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Summary

  • A recent report from Credit Suisse suggested that Kinder Morgan Energy Partners should buyout or merge with its General Partner Kinder Morgan Inc.
  • The rationale behind this move is to eliminate IDR payments, which increase the partnership’s cost of capital and has held down its valuation.
  • However, any such transaction would be extremely expensive and would dilute current unitholders.
  • In addition, there would be complications resulting from Kinder Morgan Inc’s various holdings, including its stake in El Paso and other legacy assets.

About a week ago, Credit Suisse came out with a report suggesting that the Kinder Morgan group, Kinder Morgan Energy Partners (NYSE:KMP), Kinder Morgan Inc. (NYSE:KMI) and Kinder Morgan Management (NYSE:KMR), should undergo a restructuring in order to eliminate IDR payments.

This has sparked a debate regarding the future Kinder Morgan and its MLP. While I am a firm believer in the ability of Rich Kinder and his team to find suitable attractive expansion projects, there is little question that the current corporate structure of Kinder Morgan has hampered the long-term growth potential of the MLP, with 50% of all future incremental cash flow increases slated to go to the GP. As a result, the market has heavily discounted Kinder Morgan, with the MLP now trading at a 45% discount to peers such as Enterprise Products Partners (NYSE:EPD).

Jim Cramer weighs in on the debate

During the April 9th "Lightning Round" segment of Mad Money, Jim Cramer fielded a question regarding Kinder Morgan. In his response, Mr. Cramer noted that he continues liking the Kinder Morgan group even though it has performed poorly. In addition, Mr. Cramer mentioned the restructuring concerns. Finally, and most importantly, Mr. Cramer noted that Rich Kinder is behind the stock and will do what is best for the company.

While I believe Mr. Cramer sometimes focuses too much on the "trend," it is good to see that he remains bullish Kinder Morgan. About a month ago, he had turned bearish on another of his former favorites, namely Linn Energy (NASDAQ:LINE), sending shares of that stock much lower.

Is Kinder Morgan too large to restructure?

GPs are not stupid. They create MLPs in a way that both they and the limited partners share in the benefits of growth. Oftentimes, GPs will sell assets to their MLPs at lower than market multiples in order to facilitate distribution growth and thus increases wealth for both sides.

When an MLP gets to a certain size, the IDR payments oftentimes start scaling higher in percentage terms. Kinder Morgan long ago reached its cap of 50% back in the 1990's. All the while, Kinder Morgan unitholders saw a CAGR of over 20%.

However, with the Kinder Morgan MLP now a behemoth, growth has undoubtedly started to slow. Furthermore, given the discount Kinder Morgan is trading for, the cost of capital for the company has increased.

Selling units on the open market at the current depressed prices is IMO out of the question. When the partnership sold 6.9M units back in February, I questioned that move, given that the offering price was 10% below the previous one.

Furthermore, even though Kinder Morgan is growing, the quality of this growth may come under question, especially if it is focused on non-core segments.

Therefore, Kinder Morgan is in a bind. Its multiple is low due to the IDR payments. Yet, as an MLP, it has to have access to equity financing to fund its growth.

Kinder Morgan does have a source of self funding via KMR. However, this will only provide a portion ($720M) of the 2014 capex needs ($3.6B).

As I noted in a previous article, the solution here is simple. Kinder Morgan needs to restructure in a way that its MLP no longer has to pay IDRs. The market simply does not tolerate this structure anymore and will continue to trade Kinder Morgan at a discount to its peers unless resolved.

That being said, any deal would likely be dilutive and may cause a short-term dip in DCF for the MLP. However, the overall multiple applied to Kinder Morgan should increase.

I believe Rich Kinder and his team will find an elegant solution to the IDR problem. Kinder Morgan would hardly be the first MLP to buyout its GP. In addition, Mr. Kinder and other KMI insiders could in theory subsidize any such transaction in order to lessen the impact on the MLP unitholders.

Conclusion

Just to make this clear, I personally think the IDR issues surrounding Kinder Morgan are much ado about nothing. They are more an issue on bad PR and market perceptions. However, their impact is real in the form of lower prices for both KMP/KMR and KMI.

It is a shame that the market is undervaluing the Kinder Morgan group. However, for long-term investors, this merely sets up a good buying opportunity. With a yield of 7.10% along with 5% growth, you'll be hard pressed to find a better source of income than KMP. As for KMI, its 5% yield along with 8% growth rate, it has some of the best dividend growth prospects out there.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

Source: Is Kinder Morgan Too Large To Restructure?