Foreign MLPs

Foreign MLPs
Using foreign energy-related
assets to attract yield-oriented
investors
Opp
Energy companies around
the globe are taking
notice of the growth and
success of master limited
partnerships (MLPs) in the
United States. The foreign
MLP/YieldCo is one way
for foreign companies to
benefit from this unique
yield-based structure.
pportunity
Since the debut of the US MLP structure in the early 1980s,
more than 120 publicly traded MLPs have been introduced to
the market, providing capital to companies with assets that
generate “qualifying income” at a lower cost and giving
investors a higher-than-typical yield.
When evaluating the historical MLP market, successful market
participants (which have ranged from the traditional midstream
(e.g., pipeline or gathering system MLPs) to upstream,
downstream, propane, coal and a variety of other activities) have
generally shared certain necessary characteristics — namely:
• They have relatively stable earnings and cash flow, along
with longer-termed contracted arrangements — allowing for
predictable distributions.
• They have financially and commercially strong sponsors,
often with retained assets (either directly or indirectly)
that could be “dropped” (i.e., transferred) into the MLP in
the future.
• They have assets that can be strategically packaged
(e.g., a pure-play MLP) to provide an attractive offering to
public markets.
• They have an MLP treated as a pass-through entity for US
federal income tax purposes in which at least 90% of the
MLP’s gross income is “qualifying income” — that is, derived
from certain activities in natural resources, real estate or
commodities, among others.
The success of these energy-oriented MLPs in attracting
investors has drawn the attention of companies outside of the
US that are eager to raise capital. Companies with foreign assets
are increasingly looking to adopt similar business structures
— similar to the traditional domestic US MLP structure — that
may allow access to the rich yield-oriented investor base for
companies listed in the US.
The first companies to pursue these structures were
international shipping companies. Because shipping companies
literally have “floating” assets, depending on the geographical
location and type of activity, they often have a limited US
federal income tax footprint. Moreover, these first-movers
had stable, long-term contracts, strong sponsors and a clear
story to present to the market. The same holds true for foreign
companies with other types of offshore assets such as drilling
rigs. Several foreign MLPs with these types of offshore assets
have gone public over the last few years, and in 2014, the
first foreign MLP with fixed assets located primarily in foreign
countries went public. This trend is expected only to increase
in popularity.
How foreign MLPs are structured
How does the structure work outside the US? Basically, a foreign
MLP is a yield-driven company (YieldCo) formed outside the US
(typically a low-tax jurisdiction), with units or shares traded on a
US stock exchange. Further, most foreign MLPs are organized
as limited partnerships or limited liability companies in a lowtax jurisdiction such as the Republic of the Marshall Islands,
which has a variety of similarities to a US entity (e.g., legal or
regulatory), and has no significant entity-level tax liability.
Importantly, regardless of the structure chosen, foreign
MLPs typically (although not always) elect to be treated as
corporations for US federal income tax purposes. The benefit
of this election is two-fold: (a) as a corporation for US federal
income tax purposes, the foreign MLP does not have to meet
the “qualifying income” rules with respect to its operations; and
(b) tax-exempt and foreign investors may be more interested in
making investments in the entity, as such investors generally
prefer investing in entities that are treated as corporations for
US federal income tax purposes (for a variety of US federal
income tax reasons).
Foreign MLPs
1
Advantage
The primary constraints are that the foreign MLP’s assets
must produce a stable stream of cash flows over time — this
is a market requirement as opposed to a technical or tax
requirement. Further, detailed tax and economic modeling is
often required to understand and quantify the tax consequences
to the investors of the international operations, including, but
not limited to, the “tax shield” provided to investors (i.e., the
ratio of taxable income to distributed cash). A foreign MLP with
significant (or exclusive) offshore operations can mitigate its US
federal income liability tax by either (a) the lack of US operations
or contacts or (b) deductions for depreciation or other offsets.
The actual organizational structuring typically involves the
sponsor company forming either a limited partnership or a
limited liability company (the foreign MLP). The foreign MLP’s
asset is often its ownership of a wholly owned (or jointly owned)
operating company, which owns the cash-producing assets —
for example, offshore drilling platforms, terminals or storage
facilities. The operating company (or other lower-tier entity) is
oftentimes the entity that incurs the debt; however, most foreign
(and US) MLPs have debt at the MLP level as well — all based on
operational and commercial considerations.
