Plains All American Pipeline, L.P. (PAA), Kinder Morgan Inc (KMI): Buy This MLP When It Hits the Street

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At the end of last month, Plains All American Pipeline, L.P. (NYSE:PAA) announced that its general partner, Plains GP Holdings, planned to go public, trading on the New York Stock Exchange under the ticker symbol “PAGP”. Today, I’ll look at why a general partner would want to go public and what opportunity exists for investors when it happens.

Why go public?
The typical role of a general partner is to manage growth and operations at a master limited partnership. General partners can be privately held, structured as MLPs themselves, or set up as C corporations.

There are a handful of reasons a general partner would want to become a publicly traded security, but by far the most important one is exploiting the value of incentive distribution rights.

Incentive distribution rights refer to the quarterly payments a general partner receives once distributions at an MLP reach a previously agreed upon level. At inception, a general partner typically receives 2% of cash flow to correspond with its 2% equity stake and nothing else.

Plains All American Pipeline, L.P. (NYSE:PAA)As the MLP grows and distributions increase to a certain amount, the general partner will receive its 2% stake and an increasing percentage of what’s left of incremental cash flow. The exact amount and corresponding percentage due the general partner varies from partnership to partnership. Some general partners will receive “high splits,” which means IDR levels will go up to 50% of incremental cash flow, while others will stop around 25% or 30%. Additionally, in many cases the general partner reserves the right to reset IDR payments or put them on hold.

By going public, a general partner opens up more opportunities to raise equity. The GP can then use this new capital access to fund growth projects at its MLP.

IDR close-up
Let’s look at the blueprint for Plains All American Pipeline, L.P. (NYSE:PAA)’s incentive distribution payments to Plains GP for a better understanding of how this works.

PAA Distribution PAGP Cut
< $0.2250 GP Stake 2%
IDR 0%
> $0.2250 GP Stake 2%
IDR 15%
> $0.2475 GP Stake 2%
IDR 25%
> $0.3375 GP Stake 2%
IDR 50%

Source: Plains All American SEC Filing.

Based on this chart, you can see that if Plains All American Pipeline, L.P. (NYSE:PAA) distributes $0.3375 to unitholders, it must distribute 50% of its incremental cash flow to its general partner. Given that PAA’s most recent distribution was $0.5875, this is already happening. For the full-year 2012, Plains All American’s IDR payments to its general partner totaled $271 million. When you combine the GP’s 2% stake and all of the common units it owns, the total cash PAA handed over was $969 million.

That being said, many general partners will waive all, or a portion of, IDRs for a limited time if the MLP makes a large acquisition. It often takes time for new assets to prove themselves on the balance sheet and general partners are, by and large, amenable to temporary reductions.

Investors win
Now that Plains All American Pipeline, L.P. (NYSE:PAA) GP is going public as a master limited partnership, it will receive incentive distribution rights from PAA and turn around and pay out much of that cash as distributions to investors. Because of the graduated IDR structure, and the fact that the 2% general partner stake also grows whenever the MLP issues equity, general partners tend to grow their distributions at a faster rate than the MLP itself.

Let’s take a look at some other GP/MLP options that are making investors rich right now:

  • Because of its various stakes in the partnership, Kinder Morgan Inc (NYSE:KMI) received 51% of all Kinder Morgan Energy Partners LP (NYSE:KMP) quarterly distributions in 2012. KMP paid KMI $1.32 billion in IDRs alone last year.
  • In 2012, Williams Partners L.P. (NYSE:WPZ) paid its general partner Williams Companies, Inc. (NYSE:WMB) $1.1 billion for its various stakes in the partnership, including $413 million in IDRs.
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