Debt Is Out, Equity Is In
With final passage of the tax bill, Congress gave MLP investors just about everything we wanted.
But there is one potentially thorny issue relating to the deductibility of interest.
One of the big philosophical changes underpinning tax reform is that the law now favors equity over debt. As a society, that’s probably a healthier approach to capital formation.
The problem is that capital-intensive companies such as MLPs have relied heavily on debt to finance future growth. It will take time for the industry to change.
The good news is that Congress managed to find some middle ground.
The House proposal limited the interest deduction at 30% of EBITDA (earnings before interest, taxation, depreciation, and amortization), while the Senate proposal capped it at 30% of EBIT (earnings before interest and taxation).
The latter is obviously a far more restrictive standard, especially for pipeline companies that typically have huge noncash depreciation expenses.
The final bill uses EBITDA as the metric for the first four years, then EBIT after that.
I reviewed the MLP universe by comparing trailing 12-month EBITDA to trailing 12-month interest expense. Most MLPs fall below the 30% threshold. The sector averages around 28%.
But EBIT would obviously be a different story.
In digging through the text of the tax bill, it looks like there is an exception granted for gas transmission pipelines. But that’s the only midstream infrastructure specifically referenced.
Still, a special carve-out for MLPs could be subsequently added via a tax extenders bill.
That’s not a great solution—extenders are technically temporary, though many get renewed year after year.
EPD’s Dividend Booster
While preparing the most recent issue of Utility Forecaster, I discovered a noteworthy benefit of investing directly with Enterprise Products Partners LP (NYSE: EPD). So I thought I’d share it with you.
These days, most income investors ignore dividend reinvestment plans (DRIPs) because brokers will reinvest their dividends for free.
But some DRIPs still offer an advantage over even the lowest of the low-cost brokers.
EPD is one of them. The MLP’s DRIP does not charge fees for buying new shares or reinvesting the distribution.
And while most DRIPs no longer offer incentives such as discounts on reinvestments, EPD still does.
The MLP’s plan allows it to set the discount up to 5%, which is where it was until recently.
However, EPD recently lowered the discount to 2.5%.
Even so, that’s still more generous than most DRIPs. And EPD could always increase it back to 5% when market conditions are more favorable.
The discount may not seem like all that much, but think of it as an enhancement of an already-high yield.
Further, the compounding effect of all the discounted reinvestments over time is probably pretty meaningful.
Anyway, I think this is a good deal. The only catch is that you need to already own at least one share of EPD to qualify for its DRIP.
Now there’s another reason to add it to your portfolio. EPD remains a Buy.
From Two Tenants to One
In other news, Gaming and Leisure Properties’ (NYSE: GLPI) two main tenants finally made a deal.
Penn National Gaming Inc. (NSDQ: PENN) agreed to acquire Pinnacle Entertainment Inc. (NSDQ: PNK) in a cash-and-stock deal worth $5.7 billion including the assumption of debt.
Pinnacle shareholders will receive $20 in cash plus 0.42 shares of Penn stock for each share held.
The terms imply a total deal price of $32.47 as of the time of the announcement, or a 36% premium prior to when speculation about a merger first circulated.
One of our concerns about the deal had been that Penn already has significant leverage, and an acquisition could boost leverage in the near term.
The good news is that Penn plans to complete a series of divestitures to help fund the deal.
The company has agreed to sell four gaming operations to Boyd Gaming Corp. for $575 million in cash. Boyd will enter into a separate lease with GLPI for these properties.
And Penn has also agreed to monetize two properties by selling them to GLPI for $315 million in cash. In exchange, GLPI will get a nice rent increase on the properties based on current market conditions, to the tune of $13.9 million.
Further, Penn anticipates realizing $100 million in synergies within two years of the deal’s close.
The net result of all these transactions is that Penn’s pro-forma leverage is expected to tick-up to 5.4 times from 5.3 times.
Since GLPI essentially has one primary tenant now, we’re glad Penn didn’t blow out its balance sheet on this deal. GLPI remains a Buy.