Two top reasons for Kinder Morgan move: stalled share prices, lower tax bill


Before today’s pop, all four Kinder Morgan stocks traded roughly flat to slightly down in 2014, and a source familiar with the just-announced Kinder combination tells WSJ the stalling share price of the four stocks was one reason Richard Kinder moved to simplify the structure.

Another reason for the deal: the consolidated company will be more tax efficient - even with the restructuring, Kinder Morgan says it actually will cut its tax bill by $20B over 14 years despite relinquishing the MLP tax benefits.

The source says KMI now is likely to focus squarely on the midstream space, buying up more energy infrastructure in the U.S. amid the country’s oil and gas boom.

KMI +10.7%, KMP +18.7%, KMR +26.2%, EPB +22.5%.

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Comments (43)
  • Mnewz
    , contributor
    Comments (30) | Send Message
     
    Sure, the combined company's tax bill will go down; but the tax bill for holders of KMB will go sharply upwards.

     

    Look for lots of volatility in the price while holders of KMB sell out.
    11 Aug 2014, 01:04 PM Reply Like
  • sarichter
    , contributor
    Comments (587) | Send Message
     
    What is KMB? KMP? If so... I hope they do! It will allow me to buy a ton more at a discount!
    11 Aug 2014, 01:41 PM Reply Like
  • virginia long view
    , contributor
    Comments (174) | Send Message
     
    Can't say I understand what the tax issues are but assume this will be treated as an MLP sell. Hopefully the $10 per share will cover the liabilities but no easy way out at this point relative to taxes. But a great company and I want to stay in.
    11 Aug 2014, 01:09 PM Reply Like
  • sarichter
    , contributor
    Comments (587) | Send Message
     
    Best CEO hands down...
    11 Aug 2014, 01:41 PM Reply Like
  • PendragonY
    , contributor
    Comments (11184) | Send Message
     
    Kinder estimates that the tax liability will be between $12 and $15 a share depending on the price of KMI when the deal closes. This assumes an ordinary income tax rate of 35% and a capital gains rate of 22%, so your results may vary.
    12 Aug 2014, 08:10 AM Reply Like
  • virginia long view
    , contributor
    Comments (174) | Send Message
     
    Thanks
    12 Aug 2014, 08:24 AM Reply Like
  • smurf
    , contributor
    Comments (6147) | Send Message
     
    Brace yourselves for about 3 dozen articles on this subject in the next week or two.
    11 Aug 2014, 01:53 PM Reply Like
  • mbn
    , contributor
    Comments (905) | Send Message
     
    Smurf;

     

    I think we had close to that today alone. My guess is 50 articles over a 2 week period.
    11 Aug 2014, 04:47 PM Reply Like
  • searcher
    , contributor
    Comments (1681) | Send Message
     
    Reading every cotton pickin' article is just like an extra victory lap for this holder of warrants at essentially zero cost. Be happy for me, smurf.
    11 Aug 2014, 06:37 PM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    A lot of questions for KMP holders today;

     

    reduction in dividend stream, loss of tax shelter as Kinder transitions to a C-corp, will the conversion to KMI trigger a taxable event (since many KMP holders have low cost basis)? Lower income stream and loss of tax benefit may prompt many to look elsewhere.
    11 Aug 2014, 02:00 PM Reply Like
  • PendragonY
    , contributor
    Comments (11184) | Send Message
     
    Yes, its a taxable event for KMP holders.

     

    Kinder estimates that the tax liability will be between $12 and $15 a share depending on the price of KMI when the deal closes. This assumes an ordinary income tax rate of 35% and a capital gains rate of 22%, so your results may vary.

     

    Dividends will be lower for a bit, but will eventually be higher under the projections announced with the deal.
    12 Aug 2014, 08:11 AM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    I can't really complain - I'm up big on KMI - but I think Rich Kinder let me down a little. I realize that he's walking a fine line with all the conflicts of interests and he wants to avoid the appearance of impropriety (since he mostly holds KMI), but I think he's gone too far. The way things stand now, the whole complex is up around 20%, with the MLP holders up 20-30% and KMI up only 10%. So, there has clearly been a give-away in value from the KMI shareholders' pockets to the LP unitholders on this deal.

     

    Because this is not a traditional merger (more of a consolidation of companies operating as one unit already), I believe that a premium is unwarranted in this case. I would have preferred for him to do an equal exchange of stock at Friday's close price to let all holders enjoy the benefits of the combination ratably. If he wants to do a give-away so he looks like a great guy, he should do it with his own money.

     

    Still, this is more of a "could be better" critique than a criticism (like trying to improve a professional golfer's swing). I've bet 2/3 of my portfolio on KMI (accumulating between 31-37) as it looked like one of the very few bargains in a richly valued market. It looks like my faith in Rich Kinder was rewarded.
    11 Aug 2014, 02:02 PM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    etern- are you suggesting that KMP holders received a premium?

     

    From the limited news released this morning, it looks like KMP holders will see a reduction in income. Even if they reinvest todays runup plus the $10.77 cash per share, I can't see how they gain. The fact that they can no longer defer their tax liability is an added expense.

     

    Perhaps others can do the math on this as further details are released, but I think ones perspective will be shaped by how this transition fits their investing goals.
    11 Aug 2014, 02:46 PM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    Yes - their units are now valued 17% higher than yesterday's close. KMI's shares are now valued only 8% higher. This suggests greater value to the KMP unitholders. Tax deferral is not the same as tax elimination. Its value is the time value of money. You will be paying the full federal rate on that income either currently (depending on how long you owned the units) or when you sell through depreciation recapture. The dividend on the new shares will only be taxed at 20% (until our president tries to take more money out of our pockets for having the gall to try to get paid from the stocks we buy).

