The title specifically refers to the complex relationships among KMP, KMR and KMI. In deciding which of these companies you wish to invest in, you need to know exactly what you are getting and not getting. While each reader will have his own needs based upon his situation, I will tell you what I am doing in my Conclusion section.
There are many areas to cover. Some because it is necessary to clarify some aspects of the KM complex and some to summarize the various positions held for some of the other aspects. The subjects to be covered are so many and complex, I have elected to divide the article into Part I and Part II. The subjects covered by each article are:
* Background--How an investor needs to understand the makeup of the various entities.
* The current hot topic: Dealing with KMI's IDR from KMP
* The "L" game: Limited Partnerships & Limited Liability Companies
* The why and how of KMP and KMR
* What does everyone want? Distributions! When do they want them? Now!
* The Great Mystery: Why does KMR sell at a discount from KMP?
* The next bitter battle: Does KMR provide funds for KMP?
* Summary & Conclusions
The Kinder Morgan ("KM") companies, as group, form one the largest energy companies in the USA. There are four Kinder Morgan companies that are publicly traded:
The following Master Limited Partnerships are the operating companies:
Kinder Morgan Energy Partners, L.P.
El Paso Pipeline Partners, L.P.
Kinder Morgan Management , LLC (NYSE:KMR) is the shadow (my term for the relationship) company of KMP. It was organized to make it easier for institutional investors to invest in KMP.
I have omitted further reference to EPS in this article because it has an effect on only one of the other companies, KMI, and that is a modest effect.
Many comments on articles about the KM group are the result of basic misunderstandings or lack of knowledge of the organization of each individual company in the group. A good number of such comments would not be necessary simply by understanding the type of organization involved and how that influences what and how they do things.
BEFORE WE BEGIN, let's check your knowledge of the KM companies. Which of the following statements are true and which are false:
A. There are two KM directors that have dollar-a-year salaries.
B. A vote of 66.6% of KMP Units can change the MLP's GP.
C. If any outside entity or person owns 20% of KMP/KMR, they are prohibited from voting their Units..
D. KMI can purchase all the outstanding KMR shares if they own 80% of KMP and KMR .
(Answers are revealed elsewhere in this article.)
THE CURRENT HOT TOPIC: DEALING WITH KMI'S IDRs FROM KMP
Over the past month there has been an avalanche of comments questioning the IDR provision in the KMP partnership agreement. These have ranged from those who want to know what an IDR is to what the effect of IDRs is on the market value of KMP and KMR. The culmination of this has been a whole series of articles discussing the subject. In the articles I have seen, it is either stated or implied that eliminating the IDRs or at least decreasing the amount of IDR would be beneficial. Most of the arguments have concerned whether or not eliminating them is practical or even possible.
Anything is possible. Whether it is probable is another question. The KM organization has been publicly opposed to any changes in the organizational structure; but grasping at straws, one writer felt that when KM was recently asked during a response to an article in Barron's if they still were opposed, they didn't say yes or no but spelled out one scenario. They said they would consider other options in connection with KMI and KMP if it came to a point where they couldn't deliver attractive returns. Having said that, I believe they have put themselves in a box. If down the line they go ahead with some plan, wouldn't the investing world consider KM to be in deep trouble? Further, if doing something at that point would be beneficial, why wouldn't it be beneficial to do now? The point is, if KM is going to do something, they should do it sooner than later.
Theoretically there are several ways the problem could be solved: exchange of KMP Units for IDRs or for KMI stock, etc. One novel suggestion would avoid the complications and cost of any swapping. It calls for cutting back the DCF of KMP which would lower the amount of IDR paid to KMI. The amount of cash cut back would be used for reducing debt or financing new CAPEX.
This procedure would, of curse, also cut the distributions to KMP unit holders and to KMI stockholders. No one can predict the results of this. Cutting the distributions may offset any benefit from cutting the IDR, at least in the short run. No plan has yet been suggested that wouldn't result in cutting everybody's distribution.
Interestingly enough, as described on page 51 in the KMI 10-K for December 31, 2013, there is a provision for the removal of KMP's (and /or EPB's) GP. It requires a vote of 66.6% of the Units to accomplish this but if done, the IDRs are abolished. Two problems with this: one is that it calls for a payment to the GP but does not appear to describe the amount or formula to be used; second it ignores the fact that KMR, through its I-Units, controls over 28% of KMP and since KMI owns all the voting shares of KMR, KMI actually controls that 28%. Add the 12% or so that KMI directly owns of KMP units and that leaves only 60% of the votes available and doesn't even consider the shares held by Kinder and the management group.
(By the way, note that the above is in agreement with question "B" of the quiz. Thus "B" is True as is the answer to each of the other statements. "A" is true as not only has Richard Kinder forsaken any remuneration, but the COO, Steven Kean, has now done the same. "C" and "D" can be verified by reference to pages 12 of the KMR and page 52 of the KMI 10-Ks, respectfully.)
There is only one way any change can be made and that is if Richard Kinder wants it made.
