Going Public Strategies

Transcription

1 Going Public Strategies Tulsa Master Limited Partnership Conference Tim Fenn, Partner, Latham & Watkins Greg Matlock, Partner, Ernst & Young vember 12, 2015 Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom, France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins associated office in the Kingdom of Saudi Arabia. In Qatar, Latham & Watkins LLP is licensed by the Qatar Financial Centre Authority. Copyright 2014 Latham & Watkins. All Rights Reserved.

2 Ready - Structuring Your Energy IPO Panelists Tim Fenn, Partner, Latham & Watkins Greg Matlock, Partner, Ernst & Young

3 Overview Corporations MLPs Yieldcos Up-C

4 Corporations A traditional corporate IPO is the most common and well-known form of accessing public capital. The traditional corporate structure generally results in two levels of tax (double taxation) the public corporation pays tax on its earnings, and the shareholders generally pay tax on distributions received from the public corporation. Well recognized and accepted in the public market. Historically, a desirable form of accessing public capital for a variety of reasons/circumstances: Insufficient qualifying income traditional public company is not subject to any qualifying income or qualifying asset tests Long-term capital expenditure needs Desire to reinvest or grow through acquisition, as opposed to distributing out profits Global investor base Value based on prospective earnings growth (as opposed to a cash yield-based valuation) If currently in partnership form, consider method of conversion (and timing) to corporation in preparation of IPO (e.g., assets-over, assets-up, interests-over, formless). Historic Shareholders 100-X% X% Public Company Operating Subsidiaries Public

5 Master Limited Partnerships A master limited partnership ( MLP ) is a partnership or limited liability company that is traded on a stock exchange. In contrast to corporations, partnerships generally do not pay federal income tax at the entity level. However, publicly traded partnerships are taxed as corporations unless 90% of the gross income is qualifying income (the Qualifying Income Test ). The most prominent category of qualifying income relates to natural resources activities. State Law Entity that Can Be Treated as a Passthrough for Tax Purposes Limited Partnership (most common) Limited Liability Company Business Trust Publicly Traded Liquidity & Float in the Market Nature of Holders Historically retail, rather than institutional - Mutual fund/tax-exempt holders minimal Domestic, rather than foreign Fungible Securities Listed on Major Exchange Contrasts with other Treas. Reg concerns TYPICAL MLP ORGANIZATIONAL STRUCTURE Sponsor G 2%/L/IDRs LP LLC Assets 100% L Public Lenders = ownership = debt G = general partner L = limited partner IDRs = incentive distribution rights

6 Master Limited Partnerships Distribution Characteristics MLPs typically pay out all of their available cash (essentially cash receipts less cash expenses and reserves) on a quarterly basis (partnership agreement requirement; not legal requirement). One of the hallmarks of the traditional MLP has been the relative stability in its quarterly distribution payments; the primary goal of most MLPs has been to maintain or grow distributions every quarter. Any decrease in an MLP s quarterly distribution is typically perceived very negatively by the investment community and there is usually a significant drop in the MLP s unit price when a distribution cut is announced. Typically, half of the LP interests are subordinated units retained by the sponsor. During the subordination period (typically 3 years), the subordinated units do not receive distributions until the common units receive the MQD. The sponsor retains incentive distribution rights (IDRs) that receive an increasing percentage (typically 13%, 23% and 48%) of distributions after the MQD and certain target distribution levels have been satisfied. The classic MLP is a pipeline company with long-term transportation agreements and low capital expenditures, which provides for stable to increasing cash distributions over time MLPs have historically managed cash flows through: (1) distribution coverage, (2) long-term contracts and (3) hedging MLPs by Energy Subsector 28% 38% 5% 5% 14% 10% Midstream Marine Terminals Refining E&P Other Source: Nasdaq

