August 15, 2014
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In the media, there is the concept of a pre-written obituary. News outlets (TV and print) prepare segments and obituaries in advance of a celebrity’s death, so they have facts straight and are ready to publish when the famous person dies. The New York Times apparently has a database of more than 1,200 pre-written obituaries, with the oldest one written in 1982 (according to this article on the subject).
When Robin Williams died earlier this week, the NY Times may have had a pre-written obituary ready to go, but most news outlets probably didn’t. If it were my policy to have pre-written obituaries on MLPs that could potentially be consolidated and go away entirely, KMP would not have been at the top of the list.
It wasn’t a surprise to see KMP announce a transaction that fixes the IDR burden on a permanent basis. The first post I wrote on this blog asked the question, can KMP sustain distribution growth of 5%+ per year given its huge GP take? It’s a question that’s been around a long time. But Kinder endured with the El Paso acquisition, which allowed KMP to continue its growth for a few more years, while sucking EPB’s coverage dry.
Eventually, KMP needed to fix itself, and certainly the expectation was that it would someone make it happen. But the market (and KMP investors in particular) was surprised at the structure of the transaction that would leave no publicly-traded partnerships bearing the Kinder name. We’ve always seen IDR buyouts where the MLP buys out the parent and continues on as a public company (e.g. EPD, MMP, BPL), even when the GP was held in a corporate structure (e.g. MWE’s buyout of Markwest Hydrocarbon, Inc.).
What follows is my post mortem on the deal announced this past Sunday, after lengthy discussion and reflection on the transaction.
Transaction Review: A Simpler Kinder Complex
Kinder Morgan, Inc. (KMI) is acquiring all of the outstanding units of KMP and EPB, and all of the outstanding shares of KMR, in a cash and stock transaction valued at $71.0bn (press release).
What will Kinder Look Like in the Future?
KMI may be advantaged relative to MLPs when it comes to buying assets outside the U.S. KMI will be able to buy non-qualifying assets abroad more easily than MLPs. Does this mean they will buy Canadian pipelines, LNG regasification terminals in Asia or Europe, or terminals in Latin America? I don’t know, but it seems like this transaction sets them up to be able to do that.
Kinder will have another MLP someday, whether it’s a spin out of existing assets in 2016 or 2017, or it’s an MLP acquired as part of buying an existing MLPs G.P., I don’t know. But the flow through tax advantages are still there.
Other Open Questions Asked this Week
Impact on the Sector
MLP Structure: Neutral Impact
I don’t think this will lead to other MLPs leaving the MLP structure. EPD is much larger than KMP, with a market capitalization of roughly $70bn. EPD is under no pressure whatsoever to convert its MLP to a corporate structure. EPD solved its cost of capital issues long ago by eliminating the IDRs, as others have done.
Capital Flows: Positive Impact
Consolidation / M&A Premiums: Positive Impact
Other MLPs are likely to carry consolidation M&A takeout premiums for a while, given how vocal KMP has been about consolidating the sector. KMP buying other natural gas pipeline MLPs is a challenge given HSR anti-trust issues, but gathering & processing MLPs and liquids-focused MLPs would be logical targets. Also, this transaction may increase pressure on other large MLPs to grow even larger, and could lead to consolidation outside of KMI.
Tax Impact: Turn in Your Deferrals
KMI is basically forcing a huge step up in basis on its largely retail investor base and then will be using that new step up to have higher depreciation and save on taxes at KMI, which is the key driver of KMI’s ability to grow at 10% a year for the next 5 years.
KMI put out an estimated tax cost for the average KMP unitholder of approximately $12.39/unit. But that is going to vary wildly. Newer unitholders will do better on an after tax basis than older ones. I personally know someone who has owned KMP since 1993. His CPA has estimated that he will owe around $27/unit in taxes. In the hypothetical, illustrative example below, I show you what that will mean (using a round number of 10,000 units) to the income he is used to receiving. He will need to sell shares of KMI to pay taxes and the net result is 44.5% less take home cash on an annual basis. This is an extreme example, but you see why long-time KMP investors, who rely on KMP for income, might be a little upset that this transaction messes up tax planning and also actual cash flow.
KMP’s Legacy
KMP first went public 22 years ago as Enron Liquids with a market capitalization of approximately $150mm and a 9.5% yield. At the time, there were only 9 MLPs. By the time Rich Kinder took over in 1997, 4.5 years later, Enron Liquids hadn’t grown very much. KMP was only a 3.5% weight in the Alerian MLP Index (Amerigas was the largest at 12.5%). But less than 3 years later, at the end of 1999, KMP had grown its market cap by 10x to $2.4bn, making it the largest MLP of all at the time, a title it carried for several years more before EPD overtook it. At the end of 1999, KMP represented a 22.4% weight in the MLP Index. That was KMP’s peak relative size. As the number of MLPs grew, and the index eventually reached its 50 stock maximum, KMP’s weight in the Index slid down to 8.5% at the end of July.
CAGR-ization
Before Rich Kinder took over Enron Liquids, MLPs were all about yield. Investors bought them in the early 90s as an alternative to bonds and utilities because of their high yield and stable cash flows, not their growth prospects. Today, annual distribution growth has become as prominent as yield when reviewing the MLP sector. The CAGR-ization of the MLP space began with KMP.
15 years ago, in July 1999, there were 21 MLPs in the Alerian MLP Index (it wasn’t until 1Q 2006 that the AMZ reached its maximum number of 50 names).
Landmark Kinder Deals
So, how did KMP grow so big so fast early on and maintain its growth over the years? Well, it wasn’t a single transaction that did it; it was the growth machine that KMP management built, first through acquisitions and later through organic growth. In all, in 17 years, KMP executed 88 acquisitions for a total of $26.5bn. It was a combination of large acquisitions and small bolt-on acquisitions, see below (click to enlarge).
Below are two press releases from two of the larger deals KMP did early on. Reviewing those press releases takes you back to a time when competition for assets wasn’t as great and capital wasn’t as easily obtained, such that KMP could buy another publicly-traded MLP and its GP and still have it be 12.5% accretive to distributions per unit, or could buy a $750mm pipeline asset at 7.5x EBITDA.