What’s Happening in MLPs: Differentiating Between Equity Offerings
MLPs have secondary equity offerings like I buy new plants—in other words, every time I see an opportunity. However, neither of us act recklessly—I need a bit of spare windowsill for the purchase to make sense, and the MLP must see some growth opportunity. Since MLPs pay out the majority of their cash flow in the form of distributions, they generally have to raise additional capital in order to grow. Back in the heyday of MLPs, it seemed like nearly every equity offering, regardless of quality, was greeted with enthusiasm and was able to be sold at a small discount.
For the past couple years though, there were few equity offerings because unit prices were so low that management teams were unwilling to issue units. Now, offerings are starting to pick up again, but the variety of discounts illuminates how investors are continuing to differentiate between MLPs.
Many follow-on equity offerings for MLPs are overnight deals. This means that the deal is completed between market close one day and market open the next. As soon as the closing bell rings, the investment banks that are underwriting the deal start calling up every institutional investor that might be interested and taking orders. Based on interest, the underwriter will price the units (aka determine the discount) before market open. The units are offered at a discount since issuing new units is dilutive and unit prices can generally be expected to fall the next day. Additionally, units bought in overnight deals might be prohibited from being sold for a certain period, generally measured in months, which is known as a lock-up. The discount allows institutions to feel comfortable buying a large block of units under these conditions.
Hi-Crush Partners – The Cost of Risk
Hi-Crush Partners (HCLP), recent winner of two Ammys for Highest Total Return in 2016 and Highest Total Risk Adjusted Return in 2016, used their recent equity offering to fund their $415 million acquisition of further sand reserves. They raised around $370 million, but it came at a high price. The overnight offering priced at a 12.4% discount to the previous day’s close, but would have needed to price at a 1.5% discount to cover the entire cost of the acquisition. All of this is before the bankers take their commission.
For the investors who bought the units, they continued to lose money: the next day, the units closed down an additional 3.6% below the discounted price. (HCLP closed at $20.55 on February 23rd. The follow-on offering priced at $18.00/unit. On February 24th, HCLP closed at $17.35.) The units have continued to fall. On March 10th, HCLP closed at $15.90, an additional loss of 8.4% and a full 22.6% below the price before the offering.
HCLP issued its previous offering in August 2016 at a discount of just 4.0%. The following day, the units traded up, to close 3.0% above the previous day. For the investors who bought the follow-on, they gained 7.3% in a single day. The issuance before that (in June 2016) also saw similar results, but the differences between these is that the issuances of last summer were for around $80 million and $50 million, respectively. In HCLP’s case, their equity offerings may be like other forms of buying in bulk—the more units that are issued at once, the steeper the discount required by the market.
Beyond the size of the deal, HCLP is a frac sand producer. This is a very commodity-sensitive business (rising and falling with the number of fracking wells) and as such, is much higher risk compared to the staid fee-based pipeline business that most MLPs operate. Investors require larger discounts to compensate them for taking on additional risk.
Tesoro Logistics – The Time Is Right
Over the past six months, Tesoro Logistics (TLLP) returned 14.9%, beating the AMZ by 11.8%. Their recent equity offering took advantage of the current price (TLLP was yielding 6.5% as of March 7, 2017) to raise around $285 million. If it had issued the same number of units in September it would have raised $40 million less. Since the proceeds were used to pay down debt, TLLP was able to pay down much more debt by issuing units now.
Investors priced the offering at a 4.2% discount and the next day, unit prices fell an additional 1.2%. While TLLP was able to capture much more than HCLP, the bland response could be due to investors recognizing that management wanted to sell at this point, and knowing that they needed to. In November, TLLP announced $1.1 billion of asset purchases, which were paid for with $750 million of debt that TLLP raised the following week. (The remaining $350 million was funded with through their revolving credit line and cash on hand.) This equity raise was equivalent to delayed financing. Or paying off your credit card bill (the revolver), if you will.
Plains GP Holdings – Premium Pricing
Naturally, I saved the best for last. Plains GP Holdings (PAGP) raised the most money (around $1.5 billion), had the lowest discount (2.4%), and traded up the next day (by 2.6%). Also, it only intended to sell 34 million shares, but demand was so strong that it sold 42 million. Note: the proceeds will be used to buy units of Plains All American (PAA), and PAGP is a C corp tracker stock for PAA.
What’s the difference here? Maybe it’s because sister company PAA is so well regarded in the industry that it won MLP Acquisition of the Year during the Ammys this week. (And, shout out to Pat Diamond who was inducted into the Hall of Fame this year for his work at PAA in investor relations.) Plains’ recent troubles (distribution cuts, concerns about an adequate coverage ratio) would, for any other company, have likely led to a very steep discount. However, CEO Greg Armstrong has been honest and transparent with the market, so investors are willing to give the companies a chance to prove themselves again. This offering had been expected, was larger than analysts predicted for 2017, and was even upsized from there.
Investors aren’t the only people ready to see Plains succeed; Moody’s removed PAA from the list for downgrade review, on which it had been placed following the January purchase of a Permian basin gathering system for $1.2 billion. The downgrade review had been initiated due to the temporary high leverage resulting from the acquisition, essentially requiring an equity raise. The removal of PAA from the list for downgrade review reflects both their successful equity issuance (which will be used to repay short-term debt), and the expected decrease in leverage through 2018.
The Next Offerings
The equity offerings mentioned above were all follow-on offerings, meaning that the units sold were all newly created. However, there are also secondary offerings where a large holder resells the units it already owns. Occidental Petroleum (OXY) owns around 30 million Class B units of Plains (which can be converted into either PAA units or PAGP shares). On its recent earnings call, OXY management stated their intention to monetize these interests (referring specifically to PAGP) in 2017. Typically, adding that many shares into the market would put downward pressure on prices, but PAGP has not traded noticeably downwards following the announcement. Which, seen together with PAGP’s secondary, implies there is still plenty of demand for Plains exposure.