As he has stated, the IDRs have been at or near their ID maximum for years and KMP and KMI have enjoyed excellent returns during that time..
Enterprise Production Partnership (NYSE:EPD) bought out their general partner and the inference is there is no GP in that MLP. There is, in fact, a GP just as required of a Limited Partnership as discussed above. In the case of EPD, however, the GP has no economic interest in the partnership meaning it doesn't share in the profits and has no IDR.
THE "L" GAME: LIMITED PARTNERSHIPS & LIMITED LIABILITY COMPANIES
Upon reading the many comments that follow articles on the KM companies, it is clear that there is a great deal of general misunderstanding about Limited Partnerships (LP) and Limited Liability Companies (LLC).
The main distinctions of any partnership, for our purposes, are (1) Every partner is a General Partner who is legally liable for all the debts of the partnership and (2) there is no "partnership tax"-- the income is passed thru to the partners who are liable for income taxes on their share of the partnership income. To qualify as a Limited Partnership, there are two important requirements. First, there must be at least one General Partner, and second, the Limited Partners are limited in that they normally cannot lose more than what is in their capital account and that they have no say in the running of the business. In fact, in some cases limited partners have been found to be liable as general partners for the partnership's debts because they were active in the business. Just as noted for a General Partnership, there is no Federal Income Tax at the partnership level in a Limited Partnership, it is passed through to each partner. Note that there is no Board of Directors in a partnership. There may be committees set up to help in the administration but nobody to protect the partners.
KMP is a Limited Partnership and when you buy a Unit on the stock market, you become a Limited Partner.
In a Limited Liability Company (LLC) each partner may work in the business and each partner is protected from partnership liabilities in excess of their capital account. LLCs are normally treated as partnerships for tax purposes; however, they may elect to be taxed as a Corporation as is the case with KMR.
In this case KMI is the general partner of KMP. It would be difficult if not impossible for KMP to force a buy-out of KMI as KMI controls, directly and indirectly, such a large percentage of KMP's votes. For instance KMI (through KMGP which it owns and which is the direct GP of KMP) holds all the voting shares of KMR and KMR owns over 30% of KMP.
If all of the above has not confused you, add this to the pot. KMGP, KMP's GP, has assigned, to the extent permitted by law, almost all of its GP duties to KMR. What it didn't assign, of course, were such things as the right to change corporate structures. KMP's partnership agreement leaves minimal power to the limited partners.
KMI, as a public corporation, has its own stockholders to satisfy. (If anything, I am surprised that some KMI stockholders have not complained about KMI waiving some of its IDR with KMP.)
This is what makes investing in MLPs and KM in particular so difficult. One needs to understand partnership and related taxation issues in general as well as the specific partnership agreements. Much more research is required than with a conventional corporate investment.
THE WHY AND HOW OF KMP AND KMR
In 1997, Richard Kinder and William Morgan organized a LLC, KMR, as a way to induce institutions to invest in KMP. Institutions up to this point were reluctant to get involved with partnerships for many reasons including the desire to avoid having to deal with K1s which is a partnership tax reporting schedule issued to each limited partner for his use in preparing his tax return. As a result, KMR is currently 48% owned by institutions.
Interestingly, KMR has attracted individual interest because it essentially gives the owner the earning power of KMP without the headaches of a K-1 and the suitability for tax-advantaged accounts such as IRAs.
KMR has elected to be taxed as a C Corp. As such, it does not pass through its income to an owner for tax at the ownership level and while normally such a company would issue a 1099-DIV for reporting income to its stockholders, KMR does not. See the last paragraph in this section as to why they do not.
At its initial offering, KMR was obligated to purchase with the proceeds a special class of partnership unit from KMP known as an I-Unit. These Units have the following distinctions from publicly traded units.
1. The I-Units cannot be sold publicly or to any company except KMR.
2. The I-Units are not allocated any part of KMP's annual taxable income.
3. The I-Units, upon any liquidation of KMP are allocated their proportionate part of KMP's assets.
At each subsequent issuance of KMR stock , whether through a stock offering or as a stock dividend, the same conditions as noted above apply. Any time KMR receives I-Units, it issues a like number of KMR shares. Any time KMR issues shares, it, it takes the proceeds and buys an equal number of I-Units. As a result, each share of KMR is always backed by one I-Unit.
As noted in #2 above, I-Units are not allocated any portion of KMP's taxable profits. Therefore KMR pays little if any Corporate income taxes.
KMR only issues stock dividends to its stockholders which per the IRS are not taxable.. Thus, not only does KMR not issue a K-1, it does not even issue a 1099-DIV. The only tax payable is upon sale of KMR shares, which after being held for a year are long term capital gains. Note that the stock dividends are allocated to each lot of KMR purchased and no matter when they are acquired, they take the same holding period as the lot to which they are allocated.
Disclosure: I am long KMR, KMP, KMI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not an Investment Advisor nor have I any special expertise or training in investing. Each investor is responsible for doing their own research on any investment mentioned in the attached article.