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July 27 (IFR) - When oil refiner Northern Tier Energy marketed its IPO this week, it promised investors far more yield than would normally be available, by offering them direct exposure to a commodity in the form of a publicly traded security.
But their chosen structure -- known as a variable-pay master limited partnership (MLP) -- ended up pricing at just $14 per share, well below the $19-$21 the company had been expecting.
Connecticut-based Northern Tier told investors that the variable-pay MLP would distribute all available cash. In good times, the payouts would rise; in bad times, they would fall.
They are only the fourth company ever to issue a variable-pay MLP, which has introduced the element of volatility to the traditionally staid MLP asset class.
"The whole purpose of the variable MLP is to be variable," said Tim Fenn, a partner at Latham & Watkins, in a recent webcast about the fledgling asset class.
"There is nothing wrong with the fact that if the commodity price moves in the wrong direction, then the yield is going to move up, because the expectation is that it will go down at some point in time," he said. "The investor base is expecting to be able to play the commodity itself in a public security."
In the case of Northern Tier, which is backed by affiliates of ACON Refining Partners and Texas Pacific Group, the company was forced to accept pricing on its 16.25m unit IPO at just US$14.
That pricing set the implied yield on the units at a staggering 19.1%, versus 13.4% at the original guidance pricing.
The company believes it can meet that target by distributing US$245.9m to investors over the next year, to set the targeted pay out at US$2.68/unit. It is projecting a $92.7m payout in the September quarter, followed by $73.3m, $57.1m and $22.8m through June 30, 2013.
The low pricing has raised questions about the usefulness of the variable-pay MLP model.
On the basis of EV-to-Ebitda, Northern Tier garnered a forward multiple of about 5 times, based on the consensus estimates of the underwriting banks -- Goldman Sachs, Barclays and Bank of America Merrill Lynch -- used in the marketing. That compares to 4.7 times for HollyFrontier, a C-Corp refiner viewed as the purest comparable.
"If you don't get a step-up in valuation by offering yield," said one banker, "you have to question why companies would elect to structure as an MLP."
There was a view that the variable-pay structure would open up the capital markets to a wider variety of companies, drawing in investors with the promise of higher yield.
But traditional buyers of MLPs, accustomed to predictability of cashflow streams from diverse holdings of low-risk pipeline, gathering and storage assets, are hesitant to accept variability and single-asset risk. Sector-specialist funds are more likely to benchmark against tax-paying C-Corp comparables; and retail investors, a typical MLP target, are not ideally suited to the variable-pay MLP because of the inherent volatility of the structure.
Roughly 70% of Northern Tier's IPO was allocated to institutions, including dedicated MLP funds, sector specialists and income -- a much higher percentage than the 50% typical on a traditional MLP IPO.
"To a certain extent we're in uncharted waters," said one MLP banker who worked on the deal.
"Each of the variable-pay MLPs are somewhat unique," The banker said. "There is a lot more price discovery than on a traditional MLP. You are educating on structure, but more so on the specifics of the underlying asset."
Only three other companies have used the structure for their IPOs -- propane-dehydrator PetroLogistics in May, and fertiliser-manufacturers CVR Partners and Rentech last year.
The experience of PetroLogistics, a manufacturer of propylene, has highlighted the risks inherent to commodity-based investments.
The global economic slowdown led to softening prices for propylene, a basic industrial feedstock made either as a derivative of oil or, in the case of PetroLogistics, natural gas.
PetroLogistics on Thursday said it would pay a second-quarter pro-rated distribution of 26 cents from the May IPO (45 cents for the full quarter) based on distributable cashflows US$62.7m.
It earned only an average spread of 37.9 cents per pound on the 310m pounds of propylene sold during the period -- short of the 39.6 cents estimated in its IPO prospectus and estimates of 43 cents earlier in the roadshow.
On that news, the company's units fell 28 cents, or 2.6%, on Friday to US$10.57, down 41.3% from its US$18 debut.
On that news, the company's units initially fell Friday but have since recovered to $11.07, up 22 cents, or 2%, but well below its $18 debut.
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