Scorpio bulkers

Tax-Free MLPs Sweeping the Shipping Industry

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September 11, 2014

Scorpio bulkers

By Isaac Arnsdorf

Sept. 11 (Bloomberg) — Master limited partnerships, tax- exempt companies that pay investors most of their income at the cost of added risk, are spreading in the shipping industry.

Scorpio Tankers Inc., the largest owner of vessels hauling refined fuels, is “seriously” considering starting an MLP, President Robert Bugbee said in an Aug. 26 phone interview. The Monaco-based company would join GasLog Partners LP and Dynagas LNG Partners LP among shipping companies that recently reorganized as publicly-traded partnerships that pay no corporate income tax.

MLPs trade at a higher multiple of their assets than do corporations, and are popular with investors hunting for better returns in the sixth year of near-zero interest rates, leading them to riskier businesses. The cash streams from some MLPs may not be reliable because shipping rates, for instance, are volatile. Scorpio is considering the structure a month after the man who popularized it, Houston billionaire Richard Kinder, said he was dissolving his company’s MLPs.

“It would be appealing because if you have an MLP you can sell assets at a premium,” said Erik Folkeson, an Oslo-based analyst at Swedbank AB. “The volatility in shipping has discouraged MLPs so far, but if they can line up a series of long-term charters, it should be possible.”

Attractive Deals

Scorpio hired a banker to advise the company on the process, Bugbee said in the interview. If it decides to form an MLP, Scorpio would be the controlling company, known as the general partner, he said.

At least a dozen shipping and offshore drilling companies have formed MLPs since 1987, with 11 currently trading. The most recent additions are Hoegh LNG Partners LP on Aug. 7 and Transocean Partners LLC on July 31.

MLPs are attractive because they provide funding to companies with big expansion plans and their shares trade at 1.5 to 2.5 times the value of their assets, compared with 1 to 1.5 times for regular corporations, Michael Webber, an analyst at Wells Fargo Securities LLC, said in an August 7 report.

The partnerships may also pose risks to investors as companies with less stable cash streams adopt the structure, according to Morgan Stanley.

The interest extends beyond shipping. Among energy companies, Hess Corp.’s July 30 announcement that it would form an MLP sent shares to a five-year high. Royal Dutch Shell Plc said a month earlier it would spin off U.S. pipelines into a partnership. Also in June, Consol Energy Inc. and Noble Energy Inc. said they’d sell stock in a natural gas pipeline.

Paper Rally

Shares of paper companies rallied after New York-based hedge fund Perry Capital LLC bought stakes and said mills could become MLPs. Rock-Tenn Co. called the structure “potentially attractive,” while International Paper Co. said the discussion is “theoretical” without the blessing of the Internal Revenue Service.

MLPs began in the 1980s and are limited by law to companies whose revenue comes from natural resources, including transportation. The number of MLPs has almost doubled in the past four years to 123, according to law firm Latham & Watkins LLP.

The IRS announced a pause on approvals earlier this year, noting the proliferation of new MLPs. Last month, Kinder, who popularized the structure, abandoned it by reorganizing his empire so that Kinder Morgan Inc. bought out the MLPs it controlled.

Cash Payouts

Other U.S. companies have reduced their taxes by buying smaller foreign companies and moving their address. President Barack Obama called the practice, known as inversions, unpatriotic.

While not technically required, the majority of the partnerships pay out almost all their cash to shareholders. Many own pipelines that collect fixed fees on multiyear contracts, providing predictable returns, according to Morgan Stanley.

Early MLPs show the challenges of adapting the oil pipeline model to the shipping industry. Along with publicly-traded companies, Capital Product Partners LP, which runs the same type of ships as Scorpio, cut its dividend in 2010 as its vessels’ contracts had to be renewed amid slumping freight rates.

Navios Maritime Partners LP bought container ships last year to compensate for the drop in earnings for its dry-bulk carriers. The Piraeus, Greece-based MLP hasn’t raised its payout since 2012. Laura Hynes-Keller, an external spokeswoman with Rubenstein Associates, said Angeliki Frangou, Navios’ chairman and chief executive officer, was unavailable to comment.

Volatile Rates

Rates collapsed across the shipping industry because owners ordered too many vessels before the global recession. The recovery has taken longer than expected, weighing on shares of shipping companies this year, according to Frode Moerkedal, an Oslo-based analyst at RS Platou Markets AS.

Daily earnings for Medium-Range oil-products tankers averaged $9,514 this year, 28 percent less than in 2013, according to Clarkson Plc, the world’s largest shipbroker. In January, analysts predicted rates would average $16,625 in 2014, the average of eight analyst estimates compiled by Bloomberg showed.

Scorpio shares fell 19 percent to $9.50 this year, compared with an 8.3 percent advance in the Standard & Poor’s 500 Index of U.S. equities.

The elusive recovery in charter rates has restrained the value of Scorpio’s fleet, Moerkedal said. The price of a five- year-old MR tanker fell 6.1 percent this year to $26.1 million, according to the Baltic Exchange in London. An MLP could let Scorpio improve its valuation because investors would focus on the ships’ cash flow rather than their price, he said.

“It would be a way for them to increase their valuation,” Moerkedal, whose recommendations of shipping stocks returned 17 percent in the past year, said in an Aug. 27 phone interview. “You probably have to lock in some contracts and then you’re set to go.”

Copyright 2014 Bloomberg.

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