We recently published an open letter stating that we believe MLP management teams need to address three issues to become better aligned with investors. Here is our message to MLP management teams:
First: Eliminate incentive distribution rights aka IDRs. As long-term investors in MLPs for 20 years, we call on all MLPs to eliminate IDRs now. Not when they become a burden (they have been a burden from the get-go), not when management's "review" is completed, not when they start to seriously impact growth projects, but now. We believe year-end 2018 is an achievable goal that would simplify the structures of MLPs and help investors better understand their investment.
When we analyze MLPs to understand distribution cuts, we look first at balance sheets. Leverage is often fingered as the culprit. But would leverage have ever gotten to where it is if not for IDRs and the general partners' share of cash flow? We analyzed more than 40 midstream MLPs, and between 2015 and 2017, we estimate over $12 billion dollars was paid in IDRs, representing almost 8% of total debt outstanding at the MLPs paying those IDRs. In addition, the IDRs paid represent 20% of total distributable cash flow generated during that period. The $12 billion paid in IDRs could have been used to pay down debt, contribute to higher coverage ratios, fund organic growth projects, or pay higher distributions to limited partners. Instead, the IDRs were used to enrich the general partners.
Capital is not unlimited. You have alienated many potential and former investors with your inaction on IDRs. Many of you have voiced displeasure with your "high" yields, stating it's difficult to raise equity to fund capital projects. The markets have been telling you something, but you've not listened. As one of your partners, we call on you to take action.
Second: Increase disclosures about operations. Under the guise of "competition," MLPs demonstrate a general lack of disclosures. We get it: contracts are expiring and you don't want to disclose new rates, contract terms, and volume commitments. That's understandable. But the lack of data you provide is inexcusable. We can't come up with one valid reason why you don't, at minimum, provide the percent of contracts expiring each year. We heard at an investor meeting that we should expect one of the company's contracts to be renewed at "significantly" lower rates. Not surprisingly, we saw a considerable range of opinions on what the definition of "significant" was. You need to disclose and quantify data or investors will continue to believe you're hiding operational issues.
Third: Address shareholders' environmental concerns. The face of investors is changing. Younger investors are asking questions that may be different from those of previous generations. Importantly, these new investors are much more concerned about environmental issues. Each year, we ask many of you to disclose information on emissions, leak detection and repair systems, and other environmental metrics. To date, the responses have been disappointing. We understand the business you operate in: the transportation and storage of hydrocarbons. We're on your side. But there needs to be more transparency around environmental issues. We're not looking to point fingers. Rather, we believe having more information will help investors be comfortable with their investments.
At Miller/Howard Investments, we have always been, and continue to be, big believers in the economic role of midstream companies. But times change. MLPs need to evolve. You need to eliminate IDRs. You need better disclosure. You need to elevate safety and environmental concerns. Be aware of who your future investors are and what they want. Investors want to be your long-term partners. The days of financial engineering and over-leveraging these great and stable assets are over. It's time for MLP management teams to chart a new course.
Up to now, responses from the management teams have been discouraging. Is it arrogance? Apathy? Denial? These are issues that cannot be ignored and will not go away. That is why we will continue to press MLPs to take corporate governance seriously and address our concerns.
