Shell MLP IPO (NASDAQ: SHLX)

In February of 1907, two competitors merged to form a behemoth oil company.

The companies were the Royal Dutch Petroleum Company and the “Shell” Transport and Trading Company. Combined, the two businesses went by the name Royal Dutch Shell.

The conglomerate established a monopoly over the world’s oil for much of the 20th century. By the end of the 1920s, Shell owned 10% of the world’s tankers and 11% of its known crude oil supply.

By exerting complete control over two phases of oil production — midstream and upstream — Shell engulfed unparalleled sums of profit as the age of oil hit its prime during World War I, World War II, and the post-war suburban sprawl in the United States. 

Today, its storied history has allowed the giant company to own downstream, midstream, and upstream operations from Nigeria to the Arctic Circle and in just about any other resource basin you can think of.

So it may be strange to hear that the company plans to revert to its pre-1907 status… this year.

19th Century Business Model?

In June, Shell announced it would spin off its midstream company, Shell Midstream Partners, with an IPO that would raise about $750 million.

However, last Monday, Shell Midstream — which plans to trade on the Nasdaq under the ticker symbol SHLX — announced a change of plans.

In an SEC filing, the company upgraded the value of the IPO to $950 million split among 37.5 million common shares priced between $19 and $21.

Underwriters will have the option of buying an extra 5.625 million common shares, which means the “limited partners” in this MLP could own anywhere from 27.2% to 31.3% of a company that’s been around for more than a century.

I should be clear: Shell and Shell Midstream will not be two completely different companies. The parent will still own at least 68.7% of the midstream business when it’s all said and done. 

Still, many analysts have called this IPO historic since Shell is a massive company that’s diving headfirst into the red-hot MLP market.

And while I wholeheartedly agree with these analysts, one important question remains…

Should you dive in headfirst and buy shares?

The Pros

Shell Midstream owns and operates a solid stable of pipeline assets in North America, most of which are in Texas, Louisiana, and Mississippi — the throat of the shale boom.

The company also holds a working interest in the massive Colonial Pipeline system that runs from Texas to New York.

Plus, the company saw solid growth during 2014, boosting revenue by 57% to about $80 million, while net income tripled.

Because of its MLP structure, Shell Midstream Partners will distribute at least 90% of its earnings direct to shareholders, so you can expect to see a high yield.

Beyond that, the intangibles like solid management and track record are mostly present. Even though I’m skittish when it comes to Big Oil, Shell has been — and probably will be — around forever, which is always an important factor.

But based on the MLP market itself, I have some doubts.

Final Verdict

While the Shell Midstream IPO has a lot of good things going for it that would normally signal a buy, contextual factors have manipulated the soon-to-be stock.

The growth in revenue and net income over the year happened because in the previous year, the company suffered losses for environmental cleanup at a spill.

Any undue attention, especially a spill, can slaughter an investment, so I don’t know how much confidence I have in management’s ability to mitigate these risks.

Also, the MLP market has been blowing up…

Last year, we saw 19 new master limited partnerships debut, and this year, several more have debuted or been announced as companies look to avoid corporate income taxes and investors search for lucrative high yields.

Dominion, another major, is planning one, while Hess announced one a few months ago. 

But with a finite number of investors searching for high yield, more MLPs jumping into the mix will dilute the pool of money investors plan to pour into the companies.

So it is imperative, especially with oil prices hovering near $80 per barrel, that MLP investors find an investment that will stand up to fluctuations in price and a dilution of share value.

Because of this, your editor has decided to approach SHLX with a wait-and-see attitude. I’m not going to buy it on the IPO day, but I could buy later if its performance stays at a high level.

I would suggest you do the same.

Good Investing, 

Alex Martinelli

With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor’s page.