For the next two weeks of columns, I want to tackle two major trends in MLP equity issuance: at-the-market (ATM) equity offerings and variable distribution MLP IPOs. This week, I’ll cover ATM deals, then next week, I’ll review the large increase in the number of MLPs going public with a variable distribution structure (with no incentive distribution rights, no subordinated units) rather than the more common minimum quarterly distribution structure (with IDRs, and subordinated units).
History Lesson: MLP PIPEs
MLPs need massive amounts of equity each year to fund growth, because they pay out most of their cash flow. The traditional method of raising equity is a marketed follow on equity offering, which involves a 2 or 3 day marketing period (or book build). During that 2 or 3 day period, however, the MLP’s price tends to fall quite a bit. Demand for MLP units has developed to such an extent where nowadays, a 2 or 3 day book build is unnecessary, and MLPs are doing overnight equity offerings, which involves launching a deal after the market close and pricing it before the market opens the next day. The vast majority of MLP equity since 2009 has been raised via overnight offerings.
MLPs are always looking for alternatives to the traditional methods. Every few years, a new way to issue equity catches on in the MLP space. In 2006 and 2007, private investments in public equities (PIPEs) invaded the MLP space. For a PIPE, the MLP would sell equity directly to private buyers (MLP funds, hedge funds, etc.) at a negotiated discount. The units sold carried a restriction period during which the units could not be sold (called the lockup).
PIPEs were great for the issuer initially, because there was no market volatility around the equity offerings. However, these deals became so popular that eventually the amount of locked-up equity was so great that it limited the amount of float actually trading in the marketplace and created huge equity overhang pressure, because the (increasingly illiquid) market was anticipating that these large private buyers would eventually sell their equity. In 2007, PIPEs peaked, and represented more than half of the $17.5 billion in equity issued by MLPs. The PIPE overhang and the financial crisis in 2008 put a halt to most PIPE issuance, although you do see some PIPE deals popping up now and again.
At-the-Market Equity Deals
A new equity issuance mechanism has emerged the last few years: the at-the-market (ATM) equity offering. ATM deals work like this: an issuer hires a bank and grants them the ability to sell up a certain dollar amount of equity (say $100mm) at the prevailing market price. The issuer will likely have a limit price in place below which the bank cannot issue the equity. The bank serves as an agent and finds buyers in the public market, or can sell the equity in block trades, but the equity gets sold over several weeks.
Before 2009, there were no MLP ATM deals, but starting in 2009 (as shown below), the structure has grown in popularity. In 2011, there were 8 MLP ATM deals for $2.3 billion in equity, at an average of $283.0 million per deal. So far in 2012, there have been 3 ATM deals filed with an average per deal size of $569.5 million. 2012 will almost certainly be a record year in terms of deal size and total ATM issuance.
ATMs are usually executed by the larger and more liquid MLPs, because in order for the ATM deal to work, there must be a significant amount of trading volume such that the equity sales won’t push down the price too much. The issuers so far this year have been Kinder Morgan Energy Partners (1 offering at KMP and 1 at KMR) and Plains All American (PAA), two of the largest and most heavily traded MLPs out there.
The interesting thing about these deals is that besides a 424B5 filing with the SEC, you don’t hear much about these deals until that MLPs earnings release where management may mention that the firm raised a certain amount of equity via at the market offerings during the most recent quarter. Because of the stealthy nature of these deals (i.e. no press release), the prices of these MLPs are generally not as negatively impacted as they would be in the case of an overnight registered public equity offering when all the dilution hits at once.
ATM deals seem like a logical way for an MLP to dribble out equity into the public market without materially impacting stock price, and doesn’t create the overhang problems like the great PIPE deal boom of 2006 and 2007. However, as investors, always check the SEC filing and be aware of which MLPs are issuing equity “at the market” before you buy them.