After the bell Tuesday, MarkWest Energy Partners (MWE) announced a secondary offering of 4.75 million units, which raised $301 million (press release available here). These funds will be used for general partnership purposes and could eventually be used to pay down debt or fund growth projects. After this offering, existing unit holders will be diluted by roughly 3%, and after hours, units were down an additional 1-2% percent. Frankly, investors in MarkWest should be upset by the secondary, and this MLP should not be in anyone's portfolio.
When a company launches a secondary offering, it is a sign that management believes units are either fairly or over-valued. If units are cheap, then it is extremely dilutive and unwise to sell additional stock unless it is necessary for the survival of the firm. MarkWest has no liquidity issue, so this was a secondary of choice not necessity. While units are still up solidly on the year, they have been slammed after a truly disastrous quarter. As a consequence, it would obviously have been preferable to have the secondary when the unit price was $10 higher. There are really only two possible reasons why management would do a secondary even with units so far from their high.
The first and extremely unlikely reason is that management does not care whether investors do well in MWE. In such a situation, they would have no issue selling shares at a relatively low price, diluting unitholders more than necessary. This would be particularly damning, and I have a hard and fast rule of not owning stock or partnership units in companies where management is not concerned about the well-being of shareholders. In certain instances, I have missed out on well performing stocks because the business performed well enough to move shares higher despite management. But in general, it is wise to pass on stocks with management that is uninterested in strong shareholder returns. If this is the case with MWE, investors would have to sell out, especially as there are a plethora of strong MLPs like Plains All American (PAA) and Kinder Morgan Energy Partners (KMP).
I have no particular reason to believe management does not care about investors, and the history of strong distribution growth also suggests management is unitholder friendly. As a consequence, I urge investors to assume the first explanation is wrong. While management's timing on the secondary was far from perfect, management is not an anti-investor. I wish management did not do the secondary because of the low price but would not harbor ill will because of it.
That leaves me with the second possibility: management believes $65 is above MarkWest's intrinsic value. While units are lower than recent highs, management thinks they are still too high. As a consequence, management is smartly taking advantage of the high price to sell additional units and raise money at an attractive price. This would be along the lines of what Icahn Enterprises (IEP) did last week. If this is the case, and management thinks fair value is below $65, investors should be selling here.
Based on recent results, I can see why management would think units are still headed lower. Despite its exposure to the Marcellus shale, the company saw a sequential decline in distributable cash flow in the most recent quarter (press release available here). In fact, the company had a coverage ratio of 0.92, which suggests the current distribution may not be sustainable. Moreover, the company was forced to cut 2013 guidance because of the weakness of results with DCF now forecasted to be $475-$485 million, down $55 million from the previous estimate. Next year, the company expects to generate DCF of $600-$690 million. After this secondary, that would translate to $3.90-$4.45 or $1.05 per unit, which would be solid growth from the current $0.85 payout.
However, the company plans on spending roughly $2 billion on growth capital expenditures, which will be funded with debt and equity. Historically, MarkWest funds these projects with 67% equity, and with yet another secondary, it would seem management is uninterested in gearing more towards debt issuance. At the same time with sequentially declining results, I do not believe the company can grow DCF by 25% next year and am targeting $575 million. When you factor in another $1-$1.2 billion in equity issuance throughout 2014, MarkWest will have the capacity to pay $0.83-$0.89, right around its current payout.
While MarkWest may be a growing company, its unit count is growing as fast as its business, meaning there is no distribution growth per unit. MarkWest's secondary is another sign that the company has massive funding needs, and its company cannot grow enough to justify these secondary offerings. Unfortunately, for investors, this secondary was done at a relatively low price, making the offering more dilutive than it would have been two months ago. With limited distribution growth, I believe MWE should trade another 10-15% lower, and at $57 would offer a fairer 6% yield. At $65, MWE is a conviction sell. Investors should dump it and rotate into higher quality MLPs that can actually grow the distribution per unit.