Common Units in High Demand on Distribution Growth Potential and Industry Leading Sponsor in Royal Dutch Shell
Shell Midstream Partners, L.P. (NYSE: SHLX) went public on October 29, 2014, with 40,000,000 common units priced at $23 per common unit, with a 30-day overallotment option on an additional 6,000,000 common units.
Units are attractive on fundamentals such as the MLP’s relationship with industry-leading sponsor Royal Dutch Shell (RDS), predictable and growing cash flow from long-term transportation agreements and fee-based contracts, unique strategic advantages of asset location, a clean balance sheet and good financial flexibility, and experienced management.
At $33.86 (as of 10/31/2014), units offer a distribution yield of 1.9% which is expected to steadily grow 20% – 30% annually as RDS uses the MLP as its dropdown and monetization vehicle for sizable midstream assets in the U.S.
On strong investor demand, the
offering was scaled up from 37.5 million common units to 40 million common units and the offer price was raised from a range of $19 to $21 per unit to $23 per common unit.
In a strong first-day debut, units closed up 46% on their first day of trading. Through this IPO, the MLP will raise close to $1 billion (assuming full exercise of overallotment), making this the largest MLP IPO over the past decade. The MLP intends to retain $100 million of IPO net proceeds for general partnership use, make a contribution to Zydeco Pipeline Company for recent upgrades and distribute the balance to its sponsor, Shell Pipeline Company (SPLC). As of June 30, 2014, the MLP had net tangible book value of approximately $3 per unit so public buyers of common units will experience substantial immediate dilution.
Post IPO, public investors own a 29% limited partner interest (or 33.4% if underwriters fully exercise their overallotment option).
Shell Midstream Partners was formed as a master limited partnership (MLP) by Shell Pipeline Company (SPLC), an affiliate of Royal Dutch Shell PLC (RDS), to focus on onshore and offshore midstream assets in the U.S., with crude oil and refined product pipelines in the U.S. Gulf Coast as initial contributed assets and the option to acquire additional assets through future drop-downs.
The MLP’s initial assets offer a compelling growth story underpinned by strategically-located crude oil and refined products assets. The MLP is structured to have no debt at IPO and $100 million of cash to support future growth opportunities.
Distributions Expected to Grow 20% – 30% Annually Off $0.65 Minimum Distribution
The MLP plans to pay make minimum quarterly distributions of $0.1625 per unit ($0.65 per unit annualized) from Available Cash after the establishment of cash reserves and fees and expenses to the General Partner. In the current quarter (ending December 31, 2014), the company plans to make a prorated distribution.
Each quarter, common unitholders will receive 98% of Available Cash and the General Partner will receive 2% of Available Cash until each common unit receives a minimum quarterly distribution of $0.1625 plus arrears from prior quarters. Thereafter, 98% of remaining Available Cash will be distributed to subordinated units and 2% to the General Partner until each subordinated unit has received $0.1625. Thereafter, 98% of residual Available Cash will be distributed to all unitholders, pro rata, with 2% going to the General Partner, until each unit receives $0.186875. If cash distributions exceeded $0.186875 per unit in any quarter, the General Partner will receive incentive distributions up to 48% of residual cash.
At $33.86 (as of 10/31/2014), units offer a minimum distribution yield of 1.9% and a maximum distribution yield of 2.2% which is low by MLP standards but not cause for concern because of expected 20% to 30% annual distribution growth from strong organic growth and asset dropdown potential.
Subordinated units will convert to common units at the end of three consecutive years of $0.65 in annualized minimum quarterly distributions to common units. Thereafter, common units will no longer be entitled to distribution arrears.
MLP Off to Good Start with Zero Debt, $100 Million Cash and $300 Million Undrawn Revolver
As structured, the MLP will have predictable and growing cash flows, distribution growth and disciplined financial policies. Over 75% of projected cash flows will be generated from contracts or result from unique logistical and location advantages. The majority of the MLP’s contract shippers have investment grade ratings. As such, the MLP will have minimal exposure to commodity prices. As the MLP expands through organic growth and drop-downs, distributions are expected to increase with a target coverage ratio of 1.1x. The MLP starts life with zero debt, $300 million in undrawn revolver and $100 million in IPO cash for acquisition funding and other uses.
The MLP’s cash flows are nicely diversified by asset (four pipeline systems), by product (crude oil and refined products transport), by geography (onshore and offshore) and by operational control.
