A New Partnership
Rise of MLPs to accelerate consolidation of convenience and fuel marketing.
A Brief History of MLPs
Master limited partnerships (MLPs) were first formed in 1981 as publicly traded partnerships to raise capital from individual investors through the public markets. As the number of MLPs grew, the U.S. Internal Revenue Code (IRC) was changed by Congress to limit the size, scale and scope of publicly traded MLPs.
As part of a 1987 enactment, Congress specifically permitted an exemption for public MLPs to derive income from natural-resource businesses to promote the development of these resources and the associated infrastructure. For this reason, the majority of MLPs today generate income from the production, processing, transportation and storage of oil, natural gas, coal and refined products.
Initially, MLPs were generally pipeline companies that transported crude oil, refined products and natural gas. Over time, other qualified assets were placed in MLPs to benefit from the tax efficiency associated with the MLP structure. More recently, MLPs have been formed that derive income from the wholesale distribution of refined products to convenience stores. MLPs may also own real estate and collect rent, because real-estate rental income qualifies under the tax code.
In the next several years, it is likely that more assets involved in the wholesale distribution of refined products will end up in an MLP. However, note that the income from convenience-store retail operations, including the final transfer of fuel to consumer motor vehicles, is not qualified MLP income under the tax code.
—Mark Huhndorff, Scott Garfinkel and Roger Woodman of Raymond James
Just a decade ago, Valero Energy, then a modest regional refiner, stunned the retail world. The company paid $4 billion in stock and cash to acquire Ultramar Diamond Shamrock, suddenly making Valero the nation’s second largest refiner-marketer.
“We’re taking two of the best independent refining and marketing companies and really becoming the premier U.S. refining and marketing company,” said Bill Greehey, Valero’s chairman and CEO at the time, which was May 2001.
Over the next 10 years, San Antonio-based Valero would jump-start from local powerhouse to a national brand, extending its yellow and teal moniker across much of the country, most recently in the South. It also would embrace convenience retailing, transforming the tired Diamond Shamrock chain into an upstart motif and experimenting with new brands such as Road Runner and larger footprints topping 4,000 square feet.
So when Valero executives this summer announced plans to divest the company’s nearly 1,000-unit retail portfolio, some eyebrow lifting was certainly understandable.
More than 1,700 miles east, a similar story has been playing out: Pipeline company Energy Transfer Partners (ETP) last month closed on a $5.3-billion deal to acquire Philadelphia-based stalwart Sunoco Inc. In addition to the 7,900 miles of pipelines and terminal assets, ETP scooped up the network’s 4,900 gas stations. And, like Valero, ETP is expected to divest Sunoco’s retail portfolio.
Why the sudden retail liquidation? The answer can be found in a simple abbreviation: MLP, which stands for master limited partnership. Valero and ETP are among the wave of fuel marketers embracing the tax-friendly, publicly traded structure as a path toward greater prosperity, capital leverage and operational discipline.
A two-month CSP investigation found the following:
- Downstream flow: While earlier MLPs gravitated toward oil exploration and production (E&P), the structure has recently become popular among downstream players.
- Growing standing line: Over the past year, several prominent downstream companies have either formally filed plans or are actively considering launching an MLP. Among them are Valero, Susser Holdings, Alon USA, Delek, Lehigh Gas, Northern Tier and Marathon Petroleum. And the pipeline of prospective applicants is growing, according to multiple sources.
- Consolidation: The nation could see a major consolidation in the fuel marketing and convenience retailing sectors over the next two to three years, several analysts say. Many of the entities entering into the MLP structure are positioning themselves to retire a backload of debt and/or entertain a growth surge.
“What I see in MLPs,” says Mike Ross, senior vice president of C&G industry for Cadence Bank, “is they’re going to inject more capital into the convenience-gasoline space because you have cheaper costs to the capital. Those who don’t access the capital will be at a competitive disadvantage.”
A Good Tax Situation
MLPs are limited partnerships publicly traded on a securities exchange such as NYSE, NASDAQ and AmEx. MLP ownership interests are known as units as opposed to share of corporate stock; cash paid out to unit holders is known as distributions rather than dividends. In its purest form, an MLP combines the favorable tax treatment with the liquidity of publicly traded securities.
It is this favorable equation that spurred Susser Holdings Corp., a successful, multi-generational retailer with strong marketing origins, to form Susser Petroleum Partners (ticker symbol SUSP), and for which it launched an initial public offering (IPO) in September.
In essence, the Susser leadership team led by CEO and president Sam Susser Jr. is splitting its fuel marketing and c-store retailing arms into two entities, the former being an MLP, the latter the more conventional publicly traded C corporation. In September, 9.5 million common units representing 49.9% interest in Susser Petroleum went to market.
Citing federal restrictions, Susser executives Sam Susser and Steve DeSutter declined comment on the move or its strategic underpinnings. Indeed, executives with a half-dozen companies pursuing MLPs said they could not comment for this story due to SEC restrictions.
But several observers familiar not only with Susser’s move but also that of other industry companies pursuing similar structural changes say the MLP model provides Susser with greater access to capital, reduces corporate risk and allows leadership to leverage the advantages of the limited partnership structure and that of a traditional publicly traded company.
“One of the main factors of an MLP is generating consistent growth and cash flow year over year,” says Ross of Cadence Bank. “By having both the holdings company and the MLP, Susser can buy a diverse pool of assets and move the consistent revenue-generating assets to the MLP.
“The last thing you want to do,” he continues, “is roll into an MLP an acquisition that is going to have assets that drag down your revenue base.”
Susser Holdings, unlike its MLP cousin, can take the time to invest in slower-performing assets, infuse capital and commit the necessary funds to turn a turtle into a hare.
“Susser is really the first true convenience-store operator to realize the potential of their fuel assets,” says Michael Johns, managing director of Toronto-based BMO Capital Markets, citing that the company controls about 1.3 billion gallons annually. “On the distribution side, there is perceived stability in this kind of investment.
“MLP investors are looking for growth and a dividend yield.”
The advantages of MLPs are several, notably:
- Tax benefits: MLPs do not pay corporate taxes (a.k.a. double taxation) as long as the business is generating at least 90% of its income from qualifying income as defined by the tax code. (See “A Taxing Situation,” p. 70.)
- Control: Under the structure, MLPs give virtually all decision-making powers to the executive team. Unit holders are not vested with voting rights, so unlike C corporations, unit holders cannot trigger a power grab. In return, MLPs can offer attractive yields relative to alternative investments.
According to Philip Trinder, president of MLP Protocol, a Houston-based independent MLP analysis and investment firm, the assets/cash flows that moved Susser Holdings into Susser Petroleum went from being worthy roughly $245 million to more than $500 million overnight because of the tax incentives.
One of the leading institutions behind MLPs in the c-store and fuel marketing sectors is investment-banking and capital-raising specialists Raymond James. In addition to assisting Susser, the company has been working with other entities in the convenience and petroleum community eyeing the structure.
“This is a new universe of well-capitalized companies able to monetize their assets,” says Roger Woodman, managing director of investment banking group for Atlanta-based Raymond James.
Another benefit, says colleague Mark Huhndorff, managing director of investment banking for midstream and coal, is the large potential pool of investors. A growing number of institutional and retail investors are seeking ways to invest in income-producing securities that benefit from the growth of energy infrastructure-related assets.