continues from part 1 here…
Previously, we looked at the balance sheet effects of sponsoring an MLP or REIT. Here we’ll look at how debt can be manipulated by the parent company.
To ensure creditworthiness of the MLP, which it needs in order to issue meaningful debt (which can be funnelled back to the parent), the parent has to guarantee its fiscal performance. This guarantee usually amounts to issuing letters of credit or guaranteeing debt repayment. Most companies of a certain size have revolving credit lines from which they can access debt. Usually the subsidiaries have access to this revolver as well. Now, the bank sponsoring the revolver will need additional criteria to be fulfilled for the newcomer to qualify. These criteria are where debt guarantees come from.
Worse, since its just a guarantee, the parent is not obliged to include this on its balance sheet. Its not uncommon to find a dismissive,” We guarantee X portion of MLP’s debt. Management believes such a payment will never be called upon” buried within the footnotes. It’ll never be called upon until the shit hits the fan that is. Of course, this is assuming that the parent even recognizes the MLP as a subsidiary. Since it owns the MLP indirectly through a minority stake, the parent technically doesn’t have to disclose its obligations to the MLP or even mention it at all (mention the MLP that is; not merely the obligations). EITF 04-05 does go a long way in forcing companies to report the earnings of the indirectly held MLPs on their balance sheet but this can be circumvented as well by re-wording the agreements of the limited partners, so its in a twilight zone.
As an example, lets look at the financial statements of Williams Companies (Williams) and Williams Partners L.P (L.P), the MLP sponsored by Williams. Williams is an energy infrastructure company with enough complexity to make middle east politics seem like kindergarten. To simplify, lets just call Williams’ business “pipelines”. They deliver natural gas and get paid a rate, deliver some to themselves and further process it into ethanol etc and sell it and get paid. Justforkix they also have derivatives on the balance sheet which is perfect for frightening us into discovering the meaning of fear.
Below is a typical illustration of a “drop” of assets into the MLP and cash being raised for the parent:
In February 2014, we agreed to acquire certain of Williams’ Canadian operations, including an oil sands offgas processing plant near Fort McMurray, Alberta, an NGL/olefin fractionation facility and B/B Splitter at Redwater, Alberta and the Boreal pipeline. The transaction is expected to close in February 2014. We expect to fund the transaction with $25 million of cash, the issuance of 25,577,521 Class D limited-partner units, and an increase in the capital account of our general partner to allow it to maintain its 2 percent general partner interest. In lieu of cash distributions, the Class D units will receive quarterly distributions of additional paid-in-kind Class D units, all of which will be convertible to common units at a future date. The agreement also provides that we can issue additional Class D units to Williams on a quarterly basis through 2015 for up to a total of $200 million in cash for the purpose of funding certain facility expansions.
In English: Williams dropped some Canadian assets into the MLP. To pay for this, the MLP issued Class D units (the junk bond equivalent of equity I presume) plus $25MM in cash and also made sure the general partner got their cut of the new assets by maintaining their 2%. Now who is the general partner? From the 10-K of Williams:
Our interstate gas pipelines, domestic midstream, and domestic olefins production interests are largely held through our significant investment in Williams Partners L.P. (WPZ), one of the largest energy master limited partnerships. As of December 31, 2013, we own the general partner interest and a 62 percent limited-partner interest in WPZ.
The MLP will now pay dividends back to Williams or in the case of these Class D units, pay equivalent Class D units which can later be converted to regular units which get paid cash. Now Williams, thanks to its holding structure seems reports 2 separate financial statements. There’s a consolidated one which can be found in its usual place and discloses the numbers for all consolidated operations and another one appended to the end of the filing which are numbers only for the parent, i.e Williams. In Note 1 to the “parent” statements we find the following:
In addition to the guarantees disclosed in the accompanying consolidated financial statements in Item 8, we have financially guaranteed the performance of certain consolidated subsidiaries. The duration of these guarantees varies and we estimate the maximum undiscounted potential future payment obligation related to these guarantees as of December 31, 2013, is approximately $3.8 billion.
So a company earning $628MM a year has over $3.8B in debt guarantees. Are these on the balance sheet? Hell, no. There’s a good possibility that these subsidiaries mentioned are not the MLP but its impossible to find out from this report. Its far safer to assume it does. These guarantees come in the form of purchase obligations and debt repayment covenants and are a very real risk.
Lastly, as a further deterrent to investing in an MLP, witness the below from the 10-K of the MLP. This is pasted word for word from the business risks section:
Williams controls our general partner, which has sole responsibility for conducting our business and managing our operations. Our general partner has limited fiduciary duties, and it and its affiliates may have conflicts of interest with us and our unitholders, and our general partner and its affiliates may favor their interests to the detriment of our unitholders.
In English: We cannot listen to our own management.
Our partnership agreement limits our general partner’s fiduciary duties to unitholders and restricts the remedies available to such unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.
In English: If the managers screw you over, you have limited legal recourse.
Even if unitholders are dissatisfied, they have little ability to remove our general partner without its consent.
The very spirit of buying shares/equity in a business is that once I buy it, I own a piece of the business and the CEO works for me. Here we see an MLP which issues its own shares (units) but is beholden to its parent and is merely using investors to fund the parent’s cash flow. Theoretically, such a shitty deal should be compensated by an additional payment of some sort to unitholders, some benefit. Theoretically this is what the distribution of profits and high dividend payments aim to accomplish. However, due to high dividends, investors stupidly place a premium on the unit price! So any benefit you ought to receive evaporates when you buy the unit.
All of this is over and above the fact that the units are subject to intense commodity speculation which have their own rhythms. All in all, MLPs are a rubbish investment which provide short term income but a long term headache. The sad part is its mostly retirees on a fixed income who buy these things thanks to the “income producing” nature of these securities. I’m not a big fan of excessive regulation in the markets and believe that they ought to be free as this ensures maximum transparency. MLP’s, however, should not be marketed as common stock and a retail investor should not have free access to these things.
Even if access is granted, there should be some way to inform the investor of all of the above. Greed always wins though and I wonder if anyone will take the time to be prudent instead of staring at the dollar signs before them. Preposterous!
All I Write About 