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Alliance Holdings GP LP (AHGP)

From The Energy Strategist: “A trend has emerged in a recent wave of deals among energy-focused master limited partnerships. … I’ve explained the relationship between general partners (GP) and limited partners (LP) in previous issues of The Energy Strategist, but this concept is crucial to understanding the recent wave of...

“A trend has emerged in a recent wave of deals among energy-focused master limited partnerships. … I’ve explained the relationship between general partners (GP) and limited partners (LP) in previous issues of The Energy Strategist, but this concept is crucial to understanding the recent wave of deals among energy-focused master limited partnerships (MLP). In all of these instances, LPs have acquired their GPs, eliminating the burden of incentive distribution rights (IDR). The few remaining publicly-traded GPs are potential buyout candidates.

“Every MLP is a combination of two companies, an LP and a GP. When you purchase an MLP, you’re typically buying a stake in the LP, which entitles you to a share of the MLP’s cash ?ow. The GP is best thought of as part manager and part parent. The GP manages the MLP’s assets and makes major business decisions—for example, the acquisition of certain assets or the construction of new pipeline projects. … The exact relationship between GP and LP is governed by the partnership agreement—the basic document drawn up when an MLP is formed—which also establishes the fees that the LP pays to the GP in exchange for its services. Typically these fees take the form of quarterly IDR payments that are based on the size of the quarterly distribution made to LP unitholders. IDRs are tiered such that the GP gets a larger percentage cut of cash ? ows when the LP increases its distribution, a structure that should incentivize the GP to make decisions that grow the MLP’s cash ?ow. [E.g., the GP might get 2% of any distribution up to three cents per unit, but 15% or more of anything paid on top of that.] In other words, as an MLP progresses through its tier structure, it becomes more dif?cult to grow LP distributions. A larger percentage of each dollar of DCF would go to the GP. … The latest trend: Deals in which the LP buys the GP and eliminates IDRs. There are now just three publicly-traded pure play GPs that look like potential buyout candidates.

Alliance Holdings GP LP (AHGP, Nasdaq – yields approximately 4.3%) is the general partner for Alliance Resource Partners LP (Nasdaq: ARLP), an MLP that focuses on coal production. In total, Alliance Holding GP has nearly 650 million tons of coal reserves and produces upwards of 25 million tons per annum. ... The price of U.S. thermal coal—the variety used in power plants—has been weak this year because of elevated stockpiles at utilities, an overhang from the severe economic downturn of 2007-09, when electricity demand declined substantially. The price of metallurgical (met) coal—the variety used in steelmaking—remains robust thanks to a rebound in global steel production and strong demand from abroad.

“There are also some key geographical points to keep in mind. Coal production from Central Appalachia (CAPP) remains troubled because coal seams in the region have been heavily exploited over the years, making it difficult to increase production. In addition, coal mining in Appalachia is dangerous. Although the U.S. coal mining industry is safe compared to what goes on in China, a series of high-profile accidents have resulted in more onerous regulations.

“It’s far easier to produce coal in the Illinois Basin, and regulations aren’t quite as burdensome in this region as they are in the CAPP. But coal from the Illinois Basin usually contains larger percentages of sulfur. That’s less of an obstacle now that a growing percentage of U.S. coal facilities now have installed advanced scrubbers that bring emissions in line with regulatory expectations. As the percentage of utilities with scrubbers grows, demand for easier-to-produce coal from the Illinois Basin has grown.

“Mines in the Illinois Basin accounted for about 80% of Alliance Resource Partners’ output in 2009. ... The LP’s growth opportunities are also attractive. Alliance Resource Partners is expanding its existing mines and recently opened up a new one in the Illinois Basin. This positions the firm to benefit from a recovery in prices for coal hailing from this region. Through the end of the third quarter, Alliance Resource Partners has covered its distributions by a lofty 1.9 times.

“But investors should set their sights on the general partner, Alliance Holdings. The GP owns the LP’s IDRs, so its cash flow is based on the distributions paid to the LP. ... This means that the GP’s distributions grow more rapidly than the LP’s payout; over the past year, the LP has boosted its distributions by about 8.5%, while the GP’s payout is up almost 13%.

“The GP’s units yield less than the LP’s stock—about 4.3%, compared to 5.2% for the LP—but the faster distribution growth compensates for the slightly lower yield. In this case, the GP owns a more than 40% stake in the LP, which may complicate any attempt by the LP to acquire the GP. But the MLP’s mining business is in fine shape, and the GP’s distributions should continue to grow at a double-digit rate in the coming year. In fact, given its high distribution coverage so far in 2010, distribution growth could accelerate in 2011. If there’s no deal between the LP and GP, the MLP is still on solid footing. If the two entities merge and eliminate the IDRs, expect the GP to command a substantial premium. AHGP is a buy up to 48.50. ... Use a limit order to avoid overpaying.”

Elliott Gue, The Energy Strategist, 12/1/10

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.