Incentive distribution rights have to be right up there with soul buying when it comes to the devil’s favorite transactions.

They’re just lines in the prospectus when an MLP goes public, and barely a bother for a couple of years.

But as the distributions grow a rising proportion of the cash flow ends up getting siphoned off as IDRs by the sponsor, reducing the benefits of growth for the limited partners.

It’s an unstable arrangement that exacerbates conflicts of interest between the sponsor and investors in its MLP. And while sponsors of new MLPs are understandably fond of the arrangement it’s lost favor among the larger midstream general partners.

In recent years, Kinder Morgan (NYSE: KMI), Targa Resources (NYSE: TRGP) and Plains GP Holdings (NYSE: PAGP) have either absorbed affiliated IDR-paying MLPs or, in Plains’ case, exchanged those rights for equity. Now Williams (NYSE: WMB) has followed suit and Marathon Petroleum (NYSE: MPC) plans to do so.

The case for getting rid of IDRs at large, mature partnerships is clear. By lowering the benefits of growth for the limited partners they make the investment less attractive, thereby increasing the cost of capital for the MLP and reducing its usefulness as a funding vehicle. “We felt like the uncertainty of IDRs has been a detriment to the value of securities at both Williams and Williams Partners,” said Williams’ CEO on the Jan. 9 conference call of the rationale for the restructuring transaction.

The recent downturn may also be encouraging sponsors to cash out. Having just gone through a sour patch that significantly devalued those IDRs and reminded them how quickly liquidity can dry up, general partners are likely more inclined to trade the upside for IDRs for cash up front.

Another similarity is that both Williams and Marathon Pete have been under pressure from activist investors to improve returns, and cashing out IDRs certainly offers an avenue for doing so quickly.

But there are important differences between the two situations as well. Williams sold its IDRs relatively cheaply, getting back $11.4 billion in newly issued Williams Partners (NYSE: WPZ) units for a multiple of 12.6x on its annual IDR receipts.

By raising an additional $2 billion from an offering of WMB shares that were used to buy WPZ units, the transaction significantly lowered overall leverage. (Debt will decline further once Williams completes the sale of its olefins plant and related assets for an expected $2 billion.)

The low-end multiple on the sale of IDRs also drew the sting from the 29% distribution cut at WPZ, which will help to further deleverage the balance sheet.

WPZ units are up modestly since the restructuring was announced. WMB, meanwhile, is down 12% since, despite a 50% dividend hike that has resulted in a 4.3% annualized yield following the recent discounting. WPZ units yield 6.1% at the reduced distribution rate.

Source: Williams presentation

WPZ’s payout is now projected to grow 5-7% annually for the next several years, versus annual dividend growth of 10-15% at WMB. And, of course, as the general partner, WMB retains the bulk of an upside from getting acquired.

That scenario aside, the interests of Williams and the limited partners at Williams Partners are now very closely aligned with no IDRs to skew investment decisions and Williams deriving all its future cash from its nearly 74% stake in WPZ.

This is a surgically clean excision of a malignant scheme, deleveraging the balance sheet while greatly simplifying and clarifying the story. And as the new Best Buys list suggests, I remain high on Williams’ valuation and growth prospects.

Marathon also plans to exchange its incentive distribution rights for units of the affiliated MPLX (NYSE: MPLX) partnership. But the preliminary plan unveiled on Jan. 3 anticipates a higher multiple of 15-20x for that profit stream. Meanwhile, MPC also plans to sell to MPLX this year MLP-eligible assets generating $1.4 billion in annual EBITDA. At a projected multiple of 8x the price tag would be above $11 billion, with 50% of that coming via MPLX units and the other half in borrowed cash.

So unlike the Williams transaction, this one would add leverage to the MLP’s balance sheet (although MPLX would remain less levered than WPZ.) Between the MPLX units it already owns, the equity and cash it would receive for this year’s big dropdowns and the additional units due for giving up the IDRs, MPC could end up with enough midstream assets and cash to account for all of its current valuation, with the refineries and gas stations thrown in.   

The danger with an ambitious dropdown slate like that is that the MLP investors and the creditors  who’ll be asked to finance the cash portion won’t stay optimistic enough for long enough. It’s an extreme case, but SunEdison’s collapse shows what can happen when a general partner gets too greedy with the dropdowns and loses the trust of investors. Marathon isn’t peddling the relatively financially risky residential solar roof panels like SunEdison infamously tried to, but the risk that the force-feeding of assets and debt might give the goose laying the golden eggs some indigestion is real.

So far so good on that score: MPLX units are up nearly 4% since Marathon updated its plans at the outset of the year. But given the high multiple it plans to extract for the IDRs and the sheer scale of the dropdowns planned this year, this is an MLP you needn’t be in a hurry to own despite attractive long-term prospects for organic growth. This deal isn’t going to be as fair as the one Williams made with its MLP, and MPLX is very likely to get the short end of the stick.