Note on Master Limited Partnerships

Abstract

Master limited partnerships (MLPs) are limited partnerships that trade on public exchanges in the form of units, similar to common stock. MLPs have several advantages relative to traditional C corporations (C-corps) that have resulted in their frequent use to finance energy-infrastructure assets. The general partners (GPs) retain control of the assets placed in the MLP, can drop down assets to the MLP, often at advantageous prices, and receive incentive distribution rights (IDRs). IDRs increase the GPs' share of the distributions over time, which in turn affects the MLPs' cost of capital. MLPs do not pay taxes at the entity level, which increases the amount of cash that can be paid to GPs and unitholders. MLPs trade on the basis of their yield and the stability and growth of their distributions. This technical note provides a brief history of MLPs, a description of their key features and terms, and several approaches to valuing them.

Excerpt

UVA-F-1828

May 17, 2018

Note on Master Limited Partnerships

Master limited partnerships, referred to as MLPs, are limited partnerships that trade on public exchanges. Most MLPs are formed as limited partnerships and trade in the form of partnership units (referred to as common units, or simply units), comparable to the common stock of corporations. MLPs have different governance structures in terms of voting and control rights and are taxed differently than traditional corporations (referred to as C corporations [C-corps]), whose income is taxed at an entity level. This technical note provides a brief history of MLPs, a description of their key features and terms, and several approaches to valuing them.

MLPs are pass-through partnerships that are exempt from corporate taxes. This means that MLPs generally do not pay firm-level income tax; instead, their income passes through to the unitholders. The unitholders pay tax on their distributions at their individual tax rates, but the pass-through structure allows MLPs to avoid the double taxation of income. MLPs are also generally required by the partnership agreement to pay out all available cash to investors, and as a result, investors receive relatively high distributions. Because of these features, MLPs are valued for their yields and ability to maintain or grow distributions. For these reasons and others, assets housed within an MLP structure tend to trade at higher multiples than those that reside within a C-corp (Exhibit 1).

Since the mid-1990s, MLPs have grown significantly in terms of their numbers and market capitalization (Figure1). By one count, starting from six MLPs in 1994, there are 112 energy-related MLPs with, collectively, a total market value of approximately $ 400 billion in 2016. Their growth has been attributed to their attractive yields to investors and their role in financing energy and infrastructure assets.

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Keywords: master limited partnerships, limited partnerships, MLPs, C corporations, C-corps