There were four MLP equity offerings last week, raising a total of $1.1 billion in gross proceeds. In all of 2011, MLPs raised around $15 billion in equity. MLPs probably need to raise around $20 billion in equity in 2012 to fund the growth capital budgets of existing MLPs and for pending IPOs. So far, they have raised around 60% of that with about 30% of the year left.
A baseline weekly rate of equity issuance is around $400mm, assuming $20 billion spread over 50 weeks to keep it simple. Expect MLPs to issue equity at a rate of significantly more than $400mm per week for the next few weeks and months, because (1) MLPs took the last few weeks off from doing deals, (2) year-to-date total equity raised has dropped off the pace a bit and (3) there are 15 MLP IPOs currently in registration, including the Alon USA Energy S-1 that was filed last Friday.
What to Expect
So, let’s review how these deals work and what you can expect if one of your MLP holdings launches an equity offering. Since 2009, almost all (183) of the 209 follow-on equity deals have been overnight deals (see below for a definition). Average deal size for all 183 deals was $202.0mm, with 74 deals larger than $200mm. So, if an MLP you own launches an equity deal, expect an overnight deal of around $200mm.
Below, I breakdown how large the discounts have been, and how the deals have traded relative to the MLP Index after pricing. Discounts have averaged around 3.85% overall with 2011’s 3.49% average the tightest in the last 4 years. Discounts have widened in 2012 and after-market performance has worsened a bit as well, particularly 30 days after the offering. On average in 2012, MLP follow-on equity offerings have underperformed the MLP index by 150 basis points.
So, when you see an MLP offering hit for one of your MLPs, you can expect it to go down around 3.5% the next day, and then underperform by an additional 1.5% in the next month, leading to an overall intra-sector hit to your portfolio of around 5% in the short term. Not the end of the world, and in a diversified portfolio, certainly surmountable.
Of note, the data above shows that the bigger the deal, the tighter the discount. This is a bit counter-intuitive, in that in the “real world” if you buy more of something, usually there is a bigger discount. But the MLPs that do the smaller equity offerings typically don’t have as much public float or trading volume, so the discount has to be larger to clear the market.
I’ve also broken down the statistics for follow-on equity deals since the beginning of 2009 by issuer. Of the 72 MLPs I reviewed, there are 20 MLPs that have done more than 4 follow-on equity deals since 2009, making their rate of equity offerings more than 1 per year.
Markwest Energy Partners (MWE) has tapped the equity markets more than any other MLP, with 10 equity deals since the beginning of 2009, including 3 deals this year. MWE has raised more than $2.5 billion in those 10 equity deals. It turns out the most equity capital raised in the public markets by any MLP since 2009 is ETP with more than $3.5 billion in 8 equity deals. Naturally, these serial issuers are larger MLPs with larger floats, so they are able to (and do) issue more equity per deal than the average MLP. Williams Partners (WPZ) is the MLP with the largest average deal size, edging out Energy Transfer Partners LP (ETP).
There are 2 MLPs that went public before 2009 that have not executed a follow-on equity offering: Atlas Pipeline Partners (APL) and Alliance Resource Partners (ARLP). ARLP hasn’t issued equity since 2003, choosing instead to use excess coverage to fund growth.
Of note in the above chart, the frequent issuance of equity hasn’t stopped most of the MLPs above from producing solid total returns for investors so far this year. In general, an MLP will have a compelling/accretive use for the equity capital raised, and most of the time (most recent MWE and WPZ deals excluded), an MLP’s distribution and unit price have grown since the prior offering or since you bought it, if you’re a long-term holder. There are exceptions, such as this week when NuStar Energy (NS) priced an overnight offering at its lowest price in more than 3 years. But at least one person saw that as a buying opportunity as well: NS’s Chairman Bill Greehey bought $24mm worth of the offering himself.
While these billion dollar equity issuance weeks can have a negative short-term effect on MLPs, the flow of funds into the MLP sector has more than kept pace with equity issuance over longer time periods. Case in point, the MLP Index has more than doubled since 2009, despite MLPs issuing record amounts of new equity each year, so there is clearly more demand than supply of MLP units in the aggregate. This fall, with more than $2.5 billion in MLP IPO backlog and probably 2-3 times that in expected follow-on equity offerings, will be an interesting test as to the depth of MLP demand in the market.
- Expect the MLPs in your portfolio to issue equity at least once a year
- Expect a ton of MLP equity to be issued between now and the end of the year
- Expect the immediate drop in an MLP’s unit price from an equity deal to be 3.5% to 4.0% the following day
- Expect MLPs on average to trade in-line to slightly lower than other MLPs after the market digests the deal
- Take the long view on your portfolio and get excited that MLPs are issuing equity at historically high prices and cheap cost to them
Each trading day might feel like Russian roulette as you scan the headlines for potential equity deals from MLPs in your portfolio. But in the long run, usually it’s nothing to be alarmed about and it may even be a buying opportunity.
Definitions for Some Terminology Used Above
Follow On Equity Offering:
The following definitions are all different ways of issuing equity of an MLP that is already publicly traded. Equity offerings for MLPs that are already public are referred to as follow-on equity offerings. Follow-on equity deals can be of either primary equity (brand new shares with proceeds going to the MLP), secondary equity (shares sold by some entity other than the MLP, proceeds going to selling unitholder, not the MLP), or some combination of primary and secondary.
Marketed deal is a fully marketed offering issued in much the same way as bookbuilt IPOs. While management is on the road for a few days, the lead underwriter (bookrunner) gauges demand for the offering and builds an order book. The issuer and bookrunner use that order book to help determine the price, then they distribute the shares to the rest of the underwriting syndicate.
Overnight deals are also known as accelerated book build offerings. Overnight deals work like marketed deals, just much faster. The underwriters announce an offering immediately after the market closes, then they fill their order books by working the phones that night, then they price the deal in the morning before the market opens. Issuers don’t have to travel around on a roadshow, don’t have to suffer downward pressure on their stock before pricing (although there is usually plenty after pricing). The vast majority of MLP follow ons get done overnight these days.
Bought deal is when an underwriter buys units from an MLP issuer before a preliminary prospectus is filed. The underwriter then resells those units to whoever it can, pocketed a spread between its purchase price and the sale. Issuers like these deals because they don’t have to worry about the deal getting done, and don’t have to worry about pricing, that’s all handled up front. Bought deals are usually priced at a larger discount to market than marketed deals and overnight deals. If the underwriter can’t sell the units, it has to hold them, so that’s an underwriter risk and a use of precious capital for the underwriter.