When’s a 7.4% yield not the steal of a deal that it might seem? When it’s made possible by a negative amortization loan with a 9.25% annual interest rate.

Which is another way of saying that the $500 million preferred issue announced by Crestwood Midstream Partners (NYSE: CMLP) last month and cautiously welcomed by investors as the purchase of much needed financial breathing space, is less the tonic it might seem and more of a resort to methamphetamine.

The deal will almost certainly work out great for the financier lenders and for the partnership’s growth-craving management, but only just maybe at best for the limited partners who will as usual be most at risk should this substantial levering of what was already a very levered balance sheet not work out.
This movie has played many times before, and there’s no reason anyone need pay to see it again. We’re cutting Crestwood from the Growth Portfolio, and think anyone not facing serious tax consequences would be smart to get out of this one.

If you do face a serious tax clawback at the time of sale, know that there is likely no urgent need to sell right away. But you should still consider the deal Crestwood just struck before deciding whether this is a partnership worthy of a long-term commitment regardless of the short-term tax consequences.

The $500 million Crestwood intends to borrow over the next 14 months for capital investment will not have an immediate cost: for the next three years the partnership can choose to pay interest in additional preferred units. But after three years the payments on the ballooning loan will start coming due in cash. And, while Crestwood’s press release pointed out that it sold the preferred at a 16 percent premium to the price of its common units, it didn’t mention that redeeming that high-yielding debt after three years except at the creditors’ discretion would require either strong capital gains that frankly seem unlikely or else a 50%+ conversion premium.

But for the next three years the deal lets Crestwood avoid cash interest outlays of roughly $11.6 million per quarter. This is no small thing for a partnership that’s already halted distribution growth, and which watched a third of its operating profit go out the door as interest in the most recent quarter.

Crestwood’s recent 10% distribution deficit was already not counting the cost of non-cash equity compensation and “the significant transaction-related costs and other items.” Count that $10 million as the real cost it is and suddenly the distribution deficit swells to more than 20%. Now the preferred will add another $11 million to the non-cash tab, at the cost of a reckoning in 2017.

Crestwood’s tempting but deceptive yield can be had with much less risk, only slightly less growth and a whole lot less high-interest debt from AmeriGas (NYSE: APU). Kinder Morgan Energy Partners (NYSE: KMP), still growing its well-diversified distribution 5%, yields only slightly less, also without issuing preferred junk yielding almost in the double digits. 

Let someone else try to build wealth off Crestwood. They’ll need to go to the back of a very long and very well dressed line. We’re out. Sell CMLP.