring a corporate structure over the MLP structure.
A Case Study
Brookfield Infrastructure Partners LP (NYSE: BIP) provides an instructive example. Last September, this MLP announced that it was going to spin off a new class of shares based on a corporate structure. The details, from the press release announcing the creation of the shares, explained the motivation:
“The class A shares will be structured with the intention of being economically equivalent to units of BIP, including identical distributions. The class A shares are intended to allow investors the ability to own the equivalent economic exposure to BIP, including identical distributions, through a traditional corporate structure.
The benefits of the creation of BIPC will be:
- Potential enhanced demand from U.S. retail investors due to more favorable tax attributes,
- Potential increased demand from institutional investors who are currently unable, or prefer not to, own partnership units, and
- The ability to qualify for further index inclusion, which is not available today.”
As a BIP unit-holder, this spin-off was of particular interest to me. Note that the reason for the spin-off is purely to create more demand for the shares over the MLP units, which are otherwise identical in every way.
I watched with interest as my new BIPC shares handily outperformed the BIP units. In fact, BIPC outperformed BIP nearly from the start:
Keep in mind that the company underlying these two symbols is exactly the same. The only difference is higher demand for shares over MLP units.
If you hold an MLP, probably the best thing that can happen is a conversion to a corporation. Even though MLPs do still have some tax advantages over corporations, at this point the market is punishing the MLP structure. There is a compelling case to be made for converting, because it will unlock shareholder value by increasing the demand pool for shares.
I have had my doubts as to whether this was the right course of action, but the BIP/BIPC example is compelling.
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