How to Evaluate an MLP Joint Venture

As MLPs exit the energy downturn, JVs have become a popular method not just of self-preservation, but also of securing otherwise-impossible growth opportunities. In some cases, cooperation certainly can follow or in some cases help skip consolidation. Instead of two companies with similar assets deciding that one will buy the other’s assets, they can combine them in a joint venture (JV). Neither company has to surrender a good asset and neither company has to raise the cash to buy a good asset. JVs may dilute the profits, but they also dilute the risks and responsibilities.

While JVs most commonly involve two companies, they’re not limited to that. There’s nothing preventing three or more companies from working together. Additionally, MLPs need not partner with only other MLPs; we’ve seen MLP-Private Equity, MLP-Customer (Utility or Producer), and MLP-Private Company.

JVs are also not just for new assets, either. Sometimes an MLP will form a JV around an existing asset that needs capital to pursue expansion projects. Less optimistically, if an asset is not performing optimally (either on a volumes or profits basis), an MLP may choose to sell a portion of the asset and term the sale a joint venture.

Motivations
Geographical Access – Since MLPs frequently have monopolistic footprints, a company wanting to begin operations may be able to do so more quickly and easily if they partner with a company that already has presence in a particular area.

Cost Sharing – This is most common when MLPs partner with a private equity firm. In exchange for a share of the profits, PE provides the necessary capital. Often, one partner is a silent partner; however, it’s not unheard of for two MLPs to each contribute capital to pursue a joint project either, particularly if one MLP has a stronger balance sheet than the other.

EnLink Midstream Partners (ENLK) partnered with Natural Gas Partners, a private equity firm, to expand their G&P business in the Delaware Basin. ENLK will construct, manage, and operate the assets, while NGP has contributed the cash necessary to make this project a reality by the end of the year.

1 + 1 = 3 Greater Returns Together – Combining two projects reduces competition. This is most common when two companies are trying to build similar assets in the same area, but the demand only supports one. The best example of this is when Saddlehorn Pipeline (a JV itself between Magellan Midstream Partners (MMP), Plains All American Pipeline (PAA), and Anadarko Petroleum Corporation (APC)) and Grand Mesa Pipeline (by NGL Energy Partners (NGL)) combined projects to move crude oil from the DJ Basin to Cushing, OK. Neither project alone was able to sign enough volumes to make construction worthwhile, but together the project was able to proceed.

Locking in customers – When an MLP partners with one of its customers in a JV, traditionally the customer gets priority access. As a part-owner of the asset, the customer is unlikely to take its business to a different company. Crestwood Equity Partners (CEQP) and Consolidated Edison (ED) recently partnered on CEQP’s existing natural gas storage and pipeline assets in northern Pennsylvania and southern New York. The majority of ConEd’s operations revolve around serving metropolitan New York so ED will benefit from infrastructure access while CEQP will benefit from the stability of ConEd as a customer.

Risks
Missing the Boat – If an MLP does not pursue a JV, it could be that it simply doesn’t need one. It already has a foothold in desired geographic areas, can raise the cash necessary to grow, and has customers willing to sign long-term contracts committing to the majority of an asset’s capacity. If a company does not have those things, however, it risks missing the boat. If an MLP refuses a JV until it can raise the cash itself, another company may serve the needs of its customers first. The opportunity will not last forever. Alternatively, if two MLPs are both trying to build a pipeline traversing the same area and neither has full commitments from customers, then perhaps neither will be able to make the pipeline profitable. Or neither will build the pipeline. Instead of both companies breaking even or losing money, each can benefit with a JV.

Losing Control – In a JV, the operation of the asset may be in the hands of only one partner, or it may be divided between them. However, if one partner is a minority owner with minority voting rights, it may find that the other partner makes decisions with which it doesn’t agree, but has no recourse.

Price for Everything
A joint venture (as with anything in business) is a matter of self-interest. No MLP pursues a JV for purely altruistic reasons. Strong MLPs with strong balance sheets and plenty of growth opportunities are generally only willing to participate in JVs if it will anchor a good customer. The compensation an MLP receives for giving up an interest in its assets should reflect the value of the asset and potential growth. However, in the current environment, the final agreement is also balanced by the MLP’s need for self-preservation and the potential opportunity cost of not pursuing growth opportunities.

Of course, for the right price, everything is for sale. When considering the right multiple for a new JV on an existing asset, look first to the original multiple at which it was built or bought. Consider recent multiples on similar assets. Many companies will list expected multiples after several years of improvement and while that is useful information, the future is uncertain.

And After This
What could follow cooperative JVs? At a certain point, as the rising tide lifts all boats, confidence begins to creep in when cost of capital is cheap, demand is strong, and every project turns more profit than expected. Companies begin to pursue projects without partners in order to maximize the potential profits. Many JV agreements include clauses for one partner to eventually buy out the other. At this point, investors and management teams alike should beware of arrogance (or more politely, irrational exuberance) as overpaying for assets simply to own them rarely turns a profit. However, long before that point is reached, there may be years of hard work and incremental gains.

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