Sunday, August 10, 2014

Kinder Morgan to Merge Partnerships into One Company

The Kinder Morgan group of companies issued a press release today, which discussed some interesting new developments. Basically, the general partner being Kinder Morgan Inc (KMI) will be acquiring the master limited partner structures such as Kinder Morgan Energy Partners (KMP), Kinder Morgan Management LLC (KMR) and El Paso Pipeline Partners (EPB). There will no longer be any master limited partnerships involved with the Kinder Morgan name, which would simplify things and roll all assets under one corporation. For a brief overview of the current structure, please check this article.

The limited partners in Kinder Morgan Energy Partners (KMP) will receive 2.1931 KMI shares and $10.77 in cash for each unit they hold. The limited partners of El Paso Pipeline Partners (EPB) will receive .9451 KMI shares and $4.65 in cash for each unit they hold. While I doubt that the KMI shares received would be taxable, because of the like-kind nature of this exchange, I believe that the cash will be a taxable event for some unitholders.

The shareholders in Kinder Morgan Management LLC (KMR) will receive 2.4849 KMI shares for each share of KMR. This would essentially eliminate the gap between KMR and KMP, which has existed for the past several years. This was one of the reasons why I initially purchased KMR over KMP – lower prices, plus possibility for tax-free compounding of distributions, without the added complexity of K-1 tax forms that partnerships generate around tax time.

Before the deal was announced, I was actually expecting that the limited partnerships will take over the general partner, or that the general partner Kinder Morgan Inc would merge into them, thus creating a one giant MLP. Instead, Kinder Morgan Inc will be subject to double taxation as a result of this deal, and also would no longer be enjoying the sweet incentive-distribution rights as a general partner. Those IDR’s will be eliminated, thus lowering cost of capital. However, the company would be enjoying some nice depreciation benefits, which would shelter a portion of income. The drawback is that now most of distributions would no longer pass-through directly to unitholders of limited partner units. On the contrary, the corporation would have to pay taxes on corporate income level, and then when it sends those dividend checks to shareholders, they would also be liable for any taxes.

The other drawback for other investors could be that the yields they will generate will be lower. This is because KMP yields 6.90% while EPB yields 7.50%.Even at the higher dividend of $2/share, KMI yields 5.50% at best.

One positive behind the deal is that there won’t be the need to constantly issue new shares as much as with the MLP structure. Therefore, existing shareholders would not be diluted as much as with other MLPs. In addition, it would be much easier for the company to operate as one, rather than four complicated structures. This would make it easier to move aggressively on acquisitions, which would further boost growth.

The other competitive advantage for the new structure would be that it won’t have to distribute all cash flow to unitholders for distributions, but could actually choose to reinvest a portion in the business. That should reduce need for debt, although it won’t eliminate it. The main attraction of course is that the elimination of the IDR's will make cost of capital lower.

However, the company now expects annual dividends to hit $2/share in 2015, and then grow by 10%/year through 2020. I don’t know about you, but this sounds like a pretty sweet deal, if it could be realized. Based on my calculations, Kinder Morgan Inc could end up paying $3.22/share by 2020, which is an yield on cost of roughly 9%. I believe this is a doable target, because the new company will be retaining more cash to invest in the business, and it will be able to better focus on finding acquisitions for further growth.

After this deal is closed, Kinder Morgan will be the largest position in my dividend portfolio. Kinder Morgan Inc (KMI) was already one of my largest four positions. Kinder Morgan Management LLC (KMR) has also been a decent size position. This is why I haven’t added to Kinder Morgan Inc for over an year and a half. Because this position will account for much more than any other position in my portfolio, and because its high current yield is higher than the yield on my portfolio as a whole, I doubt I would buy more shares for at least one or two years from now. The only exception is one of my IRA accounts, where dividends are reinvested automatically. As I have explained earlier, it makes sense to do so given the fact that this account is not going to get any future cash contributions in the future.

Full Disclosure: Long KMI, KMR

Relevant Articles:

Kinder Morgan Partners – One Company three ways to invest in it
Richard Kinder: The Warren Buffett of Energy
I admire Investors with Skin in the Game
Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
General vs Limited Partners in MLP's
MLPs for tax-deferred accounts

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