7 History of MLPs IPOs: Primary Industry at IPO: Exploration and Production Fertilizer CQP SXCP Refining Midstream Wholesale Distribution Shipping Other Coal Propane Timber General Partner/Holding Co. Corporate IPO EPE PVG NSH MGG HHGP ETE BGH AHGP AHD RGNC EXLP OSP NMM CPLP SEP NGLS EPB KMI NGL USAC FELP OCIR LMRK OCIP CELP NAP EMES KNOP RIGP DLNG HMLP WGP WPT GLOP UAN HCLP WNRL RMP RNF SDLP VLP AM GMLP SUN TEP SHLX TLLP LGP SRLP DM NRGP EROC DEP RRMS SXE QEPM USDP EQT PET MAR FFP WGP CRO SPH NPL NRGY NRP XTEX SXL XTXI USS KSP TGP WPZ TLP HLND TOO CLMT LINE EVEP CMLP CEQP BKEP VNR RGP OILT SMLP PSXP JPEP PAGP RNO NRGM MPLX CNNX WMLP GSJK EQM MEP VTTI PNG AMID DKL FISH PBFX TEGP CNXC EVA PTXP VAL SFL PCL FGP ETP PVR PPX STON GLP CEP QELP WMZ NKA MEMP NTI ARCX ENBL GPP BCU HWY KPP TPP UAN LEV TNH SGU CNO PAA ARLP NS MWE HEP DPM BBEP LGCY WES CHKM MCEP ALDW CVRR WLKP CPPL CAL MRP EPR PDE EEP KMP OKS EOT APU GEL TIMBZ EPD TCLP APL MMP MMLP DMLP CPNO BWP ATN ENP PSE QRE LRE PDH NSLP VNOM BSM Years

8 Currently Traded MLPs IPOs: Primary Industry at IPO: Exploration and Production Fertilizer CQP SXCP Refining Coal USAC OCIR FELP LMRK Midstream Wholesale Distribution Shipping Other Propane Timber General Partner/Holding Co. Corporate IPO NSH ETE NMM CPLP AHGP AHD SEP RGNC NGLS KMI NGL UAN RNF GMLP WGP HCLP SDLP SUN OCIP CELP EMES NAP KNOP RIGP DLNG HMLP WPT GLOP WNRL RMP VLP TEP AM SHLX EXLP TLLP LGP SRLP DM SPH NRP ENLK SXL XTXI TGP WPZ TLP TOO CLMT LINE EVEP CEQP BKEP VNR RRMS SXE SMLP RNO MPLX WMLP GSJK EQM AMID DKL PSXP PAGP MEP FISH USDP JPEP EQT TEGP CNNX CNXC VTTI EVA PBFX PTXP FGP ETP STON GLP CEP NKA MEMP NTI ARCX ENBL GPP TNH SGU PAA ARLP NS MWE HEP DPM BBEP LGCY WES MCEP ALDW CVRR WLKP CPPL PCL EEP OKS APU GEL EPD TCLP MMP MMLP DMLP BWP ENP PSE PDH NSLP VNOM BSM Years

9 Variable MLPs There is a change occurring in the MLP asset class as more and more investors look for yield without requiring stability in distributions. This phenomenon has led to the introduction of so-called variable MLPs. Structurally, traditional and variable MLPs are very similar. Although there are over 100 MLPs currently traded on U.S. stock exchanges, there are only a very limited number of variable MLPs. In the past three years the number of variable MLPs has grown from 2 to 10. Although risky, variable MLPs generally have outperformed the broader MLP universe. Variable MLPS Terra Nitrogen (Fertilizer) 1994 Dorchester Minerals (Exploration & Production) 2003 CVR Partners (Fertilizer) 2011 Rentech Nitrogen Partners (Fertilizer) 2011 Petrologistics (Refining) 2012 rthern Tier Energy (Refining) 2012 Alon USA (Refining) 2012 CVR Refining (Refining) 2013 Emerge Energy Services (Services) 2013 OCI Partners (Refining) 2013 Asset Classes Suitable for Variable MLPs Traditional MLPs Variable MLPs E&P PDP PDP, PUDs, Upside Refining Specialty products Traditional products Oilfield Services Fertilizer Mining Storage Less cyclical Uncertain market acceptance Long-term off-take agreements Long-term agreements Highly cyclical Direct commodity price exposure Spot or short-term off-take agreements Significant commodity price exposure Shipping Long-term charters Short-term charters n- Traditional Products (E.G., Asphalt, Minerals, Rail) Uncertain market acceptance Potentially spot or short-term agreements

10 Comparison of Traditional MLPs and Variable MLPs Large, Single Asset Distribution Stability Traditional MLPs Uncommon Variable MLPs More common Minimum Quarterly Distribution Coverage Ratio 1.10x 1.20x 1.0x Available Cash - Cash on hand at the end of each quarter that is required to be paid to unitholders, either through partnership agreement terms or stated distribution policy Operating Surplus - Cash generated by the MLP during a quarter less cash expenditures during such quarter, plus working capital borrowings Capital Surplus - Cash generated from asset sales and similar activities Subordination Period - Period during which the subordinated units retained by the sponsor are subordinated in right of payment to the common units Typically from 1 to 3 years, but sometimes 5 years; must meet an earn and pay test

