On Sunday evening, Kinder Morgan, Inc. (NYSE:KMI) announced a blockbuster deal that has the potential to significantly alter the landscape of the US energy industry, as the company announced its acquisition of Kinder Morgan Energy Partners, L.P. (NYSE:KMP), Kinder Morgan Management, LLC (NYSE:KMR) and El Paso Pipeline Partners, L.P. (NYSE:EPB). This will create one of the largest energy companies in North America and will simplify the ownership structure of the four companies. In the presentation accompanying the announcement, KMI management argues that the simplified structure and streamlined corporate strategy will benefit the shareholders and unitholders of the participating companies. KMI expects a timely closing of the deals in Q4 2014. KMI is poised to benefit significantly from both financial and operational perspectives. KMI should be able to show strong dividend payment growth over the long term which should attract income-focused investors.
KMI Should Experience Strong Financial Benefits From Acquisitions
Source: Kinder Morgan, Inc. Investor Presentation
As is outlined in the above chart, the $71 Billion transaction should not have a significant impact on the overall structure of the group. While the deal is largely funded through equity in KMI, there appears to be a rather small $4 billion in financing for the cash considerations of the transactions, for which KMI has already received a commitment letter for the financing from Barclays. KMI has strong plans for future growth once these transactions are completed. KMI Chairman and CEO Richard D. Kinder noted the following in the company's transaction press release:
"Everyone will hold a single, publicly traded security - KMI - which will have a projected dividend of $2.00 in 2015, a 16 percent increase over the anticipated 2014 dividend of $1.72. We expect to grow the dividend by approximately 10 percent each year from 2015 through 2020, with excess coverage anticipated to be greater than $2 billion over that same period."-Richard D. Kinder, Kinder Morgan, Inc. Press Release
This anticipated growth for the combined entity is encouraging and should encourage investors to support the deal. In addition to the financial considerations and guidance from the consolidation of these four entities, there are also significant benefits from an organizational aspect. While KMI expects its acquisitions to be cash flow dilutive in the short term, the company is optimistic about the strong long-term potential cash flow accretion from these deals. KMI currently yields 4.8% and with the dividend increase anticipated for 2015, the yield based upon next year's dividend payments is a healthy 5.5%.
Simplification Of KMI's Operational Structure Should Benefit Shareholders
Source: Kinder Morgan, Inc. Investor Presentation
As is exemplified in the above chart, the four entities involved in these acquisitions are already intermingled with various LP, GP and equity interests. The completion of the consolidation of these companies will significantly simplify the ownership and operating structure of the combined entity. One of the more significant aspects of the business simplification is the elimination of incentive distribution rights that can have a material effect on the accretion of M&A and can raise the cost of capital, making transactions more expensive. KMI sees a strong environment for energy infrastructure M&A and the potential lowering of the cost of equity issuance may be important in the company reaching its financial goals and completing accretive transactions. It is important to note that KMI will remain a C-Corporation, not an MLP. It appears that the resulting company structure will see KMI owning an operating MLP consisting of the former KMP and EPB MLPs, which will allow KMI shareholders to avoid filing a K-1 and accounting for the tax implications of MLP ownership while still benefiting from the operating nature of the merged MLP subsidiary. The organization under one C-Corporation roof is significant, yet there has been nothing to suggest that the merged KMP and EPB MLPs will convert to a different structure as a subsidiary of KMI. Of course, KMI could choose to structure its subsidiaries in another way that it sees fit.
KMI Should Be Able To Produce Strong Long-Term Returns After Acquisitions Close
While there will likely be increased share price volatility in KMI in the near term as the market digests the implications of this consolidation, the company has significant long-term potential to outperform. As for KMP, KMR and EPB, the individual performance of their securities will largely depend on the arbitrage spreads relative to their respective security prices. There may be short-term profits to be had from merger arbitrageurs in KMP, KMR and EPB once the market reacts to the acquisitions, from a long-term and fundamental perspective I would consider a long position in KMI. As a result of the financial and operational benefits from the consolidation of these four entities into one company, KMI will become one of the largest corporations in the North American energy sector while paying a sizable dividend with the ability to grow dividend payments over time. Over the long term, KMI should be able to produce strong returns for shareholders.
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