February 25, 2002; Kurt Wulff Quoted on Energy Partnerships by Jim Norman in Platts Oilgram

Platts Oilgram News, Petrodollars Column, February 25, 2002

One benefit from the Enron collapse may be some long-overdue scrutiny for a seductive form of financial engineering captivating the energy industry lately: the Master Limited Partnership (MLP). Pressured by ratings agencies to raise cash and cut debt, just about every energy infrastructure company is rushing to push assets into these tax-advantaged ownership structures.

El Paso cut a deal last week to sell its Texas midstream gas assets to its affiliated MLP, El Paso Energy Partners, for $750-mil. Williams wants to sell all or part of its mainstay crude and products pipeline to its new 60%-owned Williams Energy Partners MLP for about $1-bil. Dynegy wants to set up its own MLP to own its vast mid-stream gas properties.  Duke is looking to grow its TEPPCO Partners MLP.

Then there is the grand daddy of the MLPs: Enron offspring Kinder Morgan Energy Partners, which has paid $6.1-bil for 30 acquisitions since former Enron president Richard Kinder bought out Enron Liquids LP in 1996.  KMP, its trading symbol, now has a market value of more than $8-bil, including about $3-bil of debt.  Its profits have soared from under $18-mil in '97 to $442-mil last year.

The logic behind these MLPs is that as partnerships, rather than corporations, they dodge a 35% corporate income tax.  That presumably lets them pay top dollar for mature pipelines, terminals and other low-growth assets with stable cash flows.  Even after interest costs on high debt leverage, MLPs can thus pay out much more cash than a corporation.  And unit-holders also get tax deductions for their share of depreciation costs.

But contrarian analyst Kurt Wulff sees big trouble for investors in these debt-heavy and poorly understood repositories for probably over-valued pipelines and terminals.  "With long-lived assets, it could be relatively easy to disguise a payout too high to be sustained," Wulff warns. The business has already been shaken by Genesis Energy, a recent MLP that halted distributions after Enron's bankruptcy due to high debt and tightening credit (ON 1/2).  Still, the allure of rich after-tax cash distributions, especially for retirees, has kept MLPs priced at big premiums to other energy securities.  Even after a 12% price drop so far this year, KMP and El Paso Energy Partners (EPN) still trade at more than twice the per-unit net present value of cash flows from their assets, notes analyst Wulff.  That is more than double the same valuation on premier-rated ExxonMobil and triple the multiple on most other energy companies Wulff follows.

Do the tax breaks really make MLPs that valuable?  No, says Wulff. Far from it. Few corporations actually pay a 35% current tax bill.  And MLP payouts are not so much tax-free as tax-deferred.  Besides, corporations can pay out cash as stock buy-backs to reduce taxes for shareholders. What, then, buoys the price of MLP units? "Overstated valuation measures derived from incomplete and likely misleading disclosures," Wulff says, which are "contributing to the potential fleecing of retirement investors."

One problem, Wulff says, are the fast-rising fees raked off from MLPs by their parent companies, who are the general partners and managers.  These takes started out at 2% or so, matching the no-cost GP equity stake in these deals. But GP payouts have soared due to aggressive incentive structures that boost payments geometrically to more than 50% as distributions to limited partners rise.  Kinder Morgan Inc, the GP of KMP, could get about 52% of KMP's expected $488-mil of net income this year and 39% of its distributions.  El Paso will get 44% of the earnings from its MLP as general partner, and other 21% from its subordinated LP units: limited partners will only get 35%.

On Wulff's "Greed Gauge," both companies are above other MLPs like Enbridge, Plains, Enterprise Products and Duke's TEPPCO.  For any of these, however, "You pay the GP much more than you would ever have paid the government" in taxes, he says.

Wulff believes per-unit profits and cash flows of MLPs must be adjusted for the dilutive burden of these GP takes. On that basis, the real cash flow and book value per unit for KMP and El Paso could be half what most analysts report.  For KMP, diluted cash flow per unit last year was only $2.06, says Wulff: far less than the $3.61/unit or more reported by other analysts and even less than KMP's $2.15 payout in 2001.

To keep the LP payouts growing, and thus reap their own hefty rewards, MLP sponsors are under ever-more pressure to make acquisitions---from themselves, if possible---that can be highly levered with cheap (for now) short-term debt. But Wulff warns that approach virtually assures these things will eventually self-destruct: "How can you make an honest decision when you are so conflicted?"

The underlying problem is that few energy asset investments can meet the steep mid-teens hurdle rate for the incremental cost of capital at MLPs, due to the "GP greed" burden.  That will lead to more quick-payout but shorter-lived investments, he warns, which will compound the ultimate viability threat to some MLPs.

James Norman in New York for Platts Oilgram News, Petrodollars Column, February 25, 2002.