Similar to the ownership of a US-formed MLP, the ownership of
a foreign MLP/YieldCo is split between the sponsor company (or
companies) and public investors. The specifics of that split are
determined prior to the initial public offering (IPO), based on the
optimal size of the offering and the MLP’s capital structure. The
sponsor often retains the portion of the IPO not sold to the public
(which generally includes subordinated interests and common
units) and often a 0% to 2% stake in the MLP that represents full
ownership of the general partner (GP) (and which receives the
incentive distribution rights (IDRs) that effectively represent
the right to increasing cash flows above certain economic
performance thresholds). These features oftentimes mirror the
structural characteristics of a traditional US-formed MLP.
2
Foreign MLPs
The GP manages the day-to-day aspects of the MLP and its
operating company. It typically has its own executive team
and board of directors, both of which are appointed by the
sponsor (and subject to numerous rules and restrictions as to
composition and makeup). As one would expect, a number of
variances and options are involved in the design and structure
of a non-US MLP — as the structure is not a “one-size-fits-all”
structure — but the scenario described above is most common.
Advantages of non-US MLPs
Foreign MLPs/YieldCos share many of the key characteristics of
a traditional US-formed MLP:
• Minimal tax liability
• Cash-producing operating assets
• Often stable, long-term contracts
• Ability to attract investors with consistent (and growing)
distributions of cash
But unlike US-formed MLPs, foreign MLPs/YieldCos have no
restrictions on asset or income composition. Consequently,
additional operational flexibility may result.
Additionally, distributions by foreign MLPs/YieldCos (that elect
to be classified as a corporation for US federal income tax
purposes) to shareholders can be reported via a Form 1099
versus the more complex Schedule K-1 that is required from
MLPs that are classified as partnerships for US federal income
tax purposes, which can be a major consideration for companies
and investors alike. And since foreign MLPs are typically
considered foreign private issuers (FPIs) under US securities law,
they may receive certain filing accommodations or exemptions.
ge
These benefits may make it extremely attractive for overseas
energy companies to create foreign MLPs, particularly with
offshore assets that have limited local tax obligations.
Still a market for yield-oriented investments
Can foreign MLPs expect the welcome reception that other
energy partnerships have received from the US market? The
answer, of course, depends on the nature of the offer and the
value of the underlying assets. But, in general, there are no
signs that the equity markets have grown tired of yield-oriented
offerings.
Despite the growth in the number of MLPs in the market, there
is still an abundance of capital chasing yield-based investments
in what has proven to be a long-term, low-interest-rate
environment. That trend will likely continue for years to come,
especially as more members of the Baby Boomer generation
retire and begin seeking income-oriented investments.
With yields that can hit the 7% to 8% level, foreign MLPs can
provide an attractive option for individual retail investors and
even institutional funds — strong predictable income from a
diversified portfolio of lower-risk, high-quality assets. In fact, the
market for these types of investments has never been larger;
today, total market capitalization for MLPs is estimated to be
more than US$600 billion.
In short, there is still plenty of opportunity for overseas
companies — particularly those in the energy industry with
income-producing offshore or transportation assets — to
participate in the US capital markets through a foreign MLP.
Foreign MLPs
3
Value
MLPs can unlock value
The IPO journey
For most overseas companies, an obvious benefit to forming
a foreign MLP is access to a lower cost of capital.
Companies considering a foreign MLP should anticipate that
once a decision has been made to move forward with the IPO,
the IPO process will take six months to a year. It’s important that
companies prepare properly and make informed decisions along
the way. As with any IPO, the preparation and allocation of are
critical resources during the IPO process. For example:
But there are other advantages, too.
Creating a separate entity to hold specific, related assets
can improve the investment profile of both the MLP and the
sponsor company, increasing the value of non-core assets to the
parent company. And unlike a full spin-off, the sponsor retains
operational control over the foreign MLP’s assets and continues
to reap the benefit of regular cash distributions through its
continued ownership in the MLP. Further, the sponsor may
be able to raise equity at a higher valuation multiple than it
may be able to under its existing structure, as the yield-based
investment market may pay a premium for the structural
benefits and the promise of yield.
