The continued lack of liquidity in the MLP market has buyers and sellers stymied for choice, according to investment bankers at the recent Midstream Gas Assets A&D Summit in Houston.
“The big change in the [midstream] MLP market this year is the perspective of the buyers. They are asking themselves, can I sell this into an MLP and start again? And if I do, can I compete for assets?” said Rob Pacha, managing director for Merrill Lynch & Co.
Raymond Strong, managing director for Goldman Sachs & Co., agreed, adding that the credit markets are “horrendous” for financing right now, and are more challenging than most energy chief executives are aware. Meanwhile, the MLPs are finding themselves chasing fewer assets.
“There is such a lack of liquidity in the market that holders of MLP units have to sell one to buy another,” said Brian McCabe, managing director for Morgan Stanley.
Acquisition options and capital resources for MLPs are drying up, said Abhay Pande, managing director for Citigroup. But it’s due to technical factors, such as credit-crunch-caused illiquidity stalling buyers, rather than assets and the underlying fundamentals of the energy business, which are good. Pande tempered his remarks by noting “bankers are often wrong, but never in doubt.”
“The underlying MLP fundamentals are still quite good,” said Timothy Watson, managing director for CIBC World Markets, “which shows just how delicate the psychology of the M&A market is. MLPs are still tax efficient, and Congress is not likely to change that.”
Investors will probably see fewer M&A deals in the sector, as opposed to a further drop in multiples, said McCabe. Sellers aren’t coming to market due to high commodity prices.
This may not be a good thing. Organic growth prospects sound good, said Pande, until there are cost overruns. However, “when you buy it, you know what you are getting.”
There is a large variance in yield from one MLP to the next, the bankers said. In some cases, it can be as much as 300 basis points, and some expect even more variance in 2008.
“Institutional funds in 2006 and 2007 compressed some yields,” Pacha said. “That’s because institutions look at the market different than the retail investors. High growth and lower yield is good for institutional investors.”
Some assets that could come into the MLP A&D market, Pacha said, may come from small gas-processing and -gathering entities, pipeline companies that will convert from gas to crude transportation, and gas-storage entities.
Sellers could be motivated by private-equity harvesting investments, said Watson. Other reasons include corporations selling noncore assets, consolidations, restructurings (such as by Anadarko Petroleum and Provident Energy Trust), politics (such as that affecting Citgo Petroleum), and storage facilities that could be sold then leased back.
Regarding midstream MLP hedging, Pacha said, “dirty hedges” of gas liquids to crude will be less prevalent. Natural gas liquids “can’t keep up with crude prices, so those hedges will become shorter term.”
As a group, the bankers agreed that IDR (incentive distribution rights) MLP structures, in circumstances with subordinated units, are still appropriate, concurring that “the model is not broken.”