Premium Location of Initial Assets Provides Solid Base for Cash Generation
Shell Midstream Partners will initially own equity stakes in four pipeline operating companies: Zydeco Pipeline Company and Mars Oil Pipeline Company for crude oil, and Bengal
Pipeline Company and Colonial
Pipeline Company for refined products, with ownership ranging from 1.6% to 49% as shown in the table below. The Zydeco pipeline (also known as Ho-Ho because it stretches from Houston to Houma) is located within the
largest refining market in the U.S.
Mars is situated in a high-growth area of the offshore Gulf of Mexico and is used exclusively by 55% of the region’s shippers. The Bengal pipeline connects four refineries in Louisiana to long-haul transportation pipelines and is 67% contracted with a weighted-average remaining term of about 2.5 years with FERC-regulated tariffs. Colonial, the largest refined products pipeline in the U.S., transports over 100 million gallons per day of over 40 different refined products. The table below shows MLP ownership and key pipeline statistics.
The MLP’s assets provide critical pipeline infrastructure for crude oil supply and play an integral role in connecting major onshore and offshore suppliers to Gulf Coast refineries.
The MLP’s pipeline systems connect to a majority of Gulf Coast refineries and provide the most efficient transport of crude to refineries, and refined products to end-user markets.
Zydeco, for example, is the only crude oil pipeline serving refineries from Houston to Eastern Louisiana and provides a critical outlet to alleviate transportation bottlenecks of crude oil arriving in Houston from Eagle Ford shale, Permian Basin and Bakken shale. SPLC completed the reversal of Ho-Ho in late 2013, and expanded it in 2014 with two new pump stations and a new connection at Nederland. Additional expansion projects in 2015 include a new third-party connection and new tankage at Port Neches. Approximately 87% of the fully expanded capacity of Ho-Ho will be under ship-or-pay contracts with a weighted-average remaining term of over 8 years. SPLC employees will operate the pipeline and the MLP will have voting control.
The Mars oil pipeline transports production from the Mississippi Canyon area to salt dome caverns in Louisiana. In 2013, shippers comprising 55% of volumes used Mars as their exclusive export solution. An expansion project added Olympus platform volumes in February 2014. Mars has several growth projects in the works including two expansions of the Amberjack system connecting to Mars at Fourchon, Jack St. Malo platform with tie-backs to additional production and the Big Foot platform. SPLC operates Mars and the MLP will have voting control of Shell’s 71.5% ownership interest in the pipeline.
Bengal is a refined products pipeline system connecting four refineries in the St. Charles, Norco, Garyville and Convent areas of Louisiana with storage tankage in Baton Rouge, Louisiana. The pipeline system is comprised of two primary pipelines spanning 158 miles and approximately 4 million barrels of tank capacity in Baton Rouge. Bengal connects with the Plantation and Colonial pipelines to provide major market outlets to the southeast and east coast. The pipeline is operated by Colonial and the MLP has voting control of Shell’s 50% ownership interest. Approximately two-thirds of Bengal’s capacity is subject to minimum volume commitments under ship-or-pay contracts, with a weighted-average remaining term of approximately 2.5 years.
Colonial is the largest refined products pipeline in the United States with 5,500 miles connecting refineries in the Gulf Coast to demand centers along the East Coast. Colonial transports approximately 50% of the refined petroleum products consumed in the east coast and delivers to approximately 270 marketing and shipper terminals across 13 states and the District of Columbia. It primarily transports gasoline, jet fuel, kerosene, home heating oil, diesel fuel and national defense fuels.
Strong Parent Company with Several Attractive Assets for Dropdown
Royal Dutch Shell (RDS) is one of the world’s largest independent oil and gas companies with a market capitalization of approximately $230 billion, presence in over 70 countries and ranked #2 by Fortune Global 500 in 2014. The company is a leading producer, transporter and refiner of hydrocarbons with 3.2 million barrels of oil equivalent (MMBoe) produced daily in 2013 and 30 refineries operated globally, including 5 in the U.S.
Royal Dutch Shell has substantial inventory of retained midstream assets that include crude oil, refined products and chemicals pipelines, storage terminals, natural gas processing plants and LNG infrastructure. In addition, Shell Pipeline Company is developing several onshore and offshore assets to support Shell and third parties.
The MLP will also benefit from Shell’s portfolio of additional North American midstream assets such as gathering and processing systems in Western Canada that serve three basins, refined products terminals in the U.S., natural gas pipeline systems in the Gulf of Mexico and several other assets including LNG transport, chemical pipelines and Marcellus gas gathering pipelines.
