It was a heck of a piece of news to release on a Sunday afternoon! A Kinder Morgan press release announced that Kinder Morgan Inc (NYSE:KMI) will purchases all of the outstanding units of Kinder Morgan Energy Partners (NYSE:KMP), Kinder Morgan Management (NYSE:KMR) and El Paso Pipeline Partners (NYSE:EPB).
The merger involves an exchange of KMI shares for KMP, KMR and EPB units, plus KMP and EPB investors will receive about a 13% cash kicker. Based on Friday's closing values, the offers for the three partnership companies are at 11.4% to 16.5% premiums. With the merger, EPB will be absorbed into KMP, which will be a 100% owned subsidiary of KMI. Post merger, KMI plans to increase the dividend to $2.00 in 2015, up 16% from the guided $1.72 dividend in 2014. Then through 2020, the dividend is expected to grow by 10% per year.
Solving Kinder Morgan's Largest Problem
Dividend and distribution growth rates for KMP and EPB are currently hindered by the high cost of equity capital for the partnerships. Paying a 7% LP distribution yield plus close to 50% of distributed cash as IDRs on new unit issuance puts the cost of equity capital close to 10%. And the Kinder controlled partnerships faced the double edged sword of slowing distribution growth resulting in lack of unit price increases, pushing the unit yield higher and the cost of capital higher. With the merger, KMI will eliminate the payment of IDRs on equity issuance, lowered the cost of equity capital. The company also stated it has contacted the rating agencies and expects the merged $100 billion Kinder Morgan to have an investment grade credit rating.
In the presentation slides for the conference call covering this announcement, Kinder Morgan compares the costs and results of a hypothetical $1,000 capex project with a 12% projected cash flow and 50% equity/50% debt financing. For the new KMI, after the cost of taxes, equity, and debt, $65 of the $120 project cash flow drops down to become distributable, allowing the dividend to be increased by 1.5%. For the same project with the current KMP, only $18 of the $120 drops to DCF, allowing the distribution to increase by 0.7%. From these numbers, Kinder Morgan expects that its future growth capex projects will allow the company to double the dividend growth rate compared to the current KMP yield and IDR structure.
What Will KMP Be Worth
Putting a value on KMP post merger generates an interesting question. What is the value of a 10% growing corporate dividend vs. a 10% growing MLP distribution. On the MLP side, Plains All America Pipelines (NYSE:PAA) distributions are expected to grow at 10% and PAA yields 4.5%. Much larger Enterprise Product Partners (NYSE:EPD) has a 6% projected growth rate and yields 3.8%. On the corporate side, the presentation makes a point to list mega-cap corporations increasing dividends by 6% to 9% per year with current yields in the 3% to 4% range.
When the smoke clears and the merger is finalized, I expect the market to put a 4% to 4.5% yield on KMI. Especially in the early years after the merger. Using the $2.00 dividend for 2015, this puts a target price range on KMI of $44 to $50. This is a healthy jump from the current $36.12. If the market decides that KMI is a 3% yielding stock, the share price jumps to $67.
Corporate Structure for the Long Term? Possibly Not!
Although the mechanics may be easier to roll the Kinder Morgan companies into the corporate structure, there will be significant benefits lost when the partnership structures are left behind. Remember that KMP will still be a wholly owned MLP inside of KMP. I would not be surprised that once much of the KMP and EPB debt has been paid off or restructured, that a smaller, lean and mean KMP is again reborn as a spin-off from KMI with a new partnership agreement and a fresh, low-cost IDR structure. Think of the drop down growth that arrangement could produce.
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