Take the money and run. "It's the first item on my list of bad reasons to form an MLP (master limited partnership). MLPs are the flavor of the month, but about half of them are formed for the wrong reasons," John Walker, president and chief executive of EnerVest Management Partners Ltd., told IPAA and Tipro members in Houston recently.
Walker is also chairman of EV Management LLC, the general partner of EV Energy Partners LP, an MLP.
"MLPs are one of the exciting things going on in the business. But I see instances where financial sponsors go out and buy assets when they see MLPs trading at 10 to 20 times cash flow. They want to get them to market. The temptation is to put debt on the entity, and then they move on, as in 'take the money and run,'" he said.
"These are not long-term players. The end game is not about putting an MLP in place, it's about where that MLP is going to be in 10 to 20 years. Sometimes it's a matter of whether the management team has enough experience in acquiring assets for the long run."
The second bad reason is using MLPs as arbitrage, such as trying to figure out how to monetize assets. "What worked a year ago may not work today. This is a very short-term outlook."
The third is to form an MLP to justify overpaying for assets. "E&P companies are selling at 4.0 to 6.0 times cash flow, while MLPs sell at 10 to 20 times cash flow. But bad acquisitions will eventually lead to poor distributions," he said.
A fourth is an MLP spin-off from a larger company. "We're seeing a lot of that. The investment-banking community is at fault here." Investment bankers go to E&P companies and ask, "What do you have that we can make money out of?"
"This is not a long-term strategy," Walker said. "It's just spending money on separate entities that may have to be rolled back up, or sold."
The fifth is forming an MLP with inappropriate assets, such as assets with too much drilling required, that are short-lived, or are too capital-intensive. "If you are using 70% to 80% of cash flow in drilling, how do you make or grow distributions?"
An MLP should drill to maintain the production curve, but too much drilling, thus too much debt, is not good, he said. An MLP should hold back a distribution cushion of about 22%, and drilling costs should be about 50% of maintenance capital. "If you ever cut a distribution, you are in the penalty box forever. The only way to properly grow an MLP is through accretive acquisitions."
When asked if he is concerned that Congress may follow Canada's lead and tax MLP distributions, Walker said, "I'm concerned about everything having to do with Washington. But will there be 60-plus votes to support it in the Senate? I don't think so."
As many as 20, or more, new MLPs are in the works, according to Walker.
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