The 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 structure 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.
Check out this graph comparing the 2012 dividend growth rate for nine of the 12 pure-play GPs to that of their corresponding LPs. Note that we omitted the pairings of Western Gas Equity Partners LP (NYSE: WGP) and Western Gas Partners LP (NYSE: WES), Golar LNG Limited (NSDQ: GLNG) and Golar LNG Partners LP (NSDQ: GMLP), and Inergy LP (NYSE: NRGY) and Inergy Midstream LP (NYSE: NRGM) because one member of each twosome hadn't recorded eight quarters’ worth of distributions. We also didn't include Access Midstream Partners LP (NYSE: ACMP) because Williams Companies (NYSE: WMB) didn't announce the agreement to acquire 50 percent of the GP interest in the LP until December 2012.
All the GPs included in our study grew their 2012 payouts at a faster rate than their corresponding LPs. The spread between these growth rates hinges on two factors: the IDR schedule and equity issuance at the LP level.
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. (Elliott discusses the ins and outs of the IDR schedule and its implications in MLP Basics: Incentive Distribution Rights Explained.)
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Elliott and Roger on Apr. 28, 2014
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