MLP Basics

[dan_s]

Since we have started covering MLP's and Vanguard Natural Resources (VNR) is speaking at our luncheon on Friday, I will be presenting the "Basics of Investing in Master Limited Partnerships" before I introduce VNR. Below is a preview. - Dan
----------------------------------------------------------------------------------------------------------------
Master limited partnership (MLP) is a limited partnership that is publicly traded on a securities exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities.

Master Limited Partnerships are limited by US Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation. Some real estate enterprises may also qualify as MLPs.

Some private equity management companies such as Blackstone Group (NYSE: BX) and Fortress Investment Group (NYSE: FIG) are structured as MLPs.

In practice, MLPs pay their investors through quarterly required distributions (QRD), the amount of which is stated in the contract between the limited partners (the investors) and the general partner (the managers). Failure to pay the QRD may constitute an event of default.

Because of such stringent provisions on MLPs, and the nature of the QRD, the vast majority of MLPs are pipeline businesses, which earn very stable income from the transport of oil, gasoline or natural gas.

Because MLPs are a partnership, they avoid the corporate income tax, on both a state and federal basis. Additionally, the limited partner (investor) may also record a pro-rated share of the MLP's depreciation on his or her own tax forms to reduce liability. This is the primary benefit of MLPs and gives MLPs relatively cheap funding costs.

However, this makes MLPs unattractive to tax-deferred funds, who must lose this tax saving advantage. To encourage tax-deferred investors, many MLPs set up corporation holding companies of LP claims which can issue common equity.

An example is the pipeline company Kinder Morgan Energy Partners. The main corporation, Knight, Inc. (formerly traded on the NYSE as KMI), is the operator of the pipelines and other assets. However, the pipelines themselves are owned by the MLP Kinder Morgan Energy Partners, L.P. (NYSE:KMP). Finally, part of KMP's limited partner interests are held by the corporation Kinder Morgan Management LLC (NYSE:KMR) which allows tax-deferred investors to participate in KMP's operations.

Usually, in the MLP structure, the general partner starts with a small (usually 2%) stake in the company but is given incentive distributions from net income after the QRD. Since these distributions are usually paid in the form of increased equity claims, over time, this allows the general partner to attain higher and higher percentage of ownership in the company.

In May of 2010, the first ever MLP mutual fund was launched, with a stated goal of providing "a high level of inflation-protected income currently through a 7.8 percent distribution yield, which is higher than equity alternatives such as REITs and Utilities." The fund is a part of the SteelPath Mutual Fund Family. [1]

[denegrem]

How can MLPs Pay out Higher Dividends than their earnings?

http://finance.yahoo.com/news/How-Can-M ... l?x=0&.v=1

[dan_s]

MLP's do not pay "Dividends". Each quarter they make a cash "Distribution" to their unit holders of the cash reserves they deem to be in excess of their needs.

For MLP's the important thing is Distributable Cash Flow ("DCF") not earnings. In fact, you really want low earnings to reduce current taxes.

Dan

PS: As I have preached here for years, cash flow per share is much more important than earnings per share. Cash flow pays the bills, not GAAP earnings. My "Fair Value" estimates for this group are based primarily on my cash flow per share forecasts plus, of course, development and exploration potential.