11 Comparison of Traditional MLPs and Variable MLPs Traditional MLPs Variable MLPs Types of Securities General Partner Interest 2.0% 0% Common Units - Units held by the public and, to a lesser degree, the sponsor Subordinated Units - Units held by the sponsor that experience the first distribution cut if there is insufficient available cash to pay the full minimum quarterly distribution on all units; a device used to protect the common unitholders (typically 49% of all outstanding units at the time of the IPO) PIK Units - Units held by the sponsor that pay distributions in-kind if there is insufficient available cash to pay the full distribution on all units t Typical (Cheniere) t Typical (rthern Tier) Incentive Distribution Rights - Rights held by the sponsor entitling it to increasing percentages typically 13%, 23% and 48% of the MLP s available cash as distributions increase

12 Comparison of Traditional MLPs and Variable MLPs Common Unit Arrearages - During the subordination period, the right of common unitholders to accrue unpaid minimum quarterly distributions and receive payment of such unpaid distributions before any distributions are paid on the subordinated units Maintenance of Distribution Coverage - The practice of paying out less than all available cash for the purpose of maintaining stability or growth in quarterly distributions (an MLP that withholds 10% of its available cash would have a distribution coverage ratio of 110%); this feature is highly monitored by analysts and sought-after by investors Working Capital Borrowings to Pay Distributions - The practice of using working capital borrowings (which are borrowings intended to be repaid within 12 months) to maintain stability in quarterly distribution payments (typically done to avoid fluctuations in distributions due to seasonal variations in the business) Direct Exposure to Commodity Price Movements - Traditional MLPs typically use hedging and other arrangements to avoid direct exposure to commodity prices (in order to mimic the distribution stability of a FERC regulated pipeline, for example) Direct and Immediate Exposure to Fluctuations in Cash Generated by the Business - The consequence of the distribution policies described above Flexible Distribution Covenants in Debt Agreements A Priority Traditional MLPs Avoided Variable MLPs Expected Depends

13 Yieldco A Yieldco owns assets, that are not MLP-able assets. In 2013, a new type of vehicle went public with a story very similar to an MLP but without possessing assets that would qualify for passthrough tax treatment. Like MLPs, Yieldco and similar companies are positioning themselves as vehicles for investors seeking stable and growing dividend income from a diversified portfolio of lower-risk high-quality assets. More of these types of vehicles are in the planning stages. Typical Yieldco Organizational Structure To date, NRG Yield, Inc. (NYSE:NYLD), a company that owns, operates and acquires contracted renewable and conventional generation and thermal infrastructure assets, which are not MLP-able assets, is the only company to go public as a Yieldco (July 2013).

14 Comparison of Traditional MLP and Yieldco Structures Traditional MLP Organizational Structure Typical Yieldco Organizational Structure

15 Comparison of Traditional MLP and Yieldco Structures MLP Type of Entity Partnership or Limited Liability Company Corporation Capital Structure Types of Equity Securities of the Common Units (right to minimum quarterly distributions, limited Public Company; Sponsor voting rights on significant matters) Ownership of Operating Company Common Post-IPO Capitalization Exchange and Registration Rights Subordinated Units (rights to quarterly distributions after payment of the MQD on common units limited voting rights on significant matters) Incentive Distribution Rights (the right to increasing percentages of cash flow ranging from 13%-48% based on increases in common unit distributions) General Partner Interest (represents the controlling voting interest in the MLP, subject to limited exceptions) MLP owns 100% of the operating company, unless using an OPCO structure (in which case the MLP owns a percentage of the OPCO and the sponsor owns the remainder) 49% held by public, 49% held by sponsor and 2% held by general partner exchange rights but subordinated units convert to common units and the sponsor has registration rights Yieldco Class A common stock of Yieldco issued to the public (initially representing x% of the voting interest in Yieldco and indirectly providing holders x% of the consolidated distributable cash flows of Yieldco s subsidiaries) Yieldco holds a Class A unit of its operating subsidiary for each share of outstanding Class A common stock (providing Yieldco x% of the consolidated distributable cash flows of Yieldco s subsidiaries) Sponsor issued Class B common stock of Yieldco (initially representing 100-x% of the voting interest in Yieldco) and a corresponding Class B unit of the operating subsidiary (providing sponsor 100-x% of the consolidated distributable cash flows of Yieldco s subsidiaries) Majority of voting control and economics held by sponsor Economics Quarterly Cash Payment Projection of Quarterly Distribution Increase (20% within first 18 months) Subordination of Sponsor Distributions from Yieldco to Public Distributions Each Class B unit of the operating subsidiary is exchangeable with Yieldco for a share of Class A common stock; sponsor has registration rights (sponsor does not own dividend paying securities in Yieldco; sponsor owns dividend paying securities in subsidiary of Yieldco that can be exchanged for dividend paying securities that is, Class A common stock of Yieldco) Incentive Distribution Rights Forecasted Cash Available for (generally 12 months after most recent balance sheet date) (24 months after most recent balance sheet date) Distribution in Prospectus Reliance on Net Operating Losses and Carryforwards (NOLs) to Offset Future Income Taxes Yield at IPO (the ratio of the annualized distribution to the IPO price) Midstream: 4-6% Shipping: % Refining: 11-15% Approximately 5.5%

