The industry is ripe for consolidation. Between the late 1990s and early 2000s, master limited partnerships (MLPs) were known to grow their businesses through mergers and acquisitions. Last year, MLPs announced nearly $60 billion of merger and acquisition (M&A) deals.

What will M&A activity look like in 2014?

Currently, there are more than 110 MLPs in the marketplace ranging from $200 million to $60 billion in market
cap. Conversations with industry management highlight significant consolidation opportunities, especially since nearly half of the MLP universe has a market cap just below $2 billion. But relatively accessible capital markets and healthy demand for organic growth projects make it less enticing for MLPs to pursue exit strategies, thereby requiring consolidation to be a perfect storm of the right price and strategic fit.

The absolute size of the acquisition is less important than its size relative to the acquiring MLP. While a $500 million asset acquisition may move the needle for the majority of MLPs, for larger cap MLPs, a larger corporate merger may be necessary to create a new engine of growth that will drive distributions higher. For example, in 2012, when Kinder Morgan Energy Partners had a market cap just shy of $20 billion, it closed the $20 billion acquisition of El Paso Corp. and El Paso Pipeline Partners.

Recent initial public offerings may have an additional advantage of greater financial flexibility to expand into new regions
or new lines of business. Cost of equity can be lower due to the partnership being in the lower tiers of the incentive distribution right split level.

Room for debt

Some of these MLPs have leverage ratios below 2.0x (vs. the industry average of 4.0x), so they have room to add debt to a relatively unlevered balance sheet in order to make outsized acquisitions. For instance, in November 2013, NGL Energy Partners, a $2 billion market cap MLP acquired the equity interests of Gavilon, a diversified midstream energy business, for $890 million. This was mostly financed by issuing $240 million of equity and increasing the borrowing capacity on its revolving credit facility by $620 million.

The merger of two MLPs can be more complicated than with corporations since four parties—two limited partners
and two general partners (GP)—will be involved, which can make MLPs with no GP more desirable as merger prospects. To that point, in the Kinder-Copano merger, Copano did not have a GP. Similarly, in the pending merger between Regency Energy Partners and PVR Partners, PVR does not have a general partner after merging with its GP in 2011.

Alerian expects to see more activity between MLPs with histories of joint ventures and MLPs that own a percent equity
interest in another MLP. The Kinder-Copano merger in 2013 made strategic sense since the two entities had a previous history of working together via their Eagle Ford Gathering LLC 50/50 joint venture.

There are a handful of MLPs that could become strong merger candidates in the coming year. Though we are not here to make predictions, MarkWest Energy Partners has had joint ventures in the Marcellus and Utica shales over the years with companies such as KMP, the Energy & Minerals Group, REX Energy Corp. and, more recently, Summit Midstream Partners’ general partner. Not to mention, MarkWest acquired its general partner back in 2007. ?

Maria Halmo and EmilyWang, CPA, are directors for Alerian, an independent indexing company that provides objective market information. More than $16 billion is directly tied to Alerian’s indices, which include the leading benchmark of MLP infrastructure equities: the Alerian MLP Infrastructure Index (AMZI). For more information, please visit www.alerian.com.

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