BP’s Move To Spin-Off Its Midstream Operations Is Likely To Enhance Shareholder Returns
With an aim to expand its midstream operations, BP Plc. (NYSE:BP) recently filed the necessary documents with the US Securities Exchange Commission (SEC) to create a master limited partnership called BP Midstream Partners LP, and initiate the initial public offering (IPO) of its common units. The move comes two months after the London-based company had hinted about its intentions to spin-off its pipeline division to derive a better value for its business. The company plans to raise $100 million from the IPO, while the market expects the issue to attract around $500 million. Either way, the incremental cash will allow BP to better manage its midstream operations, as well as generate a higher value for its shareholders due to the tax efficient structure of the new entity. Below, we take a quick look at BP’s rationale behind this move and the potential impact on the company.
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BP Midstream Partners, BMP
BP Midstream Partners, or BPMP, is a master limited partnership (MLP) formed with the aim to own, operate, develop and acquire pipelines and other midstream assets, mostly in the US. Its initial assets will include ownership interests in one onshore crude oil pipeline system, one onshore refined products pipeline system, and one onshore diluent pipeline system that carries shipments to or from BP’s Whiting Refinery in Whiting. These three assets are expected to drive more than 60% of the company’s cash available distribution in 2018. In addition, the entity will also have interests in four offshore crude oil pipeline systems and one offshore natural gas pipeline system that connect offshore production areas in the Gulf of Mexico (GOM) with the Gulf Coast refining and distribution hubs. Below is a snapshot of BPMP’s assets and their estimated contribution in cash available for distribution in 2018.
BP’s Rationale To Form An MLP
An MLP, despite being a limited partnership, is listed on a stock exchange. The most peculiar feature of an MLP is that it is exempt from paying corporate taxes on distributions, or earnings, to its partners/investors. However, in order to receive these tax benefits, the MLP must generate at least 90% of their income from qualifying activities, such as production, processing, storage, and transportation related to natural resources, commodities, or real estate. Consequently, over the years, it has become a preferred form of business structure for capital intensive industries, such as oil and gas and real estate, as its tax-efficient structure helps in reducing the cost of capital for the parent companies.
As the commodity downturn continues to pull down the oil and gas industry, BP’s decision to spin-off its midstream assets into an MLP seems to be a judicious one. The creation of an MLP will allow the company to raise additional capital to manage and expand its midstream business at a time when a majority of these assets are undervalued and companies are finding it difficult to divest or sell them. With the listing of its midstream operations through an MLP, BP expects the market to attach a rightful value to these assets, which will enable it to enhance its shareholders return.
BP is not the first company to use an MLP to enhance the value of its midstream business. Its closest competitor, Royal Dutch Shell (NYSE:RDS.A), had separated its midstream operations by creating an MLP, Shell Midstream Partners (NYSE:SHLX), in mid-2014. At that time, Shell had managed to raise around $1 billion dollars to run its midstream MLP, which currently has a market capitalization of more than $5 billion. Other oil and gas players, such as Marathon Petroleum Corp and Valero Energy Corporation, have also successfully divested their midstream businesses into MLPs, and enjoyed higher valuations.
Bearing this in mind, the company has currently offered 7.5 million common units of BPMP at a price range of $19-$21 per unit, and expects to raise at least $100 million through its IPO. However, based on the proforma numbers released by the company, BPMP’s cash available for distribution to investors for the twelve months ended 30th June 2017 was more than $113 million, and the number is estimated to increase to $117 million by 2018. Consequently, the market anticipates BPMP’s IPO to fare well among investors despite the ongoing volatility in commodity prices, and exceed the $500-million mark quite easily. In our opinion, if the company manages to raise the proposed $100 million or more from the IPO, it will be in a strong position compared to its peers due to the increased capital to run its midstream business, and higher tax-free distributions that will come in the future years.
Proposed Structure For BP Midstream Partner (BPMP)
Source: Form S-1, BP Midstream Partners
Apart from the newly infused capital, the unique structure of the MLP will enable BP to retain operational control as well as partial ownership of its pipeline assets. According to the press release, BP will own complete general partner interests, and a majority of limited partner interests in BPMP. Thus, being a general partner will enable BP to manage the day-to-day operations as well as the expansion activities of BPMP, while holding a notable share of the limited partner interests will allow the company to retain ownership in its assets. This means that the company will have raised additional capital (through the IPO) and still continue to operate and own (partially) its midstream assets.
Lastly, with a majority of limited partner interest and all the incentive distribution rights (IDR) in BPMP, BP is likely to receive a higher share in the cash available for distribution of the new entity. Plus, since a majority of an MLP’s earnings are passed-on, or distributed, to its investors without any tax burden to either parties, it will result in maximization of cash flows for BP as well as other investors.
Hence, in conclusion, we believe that BP’s move to separate its midstream operations, primarily the pipeline business, to derive a higher value for its investors is a well-grounded one. The MLP structure will enable BP not only to raise new capital to operate and expand its midstream business, but will also generate higher tax-free earnings for its shareholders. All these factors are likely to contribute to an increase in BP’s stock price in the coming years.
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