El Paso Shareholders Get Short Shrift In Kinder Morgan Deal

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Includes: KMI
by: Tim Plaehn

Last week, on March 1, a judge from the Delaware Court of the Chancery declined to halt the $38 billion acquisition of El Paso Corp. (EP) by Kinder Morgan (NYSE:KMI). However, the judge, Chancellor Leo E. Strine Jr., had some unflattering comments concerning the players, according to an article in The New York Times' Dealbook section. The big take-away from the Chancellors remarks are that El Paso CEO Douglas Foshee was negotiating for the benefit of his own interest, to the detriment of company shareholders.

The interesting points:

  • CEO Foshee negotiated the Kinder purchase himself, and did not disclose he was interested in getting his hands on El Paso's pipeline business after the merger was complete. He did voice the interest to Kinder Morgan's CEO, Richard Kinder, but not to the El Paso Board of Directors.
  • No attempt was made to look for alternative bidders to counter the Kinder Morgan offer. And when, in the middle of negotiations, the offer value was reduced, Mr. Foshee accepted the lower bid amount.
  • The Chancellor also went after Goldman Sachs (NYSE:GS) for acting as an advisor to the El Paso board while having two seats on the Kinder board of directors and Goldman's private equity arm owns 19 percent of the outstanding KMI stock.

It appears the major parties involved in the negotiation were looking out for everyone's interest but the El Paso shareholders. The ruling did not stop the acquisition, but leaves the door open for lawsuits requesting monetary damages. Since the judge's ruling, the news has been back and forth whether the Kinder Morgan purchase will be approved. The latest is than the California State Teachers' Retirements System pension fund will vote against the merger.

As I see it, if the deal goes through as negotiated, it will be a huge win for Kinder Morgan. The company will pick up the El Paso assets at a much lower cost than if the company had gone out for competitive bids. The parts of El Paso which do not fit with the Kinder businesses can be sold off for cash.

However, I think the best play right now is to pick a way to profit from a decline in the KMI share value. If the deal is approved by El Paso shareholders, the lawsuits will fly like a pack of pigeons to bread on the sidewalk. If the deal is not approved, the Kinder share price will fall on the bad news.

One option is to short Kinder Morgan, but the short interest is very high, and if my analysis is wrong, a short squeeze could be very painful. The best option at this point - with the stock at $36 and change - is a bear put spread, buying the April $35 put and selling the April $32.50 contract - you want to make the trade less than a net $1.00 debit. Profit potential is $150 per contract if Kinder Morgan drops below $32.50.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.