16 Comparison of Traditional MLP and Yieldco Structures MLP Yieldco Governance Board of Directors (at general partner) (at Yieldco) Requirement for Majority Independent Board for so long as the sponsor retains voting control Requirement for Independent Audit Committee Requirement for Independent Compensation Committee Requirement for Independent Governance Committee Use of Independent Conflicts Committee Annual Election of Directors by Security Holders Requirement to Mail Annual Proxy Statement Subject to Good Faith Duty as a Replacement for Customary Fiduciary Duties (but some MLPs have compensation committees) (but some MLPs have governance committees) (special provisions in partnership agreement regarding the legal consequences of using this type of committee) for so long as the sponsor retains voting control (but Yieldco has a compensation committee) for so long as the sponsor retains voting control (but Yieldco has a governance committee) (part of governance committee) Shareholder Approval Required to Issue Greater Than 20% of Equity Shareholder Approval Required to Issue Equity to Affiliates Shareholder Approval Required to Approve Equity Compensation Plans FERC-related Repurchase or Redemption Provisions

17 Comparison of Traditional MLP and Yieldco Structures MLP Yieldco Related Party Agreements Services Agreement Common Indemnification for Environmental, Tax and Other Liabilities Right of First Offer on Sponsor Common (but only in respect of certain enumerated assets) Assets ncompete on Specified Sometimes Business Opportunities License to Use Sponsor Marks Registration Rights Tax Matters General A partnership is not a taxable entity and incurs no federal income tax liability. Instead, each partner of a partnership is required to take into account his share of items of income, gain, loss and deduction of the partnership in computing his federal income tax liability, regardless of whether cash distributions are made to him by the partnership. Distributions by a partnership to a partner are generally not taxable to the partnership or the partner unless the amount of cash distributed to him is in excess of the partner s adjusted basis in his partnership interest. Distributions treated as dividends under US tax law only to the extent paid out of current or accumulated earnings and profits. If cash dividends exceed current and accumulated earnings and profits for a taxable year, the excess cash dividends would not be taxable as a dividend but rather be treated as a return of capital for US federal income tax purposes, which would result in a reduction in the adjusted tax basis of the shares to the extent thereof, and any balance in excess of adjusted basis would be treated as a gain for US federal income tax purposes. Requirement to Have 90% Qualifying Income Under Section 7704 of IRC. Qualifying income includes income and gains derived from the transportation, processing, storage and marketing of crude oil, natural gas and products thereof. Other types of qualifying income include interest (other than from a financial business), dividends, gains from the sale of real property and gains from the sale or other disposition of capital assets held for the production of income that otherwise constitutes qualifying income. Period During Which Federal Income Taxes are Expected to be Insignificant Form of Annual Federal Income Tax Statement Tax Shield (the reciprocal of the ratio of taxable income to cash distributions) Infinite 5 to 10 years due to NOLs, unless further NOLs are created Schedule K-1 Form 1099 Typically 80% 100% for 5 to 10 years using NOLs

18 UP-C Structure The UP-C Structure which offers tax benefits to pre-ipo investors and sponsors likely will expand among companies. In using this structure, the public company ( IPOCo ) typically owns a substantial equity interest in a subsidiary holding company ( Holdings ), which owns the operating assets. The equity interests in Holdings not held by IPOCo are typically owned by the pre-ipo investors, which may consist with individual investors, private equity funds or others. The pre-ipo investors in Holdings have the right to exchange their Holdings equity interests for shares in IPOCo, at which point IPOCo gets a stepped-up tax basis in the Holdings equity interests (which results in tax savings to IPOCo through additional depreciation and amortization) and the pre-ipo investors are taxed on any gain recognized as a result of the exchange. The pre-ipo investors and IPOCo may enter into a tax receivable agreement pursuant to which IPOCo would pay the pre-ipo investors a portion (typically 75% to 85%) of the tax benefits realized from the basis stepup resulting from the exchanges. In 2013, the following energy companies went public using a so-called UP-C structure: Athlon Energy Inc. Frank s International N.V. Jones Energy, Inc. Plains GP Holdings, L.P. Typical UP-C Organizational Structure Historic Members 100% Class B Units Exchange Right Holdings LLC Operating Subsidiaries 100% Class B Shares Majority voting power n-economic interest Tax Receivable Agreement IPOCo 100% Class A Units Sole Managing Member 100% Class A Shares Minority voting power 100% economic interest Public

