As I am somewhat new to the MLP universe, I have a question - Can a MLP buyback units as corporations can buyback shares? If we use CEP as an example, analysts and folks like Cato indicate that CEP is currently trading at a discount to its intrinsic value. Even if it is not, it is certainly trading at a huge discount as to what funds CEP enjoyed receiving from the PIPE(s) last year. Is there any technical regulation that a MLP like CEP could not use excess cash or borrow funds to buyback units? From a cash flow perspective, this would seem a prudent idea. If I can borrow at say 6% and buyback shares that pay 10+%, why would I not want to do that? Some have indicated that hedge funds where borrowing cheap to invest in MLP(s) with high yields, can't a MLP do the same? I understand that CEP is thinly traded and any attempt at acquiring a large position would drive up the price. That said, we would appear to have plenty of upside in unit price available before it would no longer be financially beneficial and there sure does not appear to be lack of big sellers around to unload some of their units. If possible, this appears to be the time for CEP to take advantage of the current circumstances to help themselves out and unitholders. So, what am I missing or not understanding about MLP(s)?
You really have to look at the laws of the state in which the MLP is formed as well as the partnership agreement to see what an MLP can do as far as buybacks.
Most MLPs are required by their partnership agreement to distribute available cash, as defined in the agreement. I don't know that the agreements say that you can reduce distributable cash to make a buyback. Retaining cash to make buybacks is not generally a good option in an MLP since income is passed through to partners and partners want their distributions. Corporations are designed to have retained earnings and thus cash for buybacks is a more natural fit.
There are some income tax aspects to partnership buybacks that would have to be thought through as well.
As far as lenders are concerned, cash flow is what really counts and a buyback doesn't increase the MLPs cash flow even though it might increase distributable cash per unit. Corporate buybacks are frequently based on attempts to bolster price by reducing share count to bump EPS. In an MLP, the buyback could, in the near term, actually reduce available cash and available cash per unit, so it isn't a terribly attractive option.
Any MLP I would invest in would hopefully do better investing its cash internally (more drilling for example) than buying back units.
I will probably be looking into the MLP agreements of my holdings to see what they say about buybacks as this is an interesting question.
One more thought -- the loan agreements with lenders might prohibit obtaining financing to buy back units/make distributions. So even if state law and the MLP agreement permitted it, there are other factors to consider as well.
I've heard this question asked at two conference calls - CEP and EVEP (or maybe LINE). In both cases, they said it was something "they might consider" (not exact quote), but didn't have explicit plans to do.
So by implication, it is possible for them to do -- though, I'm not sure how lenders would look upon it.
From a lenders view point, I think any strategy that improves cash flow would be considered positive. I do recognize that debt payments vs. distribution payments are two different animals as the later can be stopped and the business can still function.
Hopefully, as we near earnings announcement, CEP will have something more aggressive to say than "we just need to execute on operations and the rest will take care of itself" or something like that. Please note that was not a quote from management, just something I think managements often say or imply.
Cato, thanks for your posts, they stimulate thought and research.