A Partnership That's Really Limited

May marked the 26th anniversary of John McMullen's deal to purchase the Houston Astros. No, this news was not much noted on the financial pages of the day, yet it's worth recalling now if only for McMullen's rationale. Why buy the Astros when he already was a limited partner in the New York Yankees? Nothing, McMullen told sportswriters, is more limited than being George Steinbrenner's limited partner.

Much as I love to loathe the Yankee boss, Steinbrenner in this case got a bum rap. He's far from the only general partner to treat limited partners as something subhuman. Why they stand for it is, to me, one of the investment world's enduring mysteries. The latest case in point is a plan by Tulsa-based Williams Cos. to move a bunch of natural gas pipeline, processing, and storage assets into a limited partnership. Named Williams Partners, it's set to come public in a $100 million initial public offering. What will public investors get in return? The short end of the stick. That fate sometimes befalls minority holders of corporate stock; in this and many other partnerships like it, the short end is guaranteed.

TO SEE WHAT I MEAN, let's follow the money. From the $100 million to be put up by the public, the first $6.5 million is set to go to the underwriters, led by Lehman Brothers (LEH ). Next, $4.6 million will be eaten by legal and other organizing costs. Williams then stands to take $85.4 million, in partial payback for money it put into operations that are going to the partnership. That leaves $3.5 million for the partnership's cash box. For its end, Williams is contributing $107 million in operating assets and will become the partnership's managing general partner, with a 2% stake. That share, plus another 61% via the limited partner units it is not selling, leave Williams a firm grip on its offspring. So, to recap, Williams gets 63% of the equity for 52% of total contributions to the partnership; the public puts in 48%, cash, for a 37% stake.

Given this setup -- and it's typical in energy partnerships -- why would any investor bite? Yield. With interest rates on bonds and dividends on stocks still low, investors are famished for income. At its assumed IPO price of $20 per unit, Williams Partners is set to yield a minimum of 7.4%. That's pretax, and any individual's tax bill will vary. Even though the distributions are not eligible for today's low rates on dividends, other tax breaks mean most limited partners can count on aftertax yields well above what other investments pay.

Yet that bonus hardly comes free. Public investors surrender huge upside through a key partnership feature called "incentive distribution rights." In this deal, Williams has set a minimum quarterly distribution of 37 cents a unit. If operations go swimmingly and cash flow swells to enable payouts of more than 42.5 cents a unit, then Williams as general partner starts to get more and more of the excess. At 55.55 cents a unit and above, the general partner stands to keep half the excess, even though it holds just 2% of the partnership's equity. The point is to create a motive for the general partner to keep operations not just humming, but growing. If, as in this deal, the general partner also owns a big chunk of limited partner units, then it gets to take a second dip. At the deal's sweetest, Williams as general partner gets 50 cents of each $1 in excess distributions; as a limited partner, it gets an additional 31 cents.

A Williams spokesman declined to discuss any parts of the deal while it's in registration. When I asked why Williams wants this deal now, he said: "It's a way to create value for our shareholders." If this or a similar partnership tempts you, just imagine that the guy across the table is George Steinbrenner.

By Robert Barker

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