Are Buybacks Becoming Mainstream for Midstream?
When you hear MLPs and buybacks, chances are that you don’t think of dynamic combinations like peanut butter and jelly or Hall and Oates. For some, the mere thought of MLPs may conjure up memories of repeated equity issuances – the exact opposite of buybacks. When I hear the word “buybacks” in relation to MLPs, my first thought is of refiners dropping down assets to their MLPs and using cash proceeds from the drop downs to fund repurchases of the C-Corp stock, for example Marathon Petroleum Corporation (MPC) and MPLX (MPLX). In this case, the parent is using cash it receives from the MLP to repurchase C-Corp stock for the benefit of the C-Corp shareholders. The MLP unitholders receive no direct benefit from the parent repurchasing its C-Corp shares.
While C-Corp buybacks can take place for MLP parents, there can also be buybacks or unit purchase programs for MLP units themselves, which can be beneficial to investors. First, the purchase of units in the market supports the unit price by increasing demand for the units. Secondly, true buybacks lower the number of units outstanding, which means the cash available for distribution will be divided among fewer units, potentially supporting future increases in distributions per unit. Third, fewer LP units means a lower 2% general partner and IDR cash burden for the underlying MLP, thereby (slightly) reducing the cost of equity. In recent months, MLPs have become much more outspoken about buybacks, whether that’s formally announcing a common unit repurchase program or indicating that a buyback program could be on the table in the future. Simply put, buybacks are starting to become mainstream in the midstream and MLP space.
Parents Buying LP Units as an Investment (Technically Not a Buyback)
Over the years, there have been examples of parent companies buying LP units as an investment opportunity. By increasing its stake in the LP units, the parent enjoys all the traditional benefits of unit ownership, including distributions. To be clear, the purchase of LP units by the parent does not decrease the overall unit count for the MLP, and this is not technically a buyback. However, these purchases do lend price support to the LP units and show management’s confidence in the value proposition of the underlying MLP. In August 2015, general partner Golar LNG Limited (GLNG) announced approval of a program to purchase up to $25 million units of Golar LNG Partners (GMLP) over a 12-month period citing GMLP’s 11% yield at the time and the attractiveness of the investment opportunity. The private parent company of Summit Midstream Partners (SMLP) approved a program to acquire up to $100 million of SMLP units in December 2015. Refiner Delek US (DK) approved the purchase of up to $30 million units of Delek Logistics Partners (DKL) in November 2016. The extent to which parents used their authorizations varied. GLNG purchased $5 million GMLP units (20% of the approved amount), while practically all of the $100 million authorization for SMLP purchases had been used by the end of June 2016. Management indicated on DKL’s second quarter 2017 earnings call in July that Delek had exercised approximately half of its $30 million authorization.
MLP Buybacks Then
In the past, MLPs have bought back their own units in a unitholder-friendly move that decreases the number of common units outstanding – a traditional buyback. There are multiple examples from 2015, including a $50 million repurchase authorization for SunCoke Energy Partners (SXCP) announced in July 2015 and a $45 million repurchase program for NGL Energy Partners (NGL) announced in September 2015. A few months after GLNG announced plans to purchase GMLP units, GMLP announced in December 2015 that the partnership itself had been authorized to buy up to $25 million of its outstanding common units. Ultimately, SXCP bought back $12.8 million in units (all in 2015), using 26% of its authorization, and NGL bought back $17.7 million in units, using 39% of its authorization. A year after the authorization was announced, GMLP had bought back $6.5 million in units.
Were Unit Purchases and Buybacks Successful?
In general, the oversimplified answer is yes – based on the programs announced in 2015 listed above (excludes DK/DKL given its recency) and comparing the prices paid to the unit price today. Across the board, unit prices are higher today compared to the average price paid by the parent or by the MLP for units. Looking at the parents’ unit purchase programs, parents benefitted from both price appreciation and the distributions paid since the units were acquired. GLNG has seen a total return of nearly 25% on the GMLP units it purchased in August and September 2015. The SMLP units that were purchased by the sponsor have generated a total return of approximately 45%.
Looking at the true buybacks by MLPs, unit prices have also appreciated relative to the prices paid. GMLP’s unit price is up approximately 75% from the price GMLP paid for the units. SXCP units today are trading 20% higher than what SXCP paid for the units. Not all buybacks result in double-digit “returns” – NGL units today are only slightly higher than the purchase price paid. That said, measuring success in this manner is oversimplified. We don’t know what returns management teams could have gotten by investing that capital elsewhere.
MLP Buybacks Today
Fast forward to today. Midstream MLPs have begun to increasingly discuss buybacks with the conversation spanning market caps. Though no longer structured as an MLP, Kinder Morgan (KMI) remains a trendsetter in the space. In July of this year, KMI announced that its board had authorized a $2 billion share buyback program beginning in 2018, which represents ~5% of KMI’s current market cap of $40 billion. Approximately a month later, NGL announced board authorization for a $15 million unit repurchase program through the end of 2017, which corresponds to ~1% of NGL’s $1.4 billion market cap.
On October 12, Genesis Energy (GEL) indicated that it would evaluate implementing a buyback program in the future. Later that day, bellwether Enterprise Product Partners (EPD) announced it was slowing its distribution growth in favor of moving closer to self-funding. Specifically, EPD noted that by 2019 the company could potentially fund the equity portion ($1.25 billion) of its $2.5 billion annual growth capital spending and consider instituting a buyback program. While not a midstream MLP, Hi-Crush Partners (HCLP) has also announced a unit buyback program. It bears noting that GEL, EPD, and HCLP do not have the burden of IDRs.
Buybacks in the evolving MLP model
For years, equity issuances have been a fixture of the MLP space. With EPD and other large midstream companies discussing buybacks, the tide seems to be turning. Undoubtedly, this shift likely reflects the ongoing evolution of the MLP model. MLPs are increasingly focused on achieving sustainability with the distribution, preserving the balance sheet and exercising capital discipline.
At the end of the day, capital projects, distributions, and unit repurchases are all competing uses of cash. A capital project, such as a natural gas pipeline, may generate a 14% return (conservatively based on FERC-approved ROE’s for new pipelines in the recent past), but there are other issues to consider like permitting, construction, potential cost overruns, legal issues, delays, and potential opposition or negative publicity. By the time these issues and the time value of money are taken into account, the return on a project may not be as attractive as it once seemed, and buybacks could be a competitive alternative to projects in some cases. As we saw in the examples above, buybacks also provide flexibility as repurchase authorizations aren’t firm commitments.
In the past, the focus was on growing the distribution as the primary means for driving unitholder returns. Today, distribution growth doesn’t seem to be adequately rewarded by the market (see my colleague’s post: “The Irrational Investor: MLPs Trading on UNfundamentals”). When distribution growth isn’t getting rewarded, buybacks are another string to pull when it comes to supporting unit prices. Against this backdrop, management teams are understandably scrutinizing their uses of cash and the returns on that cash. Perhaps, buybacks will be a more prominent contender in the capital allocation decisions of MLPs going forward.
2017.11.08 2:00pm CST – Updated IDR footnote to clarify HCLP IDR structure.