Kinder Morgan Transaction Reasonable, Strategic: Morgan Stanley

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In an announcement that shook up long-entrenched beliefs relating to running energy businesses, Kinder Morgan Inc (NYSE:KMI) proposed earlier this month that it would consolidate its Kinder Morgan Energy Partners LP (NYSE:KMP), Kinder Morgan Management, LLC (NYSE:KMR) and El Paso Pipeline Partners, L.P. (NYSE:EPB) arms with itself.

The $71 billion transaction would create an oil-and-gas giant and dismantle the master limited partnership business structure that Kinder Morgan itself adopted and popularized so much over the years. The new structure would do away with size limitations that were hampering growth and pave the way for expansions through acquisitions so as to address the huge opportunities arising from America’s shale revolution.

KMI’s ‘transformational’ transaction is “a reasonable strategic decision given the challenges Kinder Morgan was facing and one that should now put Kinder Morgan Inc (NYSE:KMI) on more solid footing,” say Morgan Stanley analysts Brian Lasky, Robert S Kad and Matthew Giacobbe in their August 14, 2014 research note ‘Assessing Implications of the Kinder Morgan Consolidation.’

The transaction

Kinder Morgan Inc (NYSE:KMI) proposes to pay the following to shareholders/unit holders of the merging entities:

  • Exchange 2.1931 of its shares and $10.77 cash consideration for each Kinder Morgan Energy Partners LP (NYSE:KMP) unit;
  • 0.9451 of its shares and $4.65 cash for each El Paso Pipeline Partners, L.P. (NYSE:EPB) unit; and
  • 2.4849 of its shares for each Kinder Morgan Management, LLC (NYSE:KMR) share.

Overall, the cost of the transaction to KMI will be $71 billion comprising $40 billion paid through stock, $4 billion in cash and $27 billion assumed as debt.

Kinder Morgan: Factors working in favor of the decision to merge

“KMI consolidating its partnership entities (KMP, KMR, EPB) is largely structural in nature, but KMI will benefit from large tax shields derived from the asset depreciation and amortization basis step up and some financial cost savings,” observe the Morgan Stanley analysts, who estimate that the company will derive a $20 billion tax benefit.

This enabled Kinder Morgan Inc (NYSE:KMI) to enhance its dividend guidance for 2015 to $2.00 and dividend growth in subsequent years – a plus for the outside unit-holders/share-holders.

Kinder Morgan ebitda

“We expect the company to benefit from a more attractive cost of capital (project and M&A accretion is now potentially enhanced),” says the research note. New projects could therefore become attractive for the company and their location would be made easier given its already massive geographical presence across America.

Kinder Morgan Transaction Reasonable, Strategic: Morgan Stanley

New structure will enable Kinder Morgan to address its capex backlog

The analysts also think the new structure will enable the company to address its capex backlog, and better compete in the marketplace by more efficient utilization of the scale and diversity of its assets – facilitated by the new C-Corp structure.

“While we think it is important to acknowledge that the business remains the same (although structured differently), the revised and extended dividend guidance, upside revision potential and simplification should all receive appropriate value recognition over time,” observe the analysts.

The analysts rate Kinder Morgan Inc (NYSE:KMI) and its arms all as Equal Weight but have boosted price targets for the entities significantly as shown in the table below.

Kinder morgan ratings summary

At the time of writing, KMI and its sister companies were trading as follows:

  • Kinder Morgan Inc (NYSE:KMI) – $41.33
  • Kinder Morgan Energy Partners LP (NYSE:KMP) – $98.52
  • Kinder Morgan Management, LLC (NYSE:KMR)  – $100.25
  • El Paso Pipeline Partners, L.P. (NYSE:EPB) – $42.48


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