The share price slump in Kinder Morgan's (NYSE:KMI) shares and the 75 percent dividend cut could mean that another company will acquire Kinder Morgan in the future, I believe.
A year ago Kinder Morgan's market capitalization was close to $100 billion, which would have been too expensive to buy out even for very large companies such as Exxon Mobil (NYSE:XOM) or Chevron (NYSE:CVX). The high dividend yield would also have prevented an acquisition, since Kinder Morgan's shareholders would not have sold their shares in order to keep their income generation high (or they would have only sold at a very high premium).
Over the last weeks both of these issues, which have made an acquisition almost impossible in the past, were solved. Kinder Morgan is now valued at $32 billion and shareholders will not be too reluctant to sell because the current dividend yield is not too attractive either.
Who could acquire Kinder Morgan? There are two possibilities:
Another pipeline company could try to purchase Kinder Morgan, but I don't think that is very likely, since there are no pipeline companies left which have very high market capitalizations, and the ability to access cash via new debt or issuing equity is limited for all pipeline companies. Thus financing a takeover would not be easy for any pipeline company, a possible acquirer thus would likely not come from KMI's peers.
There is, however, the possibility that another energy company, whose focus is not on midstream operations but rather upstream and / or downstream operations could buy Kinder Morgan. This includes the majors like Exxon Mobil, Chevron, Total (NYSE:TOT), Shell (NYSE:RDS.A) (NYSE:RDS.B) and BP (NYSE:BP). Among these five, Shell is already making a large acquisition (BG Group), I thus would rule out Shell. Exxon Mobil would probably be the most likely acquirer, since the company has very low debt, a very high market capitalization (which would mean buying KMI would be a smaller acquisition on a relative basis) and Exxon Mobil also has a AAA rated balance sheet, which would allow the company to take on new debt at a very low rate in order to finance the acquisition. In comparison to Chevron Exxon Mobil is also investing lower amounts into its current projects, thus has more money on the sideline which can be spent on acquisitions.
What would a buyout of Kinder Morgan by Exxon Mobil look like? Kinder Morgan has a market capitalization of $32 billion, with a premium of 25 percent this would mean a buyout price of $40 billion. Kinder Morgan also has $45 billion in debt, the total acquisition price (including debt) would thus come in at $85 billion, which is about one quarter of Exxon Mobil's market capitalization (a ratio which is much lower than the one of the Shell - BG deal).
Exxon Mobil could finance this acquisition by either issuing new debt, issuing new shares or a combination of both. If Exxon Mobil were to finance a buyout by cash, Exxon Mobil would have to take on $40 billion in new debt and also take over the $45 billion in debt which are currently on Kinder Morgan's balance sheet. Exxon Mobil would be able to access debt markets at a low interest rate, the company's weighted cost of interest of the debt it holds right now is just 1.1 percent, which would mean extra interest expenses of $450 million a year. Let's assume that interest rates would be higher if Exxon Mobil took on a larger amount of additional debt, let's say the company would have to pay 2.5 percent (more than double its current weighted interest rate). The new debt, which would be used to finance the KMI acquisition, would thus cost about $1.1 billion a year. Kinder Morgan's operating cash flow after interest payments and maintenance capex will be about $4.2 billion in 2015, Exxon Mobil's cash flows from operations would thus increase by $3.1 billion (one time costs would lower this amount in the first quarters after an acquisition) -- we can thus say that such a move would be highly accretive to Exxon Mobil's cash flows. The downside would be additional debt amounting to $85 billion, which would lower the ability to finance other acquisitions with new debt and which might increase the interest rate Exxon Mobil has to pay on debt it will take on in the future. Another positive point is that Exxon Mobil would be able to refinance the debt which is currently on Kinder Morgan's balance sheet at a lower rate (since XOM has a better rating than KMI), which would mean that cash flows would grow over the years. Additional growth capex into KMI's business would grow the cash flows from such an acquisition further over the next years.
If Exxon Mobil would finance the acquisition by issuing new shares, this would mean that Exxon Mobil's debt remains as low as it is now, this would be beneficial for the company's balance sheet. On the downside such a move would contradict Exxon Mobil's efforts to reduce the amount of shares outstanding -- Exxon Mobil has done a tremendous job at reducing its share count over the last years, I don't think they would want to issue a lot of new shares in order to make an acquisition. Financing a KMI buyout with equity would also be dilutive for Exxon Mobil's current shareholders, and would thus be an option which is not shareholder friendly at all (since KMI trades at higher P/E and EV to EBITDA ratio than XOM).
Northern value has calculated future cash flows from Kinder Morgan in this article: Kinder Morgan should be able to generate the following amounts of operating and free cash flows over the next years:
|Year||Cash from operations||Free cash flow|
|2016||$4.5 billion||$2.4 billion|
|2017||$5.0 billion||($0.3 billion)|
|2018||$5.5 billion||$2 billion|
|2019||$6.2 billion||$1.5 billion|
|2020||$6.9 billion||$2.2 billion|
Over the next five years Exxon Mobil could generate additional $28.1 billion in operating cash flows and $7.8 billion in additional free cash flow by acquiring Kinder Morgan. When we adjust for $1.1 billion in annual interest payments Exxon Mobil would have to make if the company financed the acquisition via debt, this would mean additional free cash flows of $2.3 billion over the next five years. Such an acquisition would thus be beneficial for Exxon Mobil's free cash flows, despite heavy investments into Kinder Morgan's business. If the $20 billion backlog for KMI's business is completed, free cash flows would grow a lot, nearing $6 billion a year, which would be a huge boost to Exxon Mobil's cash generation ability in a couple of years.
We can summarize a couple of points: For an energy major like Exxon Mobil, with a very clean balance sheet and easy access to new debt, it wouldn't be hard to finance an acquisition of that size, and it would be accretive to Exxon Mobil's cash generation ability to buy Kinder Morgan at a moderate premium over the current share price (25 percent). The downside of such a move would be that Exxon Mobil would have to take on a lot of new debt, which would limit the company's ability to make other acquisitions in the next quarters.
Since Exxon Mobil might be waiting to make a move and acquire other energy companies (it has been rumored XOM might buy BP), it is very possible that Exxon Mobil will pass on buying Kinder Morgan and look for other assets or takeover candidates, despite the value which lies in Kinder Morgan right now.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.