MLP Secondaries: The Great, The Good, And The Risky

by: AlanHHI

I have written before that Master Limited Partnerships (MLPs) often issue more stock to fund expansions (a.k.a. "secondaries") or pay down debt. These situations can be a great opportunity to start or add to a position. In this article, I want to explore this further and show how well these secondaries have worked out in the past. I will also show when (and perhaps why) a secondary has encountered more risk.

Linn Energy (LINE) -- A Great Secondary

LINE is one of several "upstream" MLPs. In LINE's case, most of its production was natural gas, and it wisely hedged this production out for several years when natural gas prices were high. LINE paid a secure distribution of $0.63 per quarter in 2009, but natural gas prices were falling quickly.

Investors may been concerned that the distribution could not be maintained (and certainly could not be increased) as the hedges wore off. Thus, the unit price was only about $23.25 (yield of 10.8%) on October 6, 2009. On October 7, 2009, before the market opened, LINE announced an equity offering of 7.5 million units of $21.90 per unit. As is common, the offering was used to pay outstanding debt. MLPs often buy assets when available using existing credit lines, and later pay down the debt using an equity offering.

As shown in the chart below, the unit price returned to its previous level within two days. Those who bought in at or near the $21.90 offering price on the morning of October 7 got an outstanding deal. Those who found out about the secondary that afternoon and decided to wait for the price to return to $21.90 are still waiting.

On the other hand, even if you missed the secondary completely, and bought LINE the next day at $23.5 (10.7% yield) you would still have done quite well, since the present unit price is over 42! Moreover, you would have been collecting 10.7% distributions as the unit price rose.

Breitburn Energy (BBEP) -- A Good Secondary

A more typical secondary was announced by BBEP on September 6 of this year, when 10 million units were offered at $18.51 per unit. Units had closed just over $19.25 (9.6% yield) the night before, and they could be purchased as low as $18.30 (10.0% yield) the next morning. In this case, it took six trading days for the price to return to its pre-offering value, although the price was "almost there" within about four days. Thus, investors had a full day or two to get a good benefit from the offering. The current price is $19.75 (9.3% yield), so again, there were no losers (at least not yet).

An offering by Vanguard Natural Resources (NYSE:VNR) on September 12 had very similar characteristics.

QR Resource (NYSE:QRE) -- The Secondary With Risk

Not all MLP secondaries work out as nicely or quickly as the three shown above. A good example of a risky secondary was announced by QR Resources on April 11 when 17.5 million units were offered at 19.18 per unit.

In this case, units did not return quickly to the pre-offering price of about $20.40 (9.4% yield). In fact, they fell and continued to fall, and on April 26, there was another gap down for reasons not directly related to the offering. Units finally bottomed at around $16.00 (12.1% yield) in June.

The unit price has just now returned to its value before the April 11 offering. Investors who held for the entire period between the secondary and now have come out OK, and they have picked up a couple of distributions while they waited. Those who sold out in the interim may have lost money.

Differences Between The Secondaries

There were at least two significant differences between the first three secondaries and the QRE secondary.

For LINE, BBEP, and VNR:

  • The units offered were less than 20 times the average volume sold in a day (e.g., for BBEP 10 million units were offered, and the average units sold were 538,000 per day), and
  • The secondary was issued solely to pay down debt.

For QRE:

  • 17.5 million units were offered, which was almost 40 times the average volume, and
  • only 6.2 million of the units offered were being sold by the MLP to pay down debt; the remaining 11.3 million units were being sold by the sponsors to cash out.
  • Thus, two thirds of the QRE units offered were merely transfers of ownership from one unit holder (the sponsor) to another (the general public). In retrospect, it appears that too many units were sold at one time to allow the price to return to a normal level within a reasonable amount of time.

Therefore, it is always a good idea to examine why a secondary is being offered and how long it is likely to take for the offered units to be absorbed. When a reasonable amount of units are being offered, it is likely that the unit price will return quickly to the normal unit value.

When sponsors are trying to cash out, they will often offer a high number of units in relation to the average volume. These secondaries can carry more risk.

Disclosure: I am long BBEP, LINE, QRE, VNR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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