| HOUSTON/NEW YORK, April 6
HOUSTON/NEW YORK, April 6 High-yielding energy
partnerships have lured billions in capital from investors in
the past few years and the returns have often matched or beaten
But as riskier kinds of businesses adopt the Master Limited
Partnership (MLP) structure, and as interest rates rise,
investors are getting a wake-up call about some of the scary
stuff lurking in the sector.
One of the little-noticed problems is that the partnerships
have almost none of the shareholder protections that regular
companies offer - meaning that if something goes wrong investors
have little power if they want to change management or the
board, and also have little recourse to legal action.
The MLP world has grown dramatically over the past ten
years, surging from investments of just $2 billion in 1994 to
$445 billion now, according to Wells Fargo. In some businesses
they are big players - for example more than 10 percent of U.S.
oil and gas pipelines are owned by MLPs.
Cash-generating energy infrastructure companies form the
partnerships, which are listed on U.S. stock exchanges, because
the structures are not taxed at the federal level, lowering
their cost of capital.
Investors, or unitholders, like them because they mostly
provide higher payouts than dividend-paying companies, and the
returns have been beating yields available on Treasuries and
most corporate bonds.
But unlike publicly traded corporations, the partnerships
lack rigorous governance standards. They have few directors who
are independent of the controlling shareholders and top
executives and there are often no votes on executive pay,
dilutive stock sales, or sometimes even mergers. General
partners, who control limited partners, hold the power. That
means minority investors have little chance to make their voices
"If you are an investor who wants to be able to vote for the
members of the board and wants to vote on shareholder proposals,
then you shouldn't own an MLP whose general partner is
controlled by a sponsor," said John Goodgame, an attorney with
Akin Gump Strauss Hauer & Feld who advises on MLP transactions.
"You're not going to have any say in governance."
Filing lawsuits also may not help. A review by the law firm
Latham & Watkins of 10 big MLP disputes showed courts usually
sided against minorities, with judges ruling that partnership
agreements gave broad protections to general partners.
That wouldn't be so bad if the risks in the sector weren't
increasing. A range of businesses - including ones that lack the
predictable cash flow of pipeline companies - are now adopting
the structure, and they are often far from simple entities to
SAND AND CEMETERIES
MLP investors say the sector has gotten so complex that less
sophisticated mom and pop investors should take a pass.
Up to 80 percent of MLP buyers are individuals, according to
the National Association of Publicly Traded Partnerships, though
hedge funds and institutions increasingly buy them.
"The average MLP is riskier than an MLP was 5 or 10 years
ago, the spectrum of risk from high to low is a lot wider than
it was 10 years ago," said Quinn Kiley, a managing director at
Advisory Research Inc, the ninth-largest MLP investor.
The partnerships have expanded to include refining assets, a
company that manufactures sand used in hydraulic fracturing, as
well as exploration and production assets that do not have the
same guaranteed cash flow as pipelines.
Even StoneMor Partners LP, a company that owns and
operates cemeteries and funeral homes, is an MLP although it
formed years before the recent surge.
MLPs are controlled by general partners who own as little as
two percent of the partnership and can take home as much as 50
percent of the partnership's distributions. Limited partners,
who provide capital and have the bulk of ownership, have little
or no say in operations.
Because of the "unique attributes" of limited partnerships,
the New York Stock Exchange does not require them to have a
majority of independent directors, a corporate governance or
nominating committee, or a compensation committee composed of
Still, there are exceptions. Magellan Midstream Partners LP
allows unitholders to vote on its directors and the
general partner of Enterprise Products Partners LP has a
majority of outside directors on its board.
While the payout structure of MLPs is in place to align the
economic interests of general and limited partners, analysts and
investors say those can diverge.
"A GP can have debt and need distributions to service that
debt, or have other assets that become challenged. That's not
necessarily in alignment with the limited partners' interest,"
said Gretchen French of Moody's Investors Service.
Some have questioned structures like those of pipeline
company Kinder Morgan, under which general partner Kinder Morgan
Inc controls several master limited partnerships.
Kinder Morgan bought the assets that became El Paso Pipeline
Partners in May 2012. But El Paso has recently
underperformed its sister partnership, Kinder Morgan Energy
Partners LP. Over the past 6 months, El Paso shares have
dropped more than 25 percent, compared with a 4 percent drop at
RATE INCREASES AND RETURNS
Overall, MLPs have generated strong returns. The Alerian MLP
Index, which includes 50 partnerships, has delivered a
yield of nearly 6 percent over the last decade, well above the
Barclays US Aggregate Total Return Bond index yield of 2.5
percent and a 2 percent yield for the Standard & Poor's 500 as
of the end of last year.
Units have also outperformed stocks. In the last five years,
the Alerian MLP index climbed 138 percent, compared with an 86
percent gain in the S&P 500.
But rising interest rates may reduce the appeal of MLPs.
If rates do climb, investors may prefer U.S. treasury bills
with similar yields to MLPs "because an MLP is in general
estimation riskier than a T-bill," said Akin Gump's Goodgame.
Even supposedly safe investments like pipelines and storage
facilities have had their problems. Boardwalk Pipeline Partners
, a $3.3 billion midstream partnership controlled by
Loews Corp slashed its distribution nearly 80 percent this
February on weakening cash flows and a heavy debt load.
The move sent its units down over 40 percent.
"In the 7 or 8 years that we've been doing this, I don't
think we've misjudged a management team as badly as we've
misjudged this one, or what we thought was probably a pretty
good general partner," said Dan Tutcher, a principal at Center
Coast Capital Advisors and former president of Enbridge Energy
Boardwalk did not respond to requests for comment.
(Reporting by Anna Driver and Michael Erman; Editing by Terry
Wade, Dan Wilchins and Martin Howell)