Thursday saw another example of tone-deaf decision making by the management of an MLP. Teekay LNG Partners (TGP) is an operator of ships that transport Liquified natural gas, petroleum gas and crude oil. Shipping is a horrible business; unlike pipelines, ships are highly mobile and so you’re never the only transport solution from A to B. On top of that, when industry overcapacity drives a ship owner out of business the ships live on, still contributing to the pressure on rates. Bankrupt shipping companies could provide a service to their competitors by scuttling their ships, but unfortunately they never do.
TGP cut their distribution by 80% on Thursday, claiming that they would fund their growth plans with internally generated cashflow since the equity markets are effectively closed to them. In other words, the opportunities to reinvest cash in their business are so good they’re taking the decision out of their investors’ hands and redirecting the cash for them. Even though TGP was yielding 15% prior to the announcement, this implausibly high distribution yield evidently wasn’t reflective of widespread expectation of a cut since the stock promptly sank 50%. This may be due to the fact that although TGP’s press release claimed that “cash flows remain stable and growing” the company declined to provide any guidance for 2016 EBITDA. So it’s hard to know if they’re telling the truth. MLP investors value their regular distributions, and the persistent high yields on MLPs indicate that investors would prefer growth plans to be cut. A management that ignores this is looking for a new set of investors, a betrayal of the trust placed in them by the original ones. In fact, there’s something bordering on dishonesty about what TGP has done. If your operating results aren’t good enough to cover the quarterly payout, well that’s a risk that investors accepted. But TGP claims that business is good, cashflows “stable and growing.” Deciding to stop making payments to investors in order to reinvest the cash in new projects is to deny the message that the already high yield communicates. Investors don’t value those growth opportunities very highly, which is why TGP had already fallen 50% this year before the cut. There’s not much difference between TGP’s behavior and a hedge fund manager who prevents withdrawals by claiming unreasonably low prices on the securities he’d have to sell to meet the redemption. If they’re telling the truth about operating performance then they’re taking investors’ money to invest as they see fit, simply because they can, in spite of the fact that investors would clearly prefer that they did not. Or, operating performance is not as good as they say. Either way, it’s hard to see how management can regain trust after such betrayal.
The other day one MLP investor was reeling off to me a list of tickers of MLPs that he owns, including well-known names such as EPD, ETP and PAA. He noted his portfolio also included regrettable overweights to OMG and WTF. It’s been that kind of year.
While we’ve wrestled with understanding operating performance, it’s increasingly clear to us that investor psychology is far more important in explaining returns on MLPs this year. U.S. K-1 tolerant high net worth investors remain the chief source of capital for MLPs. Crossover buying by U.S. and foreign institutions is impeded by significant tax barriers, so the sales made by ’40 Act MLP funds as their investors flee have a limited set of potential buyers. We’ll be exploring this more in our 2015 letter.
We are invested in EPD.