Terra Nitrogen Vs. Terra Industries

With the recent payout of the first quarter distribution, there will be a big change for Terra Nitrogen Co. LP (TNH) shareholders. Although Terra Industries (TRA) has made no secret of the fact, TRA, as general partner and major shareholder of Terra Nitrogen, is now due to take a much larger portion of the quarterly distribution.

A little background. Terra Nitrogen LP is a limited partnership of a single nitrogen fertilizer plant. Terra Industries controls/owns the general partner and owns a bit over 75% of the partnership units. The partnership agreement includes a clause where the general partner receives a higher percentage of the distributable cash as the per share distribution exceed 60.5¢ in a quarter. The other part of the clause states the cumulative distributions must exceed 60.5¢ per quarter, so anytime the distribution is below that amount the GP must fore go its higher percentage until the shortfall is made up. After a string of low payout quarters the general partnership had built up quite a deficit to the minimum payout rule. Then the fertilizer gravy train arrived and TNH was able to make distributions that started to reduce the deficit. At the end of 2007 the deficit was at $6.70 per unit. With the last two quarter’s distributions totaling $8.65 the deficit has been wiped out and the original distribution sharing arrangement is back in effect.

Now for the interesting part. The distributable cash share arangement gives the GP higher percentages in tiers as the cash per unit exceeds 60.5¢. The top tier is hit at only $1.045, and above that level the general partner is entitled to 50% of the distributable cash. Put it the other way, the cash available for the limited partners (what we think of as shareholders) is reduced by half, or the dividend will be 50% less.

Let us see how the numbers would have worked out for the distribution announced last week. The distribution per share was $4.20 times the 18.5 million outstanding shares for a total of $77.7 million. Terra Industries holds 75% of the shares, so they collected about $58.4 million. With the back dividend deficit eliminated the GP (Terra Industries) would have taken about $39 million right off the top, reducing the distribution to $2.10 per share. Since Terra Industries owns the majority of the shares, their per share distribution would be down also, but their total share of the distributable cash would have been about $68 million vs. the $58.4 million they will receive from this latest dividend.

Terra Industries had net earnings of $100.2 million for the first quarter (see transcript), so the now in place sharing arrangement could boost their bottom line by about 10%.

As I said earlier, Terra Industries has not kept this a secret; it has been mentioned in the last two quarterly earnings conference calls and in the 10-K. Since they already own 75% of TNH, they stand to make even more. I think individual shareholders have gotten excited about a company that was paying $2 to $3 /share/year now paying over $4 per quarter and have driven the price from $20 to $150 in about 20 months. I think many individual shareholders are in for a rude surprise when the next quarterly distribution is announced.

The second quarter should be an excellent one for Terra Nitrogen, but I do not think they will have $8+ per share in distributable cash to keep the dividend at current levels. At this point investors who own and like the business of Terra Nitrogen should sell their shares and invest in Terra Industries. If my analysis is correct, the parent is going to reap significantly higher rewards from TNH than individual shareholders will.

My analysis of this situation is from information I have gathered through Terra Industries’ recent conference calls and both company’s 10-K reports. If I have made a mistake here, I would really like to hear about it.

Disclosure: I currently do not have a position in TNH or TRA.

Comments

[sdcougar]

Someplace I read that that the share division of the dividend was that the stockholder would get the first __dollar amount (?I dont have the figure) and that above that amount parent company, Terra, would get 50 percent of the remaining dividend.

Is this correct? If so then the shareholder recieves more than 50 percent of the dividend because they get the first x dollar amount.

[sdcougar]

Also, why does the Yahoo finance page still have the ex-date listed as FEB. ????

[jrad52]

2 errors in your analysis, 1 regarding the split and the other regarding the earnings effect on TRA. With regard to the 50% split to TRA, the 50% kicks in only on the incremental distribution in excess of $ 1.045. So when you took 50% of the entire distribution ($ 77.7 million), you're overstating the impact. TRA gets its 2% GP distribution on the first 71.5 cent distribution (which includes the first target), so the first $ 13.5 million distribution goes to TNH's common units (who get $ 13.3 million) and TRA (which gets $ 270K). Then, on the distributions up to $ 1.045 per unit, the common holders get $ 6.1 million and TRA gets $ 1.3 million. Only then does the 50% split kicks in. So of the remaining $ 56.8 million, TRA gets half, or $ 28.4 million. Overall, this would leave the common holders with a total distribution of $ 47.8 million, or $ 2.60 per unit.

Then, don't forget that TRA is a corporation and must record taxes on the distribution, so the impact on its bottom line should be reduced by about 35%. On TRA's 90 million shares, the EPS impact is between 5 and 7%.

So I think this hurts the TNH holders much more than it helps TRA.

Hope this helps.

[Tim Plaehn]

Thanks I was uncertain if the split started at the first dollar once the tier was hit or the tiers were followed with the splits. The wording from the partnership agreement is pretty vague (to me). Also, there are tier splits starting at $0.605 that max out at the 50% above $1.04, so if that is the case the numbers will fall in between somewhere. In any case the TNH shareholders are going to get a surprise if they are not reading here or my blog.

[Taraman]

Those who are aquainted with Terra management types are not suprised at this "arrangement"... It requires skill when you handle snakes.

[Gajonka]

"TIMES" ISN'T A WORD- IT IS "MULTIPLIED"... THANKS.

[Tim Plaehn]

I have added a post to my blog correcting the new dividend calculation. I came up with $2.57 under the new schedule. A pretty big difference from $4.20.

[Robert Kronenberg]

Thank you, Tim, for your astute observation regarding the reduction of the dividend. A pairs trade in which one buys TRA and shorts TNH appears to be a decent arbitrage play.