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A Closer Look At Kinder Morgan's Epic Transformation

A Closer Look At Kinder Morgan's Epic Transformation

Kinder Morgan (NYSE: KMI) announced on Monday it will fully acquire Kinder Morgan Energy Partners (NYSE: KMP), Kinder Morgan Management (NYSE: KMR) and El Paso Partners (NYSE: EPB).

While the move is considering to be the largest energy merger in recent memory, it may turn out to be one of the largest energy mergers in history.

“This transaction dramatically simplifies the Kinder Morgan story, by transitioning from four separately traded equity securities today to one security going forward, and by eliminating the incentive distribution rights and structural subordination of debt,” Chairman and CEO Richard Kinder said in a press release. “Further, we believe that Kinder Morgan will be a valuable acquisition currency and have a significantly lower hurdle for accretive investments in new energy infrastructure.”

And So, A Giant Is Born

With a total transaction value of approximately $70 billion (according to Reuters), Kinder Morgan has essentially simplified its structure overnight, eliminating investors' concern surrounding the cost of capital at Kinder Morgan Energy Partners and positioning the newly formed Kinder Morgan behemoth to be a consolidator within the MLP sector.

Investors were very vocal in the past that Kinder Morgan Energy Partners was unable to increase distributions to unit holders as quickly as its peers.

Under the new structure, Kinder Morgan will consolidate all the companies under a single C-corporation, instead of a master limited (MLP) structure that was previously used.

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Typically speaking, energy companies preferred an MLP status, as the company could fuel growth through acquisitions and pay no taxes because nearly all of the profits are paid out to investors in the form of a distribution.

In a note to clients on Monday, Jason Stevens of Morningstar wrote, “the deal announced Sunday turns this on its head and takes advantage of the relative discount the market had assigned to Kinder Morgan Energy Partners and other Kinder family master limited partnerships.” The analyst then adds, “because this deal eliminates the incentive distribution structure entirely, we expect the combined Kinder Morgan to be able to sustain more rapid dividend growth.”

The move should benefit all investors, ranging from large pension funds to mom and pop investors.

Kinder Morgan's sole purpose is to collect cash distributions from its ownership stakes in Kinder Morgan Partners, El Paso Partners and other assets. The company then distributes the remaining cash after accounting for taxes and expenses to shareholders in the form of dividends.

Stevens further adds why shareholders are better off in this situation in a note on March 12.

“The difference between limited and general partner distribution growth comes down to incentive distributions rights (IDRs). IDRs allow the holder to collect incentive payments that increase as the master limited partnership's per-unit distribution to limited partners increases based on defined distribution levels, which top out in the high splits, where the general partner is entitled to receive fully half of every incremental dollar paid out as distributors.”

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In more simple terms, Kinder Morgan could raise dividends at a faster rate. Naturally, being the largest midstream energy company in the U.S. doesn't hurt either.

Raymond James Has The Math Covered

In a note to clients on Monday, Darren Horowitz of Raymond James crunches up the numbers.

“Based on Kinder Morgan's math, when assuming: 1) expected 2015-20 cash distributions of $5.83/$6.18/$6.46/$6.96/$7.09/$7.30; 2) a static 6.95% yield; 3) the full acquisition consideration (i.e. KMI dividend growth of ~10% y/y from 2015-2020 starting at $2.00 in 2015, etc.); and 4) adjustments to KMP's expected distributions, the KMP pre-tax benefit post transaction is ~15%/11%/7%/5% dilutive from 2015-18, but ~3%/10% accretive in 2019/20. For context, applying the same assumptions to the RJ model with the variance being more conservative 2015-20 distributions ($5.84/$6.10/$6.36/$6.63/$6.89/$7.14), we arrive at a KMP pre-tax benefit per unit post transaction of ~15%/10%/5% dilutive from 2015-17, breakeven in 2018, and ~6%/12% accretive in 2019/20.”

Bottom Line

Kinder Morgan now has the reach to extend across the U.S. and develop a presence in any market and producing region, a fact that may have slipped under the radar by some investors who reaped large gains on Monday. The company now has a set of energy infrastructure assets that is likely to be impossible for any rival to duplicate.


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