Does Kinder Morgan's Deal Call MLP Growth Into Question?

| About: Kinder Morgan, (KMI)

Summary

Kinder Morgan's acquisition shows a potential limit to MLP growth.

Kinder's situation may be unique among large MLPs -- few others are likely to follow.

MLPs remain a sound investing choice for many investors.

With Kinder Morgan's $71 billion consolidation of its affiliates, many investors are wondering if rollup fever will sweep across the white-market for master-limited partnerships.

Houston-based Kinder Morgan Inc. (NYSE:KMI), the country's largest operator of pipelines, said Sunday it would acquire three affiliated partnerships - Kinder Morgan Energy Partners, El Paso Pipeline Partners and Kinder Morgan Management - for $44 billion in cash and stock and the assumption of $27 billion in debt and roll them into its corporate structure.

For months, Kinder had been under pressure from investors who worried that the partnerships were using too much cash to pay dividends to KMI. That cash, they argued, could be used to buy or build assets that would benefit investors. Kinder had simply reached the point where its size made it impossible to keep growing distributed cash flow at the rate investors expected.

Initially, some other large partnerships also caught investor interest. Enterprise Products Partners (NYSE:EPD), for example, jumped as high as $77.16 Monday morning after closing Friday at $75.28. But reality slowly sank in as the week wore on.

That reality is that only a few MLPs - Enterprise and Energy Transfer Partners (NYSE:ETP) primarily - are big enough to confront the sort of growth challenges that Kinder faces. In that sense, Kinder's purchase of its affiliated partnerships may serve as a template - an exit strategy, if you will, for MLPs that reach a certain size. But such deals are likely to be limited, and we aren't likely to see even large MLPs rushing to follow Kinder's lead.

For investors who are focused on income, MLPs remain a sound and rational investment decision, for all the reasons I cited in my earlier post on the subject.

While the Kinder dustup has brought a little excitement to the MLP sector, I still believe MLPs offer investors a strong return with less volatility than investing in commodities or even energy producers.

Of course, if you're concerned about volatility among MLPs, you can always consider an MLP exchange traded fund. Like other ETFs, these funds provide a good way for investors to capture some of the best performance of the MLP space with lower volatility than they might face by buying some of the riskier MLPs individually.

A word of caution: while MLPs offer tax advantages by way of avoiding corporate income taxes, they also have the hassle of K-1 income reporting on your personal taxes. This can complicate and even delay filing your tax returns on time. Also, mutual funds and ETFs that hold more than 25% in MLPs must pay the corporate tax if they generate a 1099 instead of a K-1. Some MLP focused mutual funds are strategically constructed to comply with the holding limit to keep the tax advantage. Furthermore, MLP distributions can run afoul of IRA rules on passive income and Unrelated Business Income Tax (UBTI) if held in an IRA. These tricky UBTI rules can also conflict with IRS limits on churches and foundations and other tax exempt organizations with investable dollars.

No matter how you choose to look at it, the fundamentals for MLPs remain strong. Demand for pipelines is growing thanks to the hydraulic fracturing boom, and even if the Federal Reserve raises interest rates in the coming months, the increases are unlikely to be significant enough to dampen MLP returns.

Quite simply, Kinder was a special case among MLPs. It had grown so large, it simply couldn't devote enough cash to external growth, even though it sees plenty of opportunity for growth both organically and through acquisitions. What's good for Kinder, though, probably doesn't make sense for most other MLPs.

Disclosure: The author is long KMI, KMP, KMR, EPB, EPD, ETP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.