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Inside the MLP Factory Igor Greenwald The Wealth Summit May 2014

Dec 23, 2015

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  • Slide 1
  • Inside the MLP Factory Igor Greenwald The Wealth Summit May 2014
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  • Do You Like Sausage?
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  • I know I do; let me count the ways: Grilled, with onions Smoked with sauerkraut On a stick, fried in pancake batter (Not really, but someone out there does.)
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  • What does sausage have to do with master limited partnerships? Only this: The end result is much more appealing than the preparation process
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  • Why the bad rap for sausage factories? If you like laws and sausages, You should never watch either one being made. Otto von Bismarck, maybe Another thing The Iron Chancellor probably didnt say: If you like pithy quotes, dont worry too much about attribution. Blame this man:
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  • How are MLPs like laws and sausages? Complex process Assembled by specialists Defects hard to spot Fill a need for the public Producers can profit by fooling consumers
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  • The insinuation: If only you knew The $500 billion master-limited-partnership sector is the sausage maker of the investment world. Buyers love the yields now averaging about 6% but many know little about how the yields are generated. And Kinder Morgan, the country's largest energy-infrastructure company, may be the biggest sausage maker of them all. Kinder Morgan: Trouble in the Pipelines? Barrons, Feb. 22, 2014
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  • And yet, heres what we know: Sausage is tasty Laws keep anarchy at bay MLPs have been the best investment so far in this century
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  • Deal of the Century
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  • Source: Pension Consulting Alliance
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  • How Fresh Is That Sausage? Past performance does not predict future Outperformance wont last forever Risk of reversion rises over time The role of sentiment in market cycles
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  • Reality Check Source: William Blair
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  • The Peoples Choice Predictable tax-deferred income Exempt from corporate income tax Long-term contracts, regulated tariffs Yield above bonds, REITs, utilities Growth industry amid US shale boom Great long-term track record
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  • No Contest Source: Alerian
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  • Drill, Baby, Drill Source: US Energy Information Administration Projected US energy production
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  • Moveable Feast Source: RBN Energy Government shale forecasts keep missing low
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  • Good Times, Not So Bad Times Five Best Years 2009: 76% 2000: 46% 2003: 45% 2001: 44% 2010: 36% Selected Alerian MLP Index annual returns since 1996 Five Worst Years 2008: -37% 1999: -8% 2002: -3% 1998: -3% 2012: 5% Sources: Alerian, Hinds Howard
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  • The Price of Success
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  • MLP Bulls Come Lately New investment vehicles by year of launch
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  • Drilling for Cheap Capital Source: Hinds Howard
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  • C-Corps Selling MLPs Recent Spinoffs: Phillips 66 Partners (PSXP) from Phillips 66 (PSX) top 13 MLP IPO Valero Energy Partners (VLP) from Valero Energy (VLO) Western Refining Logistics (WNRL) from Western Refining (WNR) EnLink Midstream Partners (ENLK) from Devon (DVN) and Crosstex (XTXI) Enable Midstream (ENBL) from CenterPoint (CNP) and OGE Energy (OGE) More In Store: Dominion Midstream LNG MLP from Dominion (D) Antero Resources Midstream MLP from Antero Resources (AR) LNG tanker MLP from GasLog (GLOG) Offshore drilling rig MLP from Transocean (RIG) LNG processing MLP from Energy Transfer Equity (ETE)
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  • Devons Sweet Deal
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  • Devon valued (still!) at less than 5x EV/EBITDA Deal valued auxiliary midstream assets at 11x EBITDA Devons contribution to MLP valued at $4.8 billion Market has since repriced to more than $7 billion, or 16x EBITDA MLP trading at three times Devons cash flow multiple MLP Alchemy
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  • PSX vs. PSXP PSX EV = $49.3B EBITDA = $3.4B EV/EBITDA = 14.5 The high cost of the extra P PSXP EV = $3.5B EBITDA = $67.7M EV/EBITDA = 51.7 PSX owns 72% of PSXP LP units plus 2% GP interest Investors paying more than triple for PSXP over PSX Fast distribution growth is nice, but at 1.6% yield, not fast enough PSXP up 93% in 9 months since IPO, 48% year-to-date Troubling faith in perpetual growth
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  • A Different Yardstick
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  • Bonds Have More Fun Fixed income in fourth decade of bull market Government bonds dont have business risk On plus side, bond coupons dont grow like MLP payouts If rates rise, MLP yields could follow via capital losses Why comparisons with credit yields may prove misleading
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  • Whats Wrong With This Picture? Anchoring bias assumes starting price is the right one No guarantee distribution growth builds partnership value No guarantee yield is justified by business prospects Many MLPs are beyond reproach and have very bright prospects, but the exceptions to this rule can be very costly
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  • The MLP Profits Philosophy We recommend investments, not tax shelters We do so based on long-term fundamentals, not yield Were bullish on many strong MLPs and GPs But were also not afraid to sell and criticize Or to admit mistakes and change course
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  • Strong Performance Record Last years picks returned nearly 40% annualized by year-end Portfolio comfortably beat MLP benchmark as well as S&P 500 Timely buys: Energy Transfer Equity (ETE) +66% since 6/7/13 EQT Midstream Partners (EQM) +64% since 8/12/13 Sunoco Logistics Partners (SXL) +42% since 8/12/13 Targa Resources (TRGP) +35% since 11/15/13 Timely sells: Eagle Rock Partners (EROC) -49% since 5/29/13 Boardwalk Pipeline Partners (BWP) -42% since 11/15/13 Timely re-buys: Boardwalk Pipeline Partners (BWP) +15% since 4/4/14
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  • Key MLP Profits Growth Themes LPG Exports (EPD, TRGP, NGLS) LNG Exports (ETE, WMB, KMI, TGP) Oil, Fuels Surge (MMP, SXL, BPL, OILT) Northeast Energy (EQM, WMB, MWE) GPs With IDRs (ETE, KMI, WMB, AHGP) Propane Logistics (APU, NGL)
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  • A Margin Of Safety Top 3 Best Buys (EPD, MMP, SXL) averaged excess coverage of more than 50% of distributions at end of 2013 Excess coverage can fund capital projects in place of equity/debt issuance, aiding returns Top 3 up 16% YTD, 38% in year before yield
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  • Lets Talk Incentives Incentive Distribution Rights (IDRs) pay general partner (GP) growing percentage of MLP cash flow Typical: 15% of payout above X, 25% above Y, 50% above Z, per unit Stated rationale: incents GP to grow MLP Unmentioned: dilutes rewards of growth for limited partners Perverse: Top hedge funders charge 2/20 fees; many GPs 2/50 Means GP can profit even from losing investment; fund with debt then collect almost 50% of notional cash flow boost. A sweet deal. Or fund with equity and collect extra IDRs on new units long before any return. Also why some GPs turn their MLPs into serial acquirers IDRs can have huge effect on returns and are main reason we tend to favor GPs over affiliated MLPs
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  • Follow the Bouncing IDRs
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  • In Summary MLPs in sweet spot of domestic energy boom Lofty valuations suggest increased risk Downside from higher rates, lower energy prices Returns can be tasty, but insiders eat first We watch sausage get made so you can enjoy
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  • Thank You.
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