A Master Limited Partnership (MLP) is a publicly traded partnership (PTP). It is essentially a partnership, or a limited liability company (LLC) that has chosen partnership taxation, that trades on a public exchange (NYSE, NASDAQ, etc.) or over the counter market.
The first requirement is that it is necessary for the MLP to be a state law entity that can be treated as a tax pass-through entity. Second, the MLP must be publicly traded wherein the owners of MLP units have the ability to buy and sell interests in the MLP. The publicly traded element of an MLP simply provides for the same type of liquidity (or float) that is enjoyed by a public corporation. Third, the MLP must be listed on one of the major exchanges. Today, the most common securities exchange for MLPs is the NYSE, although quite a few MLPs are listed on the NASDAQ.
MLP ownership interests are referred to as “units” as opposed to shares and cash paid out to unit holders is referred to as “distributions,” instead of dividends. Shareholders are called “unitholders.” MLPs combine the tax benefits of a limited partnership with the liquidity of publicly traded securities.
MLPs are not like regular corporations in the sense that they are not subject to double taxation. They do not get taxed on income. Instead they tend to return most of their income to investors or partners through quarterly distributions. This shifts the tax responsibility to the partners, who are taxed at their ordinary income rates. Since ordinary income rates of investors are typically lower than the income tax rates of corporations, this proves to be advantageous to the MLPs and hence their investors.
To qualify as an MLP and not be taxed as a corporation, a partnership must receive at least 90% of its income from qualifying sources as set forth in Section 7704(d) of the Internal Revenue Code of 1986. These qualifying sources include natural resource based activities such as exploration, development, mining or production, processing, refining, transportation, storage, and marketing of any mineral or natural resource. The majority of MLPs operate in the energy sector, particularly in energy infrastructure industries such as pipelines.
Units in an MLP are offered through an initial public offering. The MLP generally uses the capital from the offering to provide a cash distribution to the sponsoring entity. In addition, the MLP may issue new partnership units via a follow-on offering under the shelf registration process. The net proceeds received are typically used for acquisitions, funding capital expenditures, repaying debt, providing working capital or general corporate purposes. Like individual stocks, MLPs can be bought and sold throughout the trading day at the current market value, which continuously fluctuates and reflects the value of each unit at any particular time.
MLPs generally have two classes of owners, the general partner and limited partners. The general partner may be structured as a private or publicly traded corporation or other entity, typically controlling the operations and management of the MLP through an up to 2 percent equity interest in the MLP, plus, in many cases, ownership of common units and subordinated units. The limited partners provide capital through ownership of common units and have no role in the partnership’s operations and management. They invest capital and then receive the tax benefit of a personal income tax deduction for part of the loss during the development stages of the partnership when the costs exceed any revenues.
MLPs are typically structured such that common units and general partner interests have first priority to receive quarterly cash distributions up to an established minimum quarterly distributions amount. Distributable cash in excess of the minimum quarterly distributions is paid to both common and subordinated units and distributed on a pro rata basis. Pursuant to the partnership agreement, the general partner is also eligible to receive incentive distributions if the general partner operates the business in a manner that results in distributions paid per common unit surpassing specified target levels. As the general partner increases cash distributions to the limited partners, the general partner receives an increasingly higher percentage of the incremental cash distributions.
Due to the requirements of the IRS tax code, the great majority of MLPs – about 80 percent by number, representing about 90 percent of MLP market capital – are in energy-related businesses. The largest number of MLPs is in the midstream sector that gathers, processes, transports, and stores oil, natural gas, and refined petroleum products. There are also MLPs engaged in the production of oil and natural gas, distribution of propane and other refined products, coal leasing and mining, and marine transportation of petroleum products. In addition, there are some publicly traded partnerships in real estate, the investment industry, and various other businesses.
Here is just a brief overview of some sample Master Limited Partnerships that are currently trading in the United States:
- Cedar Fair, LP is a leading owner and operator of amusement and water parks in the United States and Canada. It trades under the ticker symbol FUN and has a dividend yield of 7.90%, which is far higher than the average common stock.
- El Paso Pipeline Partners, L.P. trades under the ticker symbol EPB. It owns and operates natural gas transportation pipelines and storage assets in the United States.
- Alliance Bernstein Holding L.P. provides investment management services to institutional, retail, and private clients throughout the world.
- Richard D. Kinder, founder of Kinder Morgan Energy Partners, an early pipeline MLP, is worth $10.2 billion, according to Forbes magazine. Mr. Kinder generated his vast wealth because of a unique clause in the structure of such partnerships.
- In January 2013, CVR, under Mr. Carl C. Icahn’s direction, placed its refineries into a new company, CVR Refining structured as an MLP. When CVR Refining finally sold shares to the public in an initial public offering, it raised $600 million. Weeks later, Mr. Icahn used that money to pay himself a huge dividend, resulting in a personal gain of nearly $1 billion. Shares of both CVR Energy and CVR Refining, meanwhile, continued to trade up and pay additional distributions.
In addition to the advantages mentioned above, an investment in MLP units also involves certain risks—risks which differ from an investment in the securities of a corporation. Holders of MLP units have limited control and voting rights on matters affecting the partnership. In addition, there is certain tax risks associated with an investment in MLP units and conflicts of interest exist between common unit holders and the general partner, including those arising from incentive distribution payments.