Master limited partnerships (MLP) have long been the province of individual investors, thanks to restrictions on fund ownership of this security class and tax complications for institutions. This ownership base and somewhat constrained liquidity explains the sharp but short-lived selloffs that intermittently afflict the MLPs, especially when individual investors set stop-loss around the same price levels.
Although the above-average yields and tax advantages associated with publicly traded partnerships have a broad appeal, some individual investors avoid these securities (or opt to gain exposure through a growing number of fund products) to avoid the headaches of dealing with the unfamiliar Schedule K-1 during tax season.
Moreover, investors that own MLP units in a 401(k) or other tax-advantaged account could be subject to levies if the unrelated business taxable income generated by these holdings exceeds $1,000 in a given year.
To expand their shareholder bases and improve liquidity, Kinder Morgan Energy Partners LP (NYSE: KMP) and Enbridge Energy Partners LP (NYSE: EEP) created I-shares, an alternative unit class that offer exposure to the same underlying assets but replace the MLP’s quarterly cash distribution with an equivalent number of I-shares. These “paid-in-kind” distributions aren’t subject to tax until the holder sells his, hers or its position, at which point the capital gains rate would apply.
Kinder Morgan Management LLC (NYSE: KMR) and Enbridge Energy Management LLC (NYSE: EEQ) garnered some additional investor dollars but lack the liquidity of their respective MLP units and usually trade at a discount. The graph below tracks the widening performance gap between these two securities over the past three years.
Linn Energy LLC (NSDQ: LINE), the largest upstream operator in the MLP space, last year launched an appealing alternative to I-shares that has broadened its investor base and provided yet another means of raising capital.
Structured as a corporation, LinnCo LLC (NSDQ: LNCO) went public on Oct. 12, 2012, raising about $1.1 billion that was used to purchase a 13.2 percent equity stake in its parent company, Linn Energy. Each share of LinnCo represents one unit of Linn Energy and its qualified dividends mirror its parent’s quarterly distributions.
In short, LinnCo provides exposure to Linn Energy’s growth story and enticing yield without the tax headaches and restrictions that have limited the MLP’s level of institutional ownership to between 26 and 28 percent. This new structure has proved to be a hit among investors, with institutions holding about 55 percent of the outstanding shares.
First and foremost, the launch of LinnCo reinforces Linn Energy’s reputation as one of the most forward-thinking names in the MLP space. At the same time, shares of LinnCo have started to trade at a premium to Linn Energy’s unit price, providing a useful gauge of investor demand for names that offer an above-average yield without the headaches and restrictions associated with MLPs.
We expect the success of this innovative transaction to provide a template for other MLPs seeking to access individual, institutional and foreign capital that had remained on the sidelines.
Elliott and Roger on Jul. 26, 2018
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