Overall, Shell is committed to the growth and continued support of Shell Midstream Partners, and has an extensive portfolio of current assets and future organic projects within its midstream asset base.
Management – Seasoned Industry Veterans
The MLP will be headed by Margaret C. Montana as President, CEO and Director. Margaret has been with Shell for 37 years, most recently as Executive Vice President – U.S. Pipelines and Special Projects – Americas in Shelf Downstream Inc.
Susan M. Ward will serve as Chief Financial Officer, Vice President and Director Nominee. Susan has been with Shell for 16 years, most recently as Head, M&A and Commercial Finance – Americas for Shell Oil Company. The executive team will be supported by additional senior staff and by its Board of Directors, each of whom has significant experience in the oil and gas sector.
Changing North American Crude Oil Landscape Supports Long-Term Growth
North America has seen an enormous resurgence in crude oil drilling as a result of new technology that unlocks hydrocarbons in unconventional resource plays. In addition, the Gulf of Mexico has re-emerged as a strategic center for new projects in offshore crude oil production. Both these trends will support Shell Midstream Partners for years to come.
Solid Financial Profile, Clean Balance Sheet, Steady Fee-Based Long-Term Contracts
Looking ahead, for the 12 months ending September 30, 2015, Shell Midstream Partners will likely receive $114 million in Available Cash for distribution based on its equity stake in each of the four pipeline systems. The systems are well maintained and underwent major upgrades and expansions before the IPO, and will likely have minimal maintenance capital requirements going forward, so cash for distributions are unlikely to be adversely impacted by unforeseen events such as shutdowns or large capital outlays for repairs.
Shell’s Rationale for Sponsoring MLP – Monetize Hidden Assets for Future Growth
Shell sponsored the MLP to cash-monetize controlled assets, to access MLP equity capital for growth, and for valuation transparency. While Shell monetizes certain assets, it plans to retain operational control to enable continued commercial alignment with Shell’s integrated operations. Shell will also benefit from General Partner cash flows that should increase significantly at the underlying MLP with future drop-downs. Further, the MLP structure makes it easier for Shell to monetize selective assets at attractive valuation multiples. The MLP currency (common units) provides an additional source of equity capital with which Shell can grow its midstream business through organic projects or acquisitions, and opens the door to moving other Shell energy infrastructure assets with steady cash flow generation characteristics into the MLP. Shell will retain majority ownership of limited partner units and 100% GP interest and incentive distribution rights (IDRs). This IPO highlights Shell’s inventory of valuable assets that were not obvious in Royal Dutch Shell’s consolidated valuation.
Overview of Sponsor – Shell Pipeline Company (SPLC)
Shell Pipeline Company is RDS’ primary midstream subsidiary in the U.S. and holds a large portion of Shell’s midstream assets including onshore and offshore pipelines and crude oil terminals. SPLC has an extensive network of strategically-located assets with ownership in over 11,000 miles of pipelines across the U.S. that transport more than 1.5 billion barrels of crude oil and refined products every year, covering crude oil, gasoline, jet fuel, diesel fuel, natural gas, chemicals and NGLs. SPLC has a long 95-year history of safe and reliable operations. It owns and operates one of the largest deepwater pipeline systems in North America, and pipelines that are strategically placed to take advantage of North American crude oil production.
In the Gulf of Mexico, SPLC owns 16 offshore pipelines stretching across 1,800 miles, and transports a significant portion of offshore production to onshore facilities. SPLC also has an extensive network of onshore crude assets – LOOP, LOCAP, Ship Shoal, Arcadia, Sugarland and Zydeco.
In addition, SPLC has pipelines and terminals located on the East Coast, West Coast and Mid-Continent regions.
MLP Ownership Structure
Shell Pipeline Company (SPLC) will have majority limited partner interest in the MLP and will own 100% of the General Partner and all incentive distribution rights. Public unitholders will own approximately 33.4% of outstanding common units assuming full exercise of overallotment. The table below shows equity percentages as filed with the SEC before the increase in IPO size.
While several MLPs have come to market over the past year, Shell Midstream Partners is attracting a lot of attention because of its growth potential from strategically well-placed assets, 20% – 30% distribution growth potential, clean debt free balance sheet and strong corporate sponsor in industry heavyweight Royal Dutch Shell. Investors are also attracted to the MLP’s relatively low exposure to drops in commodity prices due to fee-based contracts. Shares have soared on debut and offer about 2.2% distribution yield at current levels, which in itself is not too attractive, so long-term investors should consider a phased buying strategy with an emphasis on buying on dips, and stay in for the long run to see solid growth in distribution income.