IDR Elimination Could Be A Positive For MLP ETFs

With interest rates low, some income investors may want to revisit high-yield master limited partnerships and the related exchange traded funds, such as the Alerian MLP ETF AMLP.

AMLP certainly makes good on the income front with a dividend yield of 9.24%. However, there is more to the fund's story. Another reason to consider AMLP is that components in the e Alerian MLP Infrastructure Index (AMZI), the fund's underlying index, are eliminating incentive distribution rights (IDRs).

In bygone eras of MLP practices, IDRs were used to incentivize the general partner (GP) to boost the limited partner's distributions “by entitling GPs to receive a higher percentage (generally up to 50%) of incremental cash distributions when the distribution to LP unitholders reaches certain thresholds,” according to Alerian.

Why It's Important

Eventually, IDRs ended up becoming a financial burden for MLPs as the rights led to increased cost of capital. In other words, it's good for investors that AMLP member firms are doing away with IDRs.

“Multiple simplification transactions have been announced this quarter. IDR buyouts have been frequent in 2019, with the GPs of EQM Midstream, Phillips 66 Partners, and Summit Midstream Partners, among others, eliminating their MLPs’ IDRs earlier this year,” Alerian said in a recent note.

EQM and PSXP combine for 8.47% of AMLP's roster. Noble Midstream Partners LP NBLX, a smaller AMLP constituent, eliminated its IDR earlier this quarter. DCP Midstream DCP, 3.30% of AMLP's weight, did the same thing.

What's Next

It's likely other AMLP components will get in on the IDR elimination game. After all, it makes financial sense for the companies and their investors.

“Alongside the benefits of a lower cost of capital for the MLP and improved corporate governance, the IDR transactions themselves have also been mostly attractive to unitholders,” notes Alerian.

“In the case of NBLX, the acquisition of NBL’s midstream assets and IDRs is expected to be ~5% accretive to distributable cash flow (DCF) per unit in 2020, reduces pro-forma leverage, and removes the need for equity financing. Combining the expected IDR payments and 2020 EBITDA from the acquired assets implies a combined transaction multiple of 8x. Along with DCP’s IDR elimination, which represented a multiple of 9x to current IDR payments per management, these recent transactions have been attractive relative to multiples upwards of 15x seen in the past.”

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