A slightly secret aspect of master limited partnerships as a business structure is how much money the general partner can make from incentive distribution rights if the limited partner investors are paid a steadily increasing dividend. I believe the opportunities to invest in MLP general partnership companies offer very attractive growth and income potential for investors. The recent IPO of Plains GP Holdings LP (NYSE:PAGP) will be a very profitable way to tap into the IDR growth of a high quality MLP company - Plains All American Pipeline LP (NYSE:PAA).
Note: MLP companies such as Plains All American Pipeline have units and pay distributions. The words stock, shares and dividends may be used here with the understanding that the rules of MLP units apply including the tax consequences of investing in MLP units.
Quantifying the Potential
Before going into the nuts and bolts, I thought for this article I would cover the investment return potential first and then later discuss how the deal is structured to support the projected dividend and share price growth. According to the Form S-1 prospectus filed for the IPO, the initial quarterly dividend for PAGP is expected to be $0.14904 per share or $0.5962 annualized. This projected dividend rate puts the current yield at 2.6% based on the $22.80 share price at the time of writing.
The PAGP dividend will increase each time the PAA distribution grows, which has been almost every quarter since the start of the 21st century. For the last several years, PAA increased the dividend each quarter to produce a 10% annual increase in the distribution rate.
The PAGP claim in the PAA IDRs would have produced a distributable cash flow increase of 26% from 2012 Q3 through the 2013 Q3 PAA distribution. Look-back distributable cash flow for PAGP would have more than doubled from the 2010 4th quarter through the 2013 3rd quarter.
Projecting the historical numbers into the future, if Plains All American Pipeline continues to increase its distribution rate at 10% per year, the dividend from Plains GP Holdings should grow at a 25%+ per year clip. The rule of 72 shows that this growth rate will result in a doubling of the cash dividend every three years, which means if the market maintains a level yield the share price will also double in three years.
To further sweeten the deal, Plains GP Holdings LP has elected to file taxes as a corporation. This means that investors will receive a Form 1099 instead of the more complicated K-1 sent out by most MLP companies. The IPO prospectus states that the dividends are expected to be 100% non-taxable return of capital through at least the end of 2016.
The Plains All American Pipeline Cash Machine
In contrast to many MLP companies with rapid GP IDR growth, Plains All American Pipeline is one of the largest MLPs with a market cap of $18 billion. Yet the company continues to produce outstanding distribution growth through both organic and acquisition projects. My article, "Plains All American Pipeline: Growing Dividend Equals Outstanding Total Returns" provides additional background on PAA. One point I would like to highlight is that the four quarters worth of dividends through 2013 Q2 were covered at a 1.40 to 1 distributable cash flow to payout ratio, including the general partner and IDR payments.
A Complicated Business Arrangement
It took me a couple of readings to get to what I think is an accurate understanding of the PAA to PAGP business structure. Here are the highlights:
Plains AAP, L.P. [AAP] owns the general partnership interest and 100% of the PAA IDRs.
The 128 million Class A shares of PAGP sold at IPO represent a 21.2% limited partner interest in AAP and the A shares are entitled to receive 19.7% of the economic value of AAP.
The approximate 20% value of AAP ownership results in the same percentage of PAA GP plus IDR cash paid to AAP will be distributed to the PAGP shareholders.
The $2.73 billion proceeds of the IPO will be distributed to the owners of the remaining portion of AAP. The 79% non-IPO'd ownership is represented by class B shares, which can be exchanged for A shares under certain circumstances, but any exchanges would not dilute the cash flow to existing shareholders.
The PAA 50% IDR split kicks in at a quarterly dividend of $0.3375 and the current quarterly rate is $0.60. This means that to increase the dividend to PAA unit holders, an equal amount of increased cash payment must go to the IDR holders. MLP companies finance growth through a combination of debt and the issue of new units. As a result IDR payments increase based on both an increasing dividend rate and increasing number of units. However, an increase in the IDR payment can be waived by the general partner - in this case AAP - if the waiver is believed to benefit the long term growth of the operational MLP company.
Plains GP Holdings gives the opportunity to invest in "forced" 20%+ dividend and probably share price growth as long as Plains All American Pipeline can stay on its historical path of 10% distribution growth to investors. The PAA long-term history makes PAGP look like a very good bet.