19 Comparison of Conventional Public Co. & UP-C Structures Typical Conventional Public Company Organizational Structure Typical UP-C Organizational Structure Historic Members Public Historic Shareholders Public 100% Class B Shares Majority voting power n-economic interest Tax Receivable Agreement 100% Class A Shares Minority voting power 100% economic interest 100-X% X% 100% Class B Units Exchange Right IPOCo Public Company 100% Class A Units Sole Managing Member Holdings LLC Operating Subsidiaries Operating Subsidiaries

20 Comparison of Conventional Public Co. & UP-C Structures Public Market Transparency / Investor Demand Conventional Public Company Corporate structure is well recognized and accepted by public markets Variations such as dual class voting and control by parent company should be analyzed on case-by-case basis UP-C Structure Structure provides same economics and value to public investors as conventional structure In a variety of scenarios, the structure could result in substantial tax benefits to public shareholders (e.g., asset basis step-up results from company effecting secondary sale via taxable exchange of its LLC interest for C Corp stock) Accounting Public company consolidates its operations All assets and liabilities appear on balance sheet and all income and expenses appear on income statement minority interest on income statement or balance sheet IPOCo consolidates Holdings since IPOCo is managing member Consolidation is critical for capital markets and 40 Act purposes Holdings interests show up as minority interests on income statement and balance sheet (until accounting rules change), but revenues, earnings before interest and taxes (EBIT), net income before minority interest and will be neutral on earnings per share (EPS) Tax Consolidation / Single Level Taxation All of public company s earnings are subject to corporate level tax and any dividends would be subject to second level of tax ability to use operating losses from other sources to offset taxable income of public company Retains flow-through tax benefits of Holdings structure for owners of Holdings Holdings owners can use operating losses from operations or other sources to offset taxable income allocations from Holdings Increased Tax Depreciation / Amortization Future secondary sales by partner owners will result in capital gains tax but will not result in any tax basis stepup in public company s assets Future secondary sales (via exchange of Holdings interests for public company stock) will increase tax basis of IPOCo interest in Holdings by amount of gain recognized This will increase cash flow due to less IPOCo current taxes Control Vote and value typically linked unless separate class of supermajority stock issued Vote and value can be separated through several different options including issuing special non-economic golden shares to Holdings owners or via election of a majority of directors of public company or including approval rights on material transactions of Holdings

21 Comparison of Conventional Public Co. & UP-C Structures Gain Upon Formation Conventional Public Company Based on tax basis of Holdings assets Need to structure formation transaction so no boot recognized (e.g., liability assumption) UP-C Structure Could take advantage of partnership tax rules to allow partners to extract cash in IPO Need to avoid disguised sale rules upon formation Subsequent Acquisitions by Public Company Can acquire public or private corporations in tax-free mergers using its publicly traded stock as acquisition currency IPOCo can offer preferred stock (convertible or nonconvertible) as tax-free acquisition currency, but dividends on preferred are not tax deductible Can effect tax-free mergers with target corporations by merging target into IPOCo in exchange for IPOCo stock and dropping assets into Holdings Ability to acquire private companies (S corps and partnerships) using a tax-deductible preferred partnership interest (convertible or nonconvertible) as tax-free acquisition currency Cash acquisitions also feasible using variety of structures Acquisition / Sale of Public Company Would likely be structured as acquisition of stock of public company; could be structured as tax-free reorganization tax basis step-up in public company s assets to Buyer Taxable acquisition provides Buyer with tax basis step-up in assets to extent of Holdings interests acquired from partners; value of basis step-up could significantly increase purchase price Could structure as tax-free stock deal through holding company (i.e., 351) transaction; however, basis step-up is likely to be much more valuable than tax-deferral to sellers Rule 144 Secondary Sales Employee Stock Options Generally, can sell under Rule 144 after initial holding period Company can offer ISOs and NQSOs to its employees as well as restricted stock and RSUs Rule 144 may not be available for secondary sales IPOCo may be required to keep a shelf registration statement available for future secondary sales by owners of Holdings interests who exchange interests for stock of IPOCo (or use demand registration) Because Holdings is not a C Corp, it cannot offer ISOs to its employees IPOCo may offer such ISOs to employees of both the IPOCo and partnership Alternatively, could issue profits interests in Holdings which are generally superior to ISOs

22 Questions?