This article was written in collaboration with two Kinder Morgan executives.
On May 17, 2018, Enbridge announced plans to consolidate their MLP subsidiaries into a single publicly traded entity. Enbridge is one of many companies that has forsaken the MLP structure in favor of the traditional C-corporation structure over the past few years. Among the first to make the move was Kinder Morgan in 2014. We interviewed Kinder Morgan executives who shared how the company has benefitted substantially since making the transition to a corporation. Enbridge and other companies following suit have these benefits to look forward to.
Master Limited Partnerships (MLPs) began in the 1980s and served to make it economically viable for midstream energy companies to develop large infrastructure required for the processing and transportation of oil and gas. In a nutshell, an MLP marries the tax benefits of a partnership with the liquidity of a public company.
However, the attraction seems to be losing steam following a few fundamental changes impacting the overall value prospects of the MLP structure. In addition to Enbridge and Kinder Morgan, we have seen major companies like ONEOK Inc., and Targa Resources Corp. drop their former MLP distinction in favor of the more traditional C-corporation structure.
There are a several key benefits these companies, among many others, stand to reap following the dismissal of their MLP structure:
The MLP structure, for all its benefits, also yields greater complexity. K1 filing and the management of multiple companies are just a couple examples. Kristin Tatum, Vice President at Kinder Morgan explains, “There is always a lot of complexity behind IDRs, K1s, and the overall MLP structure, and complexity isn’t always properly rewarded.” Following the merger, the complexity went away and what was left was a typical C-corp structure everyone understands. Without the MLP complexity, investors could more efficiently assess the company and its operations. A simplified corporate structure also created opportunity for greater flexibility and cost savings associated with managing only one company rather than several individual entities.
There is also a significant decrease in workload without the MLP structure and K1 filings. Consolidating to a C-corp creates the opportunity to right-size the company and redistribute the workload as is best suited.
Many MLPs bear the burden of Incentive Distribution Rights (IDR). This means, as the MLP receives greater payouts, the General Partner receives an increasing percentage of the MLP’s distributable cash flow. Though it is certainly desirable for the MLP to grow, there comes a point where this structure is more restrictive than helpful. David Michels, Chief Financial Officer at Kinder Morgan, explained that 16 years into the life of their MLP, they were already "deep in the splits,” siphoning off nearly half of their overall cashflow back to the General Partner. In Kinder Morgan’s case, though the General Partner never contributed more than its contractual obligation of 2%, the MLP grew to the point that 48% of their cash flow was contractually obligated to the General Partner. Doing away with the IDR structure frees up a significant amount of cash flow and allows greater opportunity and flexibility throughout the enterprise. Additionally, the consolidation of the many companies to one unified C-corp creates a more diversified set of assets, increasing the overall value of the resulting C-corp.
To the average investor, the complicated structure of an MLP paired with the requirements of K1 filings could be enough to sway them away from MLP investments, in favor of the more easily understood C-corp investments. Switching to a C-corp could make a company more attractive to potential investors, as was the case for Kinder Morgan. Kristin Tatum explained that investors were more eager to invest as Kinder Morgan shifted to a C-corp and received a more accurate valuation. Tatum also shared, “News of the shift from MLP to C-corp was received very well by the investment community, and greater value was returned to unit holders relative to what they could have expected in the MLP structure."
A notable draw of investors to an MLP is the idea of receiving increasing quarterly distributions. This being the case, MLPs are forced to devote a primary focus on increasing distributions each quarter to remain attractive to investors. Unfortunately, this can discourage innovative technology investments not yielding immediate and tangible results. For example: investing in a leading technology to improve long-term maintenance workforce efficiency. If long term investments mean significantly reducing distributions in the meantime, investors may not stick around. Transitioning to a C-corp gives companies the option to retain cash for strategic investments since their valuation is not tied to increased distributions.
Although the structure of the MLP has its obvious appeal, it is worth digging deeper to evaluate the possible benefits rewarded to those companies making the switch to C-corporations.
Trenegy helps companies determine whether to move from MLP to C Corporation and create a roadmap for the transition. Find out more about Trenegy’s expertise by contacting us at info@trenegy.com.