At the time of the IPO, the foreign MLP’s sponsor also receives a
unique claim to future cash flow through the IDRs. As discussed
above, the IDR typically allows the GP to receive an increasing
share of cash distributions as those distributions increase over
time. As the foreign MLP’s yield increases over its originally
stated minimum quarterly distribution, the GP may earn a higher
percentage of the incremental gain (often up to 50%).
Forming a foreign MLP can also help create a well-defined
exit strategy for specific assets, by attracting the attention of
strategic investors such as other energy companies or even
private equity funds. Separating the assets into their own entity
makes it easier for potential suitors to identify opportunities and
analyze their value.
In summary, the foreign MLP approach allows overseas
companies to access US capital, increase the valuation multiple
of their assets and, ultimately, unlock value.
4
Foreign MLPs
• Has management reviewed the critical milestones of the
IPO journey, including setting up a project management
office (PMO), coordinating accounting and regulatory matters
(with a focus on audit readiness) and developing capabilities
for investor relations?
• Is the company prepared to meet all accounting and reporting
deadlines, bolster the governance and oversight function and
maintain and improve stakeholder communication?
• Has management considered accelerating the financial
reporting process by reviewing closing and reporting
processes and preparing a prioritized list of improvements and
an implementation plan?
• Does the company have the right resources to prepare
and document financial statements and related footnotes,
management discussion and analysis, selected historical
financial data and other key materials?
• Does the company’s documentation have a uniform set of
accounting policies and procedures to enable consistent
application of standards?
• Does the company have an experienced, knowledgeable team
in place to respond to comment letters from regulators in a
timely, accurate and thorough manner?
Proper tax planning is also essential. Thoughtful, effective tax
planning leaves more cash available for distributions and often
translates into a lower-yield and high valuation. It can also have a
significant impact on the after-tax rate of return to the sponsor.
For foreign MLPs, there are several key considerations:
When it comes to telling their story, potential sponsors
should focus on the foreign MLP’s customer base and the
length and strength of its existing contracts. Customer
creditworthiness is also important — investors want to know
that agreements will be honored.
• Minimizing US tax liabilities (considering the passive foreign
investment company rules, among other rules)
Of course, growth prospects for the foreign MLP are also
critical, especially as they relate to the ability to increase
distributions. Does the sponsor company have a plan for
dropping future assets into the public structure? Are there
opportunities for the foreign MLP to acquire additional
assets or grow organically? If investors can see a clear path
to growth over the next 5 to 10 years, the IPO is much more
likely to be a success.
• Minimizing tax liabilities in the jurisdictions where assets are
located
• Minimizing withholding taxes associated with the regular
movement of funds from local country operations up to the
ultimate investors
Companies should also review their existing debt covenants and
identify whether they will need to obtain consent from lenders
to create the foreign MLP. This may be a lengthy process outside
the US where lenders are less familiar with yield-oriented
business structures.
Finally, when making the decision to proceed with a foreign
MLP, foreign companies should not be intimidated by the U.S.
Securities and Exchange Commission (SEC) or the SarbanesOxley Act. There is a great deal of precedent for foreign
companies on the US stock exchange (with well-defined
processes and leading practices) receiving approval and
following related regulations. In addition, some foreign MLPs
may qualify as emerging growth companies and thereby be
subject to reduced disclosure and compliance requirements.
For overseas executives, there is a great deal to learn and
understand about the foreign MLP, and detailed tax and
economic modeling can often be helpful in analyzing the
economic viability and benefits of the structure. But one
thing should be clear: there may be distinct advantages to
this structure that can help your company become more
competitive across a wide range of measures.
Why EY
EY has extensive experience in helping senior executives
understand the benefits — and challenges — that the MLP
(both US and foreign) structure offers. Our teams can help
you understand the complexities of this structure and make
a well-informed strategic decision — one that can help your
management team to increase value and stimulate growth
in the years to come.
Foreign MLPs
5
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© 2015 EYGM Limited.
All Rights Reserved.
EYG No. DW0542
1506-1562606_SW
ED None
This material has been prepared for general informational purposes only and is not
intended to be relied upon as accounting, tax, or other professional advice. Please
refer to your advisors for specific advice.
Contact us
Greg Matlock
MLP Leader
Ernst & Young LLP
greg.matlock@ey.com
+1 713 750 8133
Deborah Byers
Partner
Ernst & Young LLP
deborah.byers@ey.com
+1 713 750 8138
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