Terra Nitrogen Vs. Terra Industries

With the recent payout of the first quarter distribution, there will be a big change for Terra Nitrogen Co. LP (TNH) shareholders. Although Terra Industries (TRA) has made no secret of the fact, TRA, as general partner and major shareholder of Terra Nitrogen, is now due to take a much larger portion of the quarterly distribution.

A little background. Terra Nitrogen LP is a limited partnership of a single nitrogen fertilizer plant. Terra Industries controls/owns the general partner and owns a bit over 75% of the partnership units. The partnership agreement includes a clause where the general partner receives a higher percentage of the distributable cash as the per share distribution exceed 60.5¢ in a quarter. The other part of the clause states the cumulative distributions must exceed 60.5¢ per quarter, so anytime the distribution is below that amount the GP must fore go its higher percentage until the shortfall is made up. After a string of low payout quarters the general partnership had built up quite a deficit to the minimum payout rule. Then the fertilizer gravy train arrived and TNH was able to make distributions that started to reduce the deficit. At the end of 2007 the deficit was at $6.70 per unit. With the last two quarter’s distributions totaling $8.65 the deficit has been wiped out and the original distribution sharing arrangement is back in effect.

Now for the interesting part. The distributable cash share arangement gives the GP higher percentages in tiers as the cash per unit exceeds 60.5¢. The top tier is hit at only $1.045, and above that level the general partner is entitled to 50% of the distributable cash. Put it the other way, the cash available for the limited partners (what we think of as shareholders) is reduced by half, or the dividend will be 50% less.

Let us see how the numbers would have worked out for the distribution announced last week. The distribution per share was $4.20 times the 18.5 million outstanding shares for a total of $77.7 million. Terra Industries holds 75% of the shares, so they collected about $58.4 million. With the back dividend deficit eliminated the GP (Terra Industries) would have taken about $39 million right off the top, reducing the distribution to $2.10 per share. Since Terra Industries owns the majority of the shares, their per share distribution would be down also, but their total share of the distributable cash would have been about $68 million vs. the $58.4 million they will receive from this latest dividend.

Terra Industries had net earnings of $100.2 million for the first quarter (see transcript), so the now in place sharing arrangement could boost their bottom line by about 10%.

As I said earlier, Terra Industries has not kept this a secret; it has been mentioned in the last two quarterly earnings conference calls and in the 10-K. Since they already own 75% of TNH, they stand to make even more. I think individual shareholders have gotten excited about a company that was paying $2 to $3 /share/year now paying over $4 per quarter and have driven the price from $20 to $150 in about 20 months. I think many individual shareholders are in for a rude surprise when the next quarterly distribution is announced.

The second quarter should be an excellent one for Terra Nitrogen, but I do not think they will have $8+ per share in distributable cash to keep the dividend at current levels. At this point investors who own and like the business of Terra Nitrogen should sell their shares and invest in Terra Industries. If my analysis is correct, the parent is going to reap significantly higher rewards from TNH than individual shareholders will.

My analysis of this situation is from information I have gathered through Terra Industries’ recent conference calls and both company’s 10-K reports. If I have made a mistake here, I would really like to hear about it.