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Master Limited Partnerships

Leveraged Growth: Our Favorite General Partners

By Roger S. Conrad, on Jan. 31, 2014

he master limited partnership (MLP) structure often comprises two entities: a limited partnership that owns the underlying assets and a general partner (GP) that’s responsible for managing the operating entity.

In addition to a minority stake in the limited partnership, the general partner holds incentive distribution rights (IDR) that entitle it to an incrementally higher percentage of the LP’s distributable cash flow as the payout reaches certain predetermined thresholds.

This arrangement effectively motivates the GP to pursue initiatives that will enable the operating MLP to grow its cash flow and quarterly disbursements to unitholders; a rising payout at the LP level translates into disproportionate increases to the GP’s incentive distribution. Many GPs also own a significant percentage of the LP’s common units.

As the MLP achieves certain distribution targets laid out in the partnership agreement, the IDR schedule allocates a growing proportion of the LP’s cash flow to the GP.

The first interval of these sharing arrangements usually starts with the GP receiving 2 percent of cash flow designated for disbursement and the LP unitholders receiving 98 percent.

Meanwhile, the top tier of the IDR schedule-the “high splits” in industry parlance-often entitles the GP to about 50 percent of incremental cash flow.

That is, in order to raise the LP distribution by $0.01 per unit, the MLP would need to pay a corresponding $0.01 to the GP for each outstanding LP unit. (See The Lowdown on MLP IDRs: Incentive or Impediment.)

The distributable cash flow allocated to the GP also increases when the LP issues equity; the general partner is entitled to receive additional payments for each additional LP unit.

Although shares of pure-play GPs tend to offer inferior yields relative to the associated LP units, investors shouldn’t overlook the importance of a growing quarterly payout to a stock’s performance: Not only do rising distributions increase the current return, but they also tend to capture investors’ attention and drive stock prices higher.

Williams Companies (NYSE: WMB), for example, has increased its quarterly dividend by 16.9 percent over the past 12 months, while Williams Partners LP (NYSE: WPZ) has increased its payout by 8.7 percent. And management’s outlook calls for the general partner to increase its dividend at an average annual rate of 20 percent in 2014 and 2015, compared to a 6 percent growth rate at Williams Partners.

However, investors shouldn’t assume that a pure-play GP’s accelerated distribution growth necessarily makes the security a superior investment to the LP units. Investors seeking regular income may prefer the higher yields offered by LP units, while others may be put off by pure-play GPs that are organized as corporations and lack the tax advantages of an MLP.

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