     

    So, assuming you take the $10.77 to pay taxes (I don't think this is a tax-free exchange) and you are taxed at the highest possible rates, your new dividend of $4.40 pays out $3.52 net of taxes. This is compared to your old unit which paid out $3.33 net of taxes, plus whatever the time value of money on your tax deferral is worth (I'm ignoring that for now given how low interest rates are).

     

    To me, it looks like KMP unitholders are going to walk away with more money (assuming you are a taxable investor) after the IRS is paid AND they have a higher rate of growth on that income stream. That's huge and it means that they clearly gain on this deal (hence the spike in the price).

     

    KMI shareholders will see a bump-up in payout, but the expected growth rate isn't increasing by 6% per year (from 4% to 10% per year if I remember correctly). It's going from 8-10%. The capitalized value of the differential in growth rates between KMI and KMP holders (4% per year) should have inured to the benefit of the KMI shareholders, resulting in an even lower dividend for the KMP unitholders - but that's not what happened. The net result, as it looks to me now, is that KMI shareholders are subsidizing the unitholders in this buyout, and is the reason why the units are up more than the shares.
    11 Aug 2014, 04:34 PM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    I am not completely following you, KMP holders currently receive $5.56/share which is tax-deferred. Upon purchase by KMI they will receive $3.77 (2.1931 shares KMI @ $1.72 for each share KMP). If in fact, the KMI dividend is raised to $2.00 at the time of the transaction, then KMP holders would be reestablished at $4.39.

     

    If you are a long term holder in KMP and your cost basis does not roll forward, you are going to need the $10.77 'goodwill' payment to pay the taxes on your reduced cost basis. After that you will be left with a +20% reduction in income that will be further reduced by taxes.

     

    I can trade some dividend yield for higher total return but I invest in MLPs for tax deferral. A lot of questions for long term KMP holders.
    11 Aug 2014, 07:46 PM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    Yeah - I get you on the tax deferral, but unless you are holding the asset until you die (no one can really count on a horizon that long - ask GM shareholders), you will have to pay the full-boat tax on all distributions you received when you sell (depreciation recapture). So, that extra 20% that you think you are getting is somewhat illusory - kind of like celebrating when money is in your checking account even though it came out of savings. In terms of after-tax total value, you are better off with the exchange and KMI dividend.

     

    To be honest, part of my thesis assumed a buyout of the GP. I was hoping to get a premium on KMI stock of 20% or so in KMP units exchanged for KMI, which would then nearly double to converge with EPD to yield 3.8%. This was supposed to net me around 2.2x the initial investment + organic price growth from an increase in profitability over the holding period. Then I would sell - I don't think MLPs are set up to succeed in the very long run because consistently creating earnings growth while adhering to a 90% payout rule - all while paying out eye-popping yields to attract new capital - is really hard to do - at least when you are not in the midst of a secular decline in interest rates. It sounds like we'd both be happy if the buyout happened the other way around, but I guess there were other ideas in the works.

     

    This combination I think gives the company the ability to double in profitability, triple in value and still have growth prospects after all that, making it a longer-term hold. But I hear you - if you are 70 years old and in retirement, enjoying the tax deferral and hoping to pass the units on to your heirs - this is going to cramp your lifestyle a little, at least until you enjoy a few years of higher dividend growth and the shortfall is made up.

     

    This buyout also gives you the ability to take your KMI shares and sell them when the transaction closes, which would net you about $80 (based on friday's closes). Essentially, you could get a like-for-like exchange into Energy Transfer Partners and break even from an income perspective. Or, you could just sell out of KMP right now and do the same and hopefully that solves your issue. Hope this helps.
    11 Aug 2014, 08:34 PM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    I think we're on the same page, just need a bit more information on the tax implications of the transaction.

     

    If it turns out that the $10.77 premium is taxable and I also need to pay tax on my reduced cost basis, then I will be comping KMI against EPD, MMP, PAA, SXL, ETE and Conoco.

     

    I do agree that the proposed structure is probably better than what they have now, just hope it isn't punitive to long term KMP holders.
    11 Aug 2014, 08:56 PM Reply Like
  • virginia long view
    , contributor
    Comments (174) | Send Message
     
    Thank you both, a lot of good discussion that helps me as a guy who has really never understood MLPs but was, and probably will continue to, betting on Richard Kinder.

     

    Any idea what happens with shares held in IRAs, I have a few there but most is in taxable accounts?
    12 Aug 2014, 08:35 AM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    Thank you for the comment - I'm glad all the brain damage I went through to understand partnership investing is a help to you. Usually, when you learn enough about these things (including the fact that you might have to pay tax on money you never get), staying away becomes more attractive than it first seems. There usually are not tax implications for shares held in IRAs, but partnerships are tricky and I don't recommend holding them in retirement accounts unless you really do your homework. There is something called Unrelated Business Taxable Income that can completely negate the tax advantages of MLP or REIT structures, particularly in leveraged partnerships. UBTI can also hit you on a sale of the partnership.

     

    1416 - Your tax liability will be the entire consideration (value of shares at closing plus the $10.77) less your adjusted basis in KMP. The difference then will be multiplied by the applicable rate. A portion of the gain will be taxable at the capital gains rate, though any returns of capital you received while you owned the shares resulting from depreciation reductions will be taxed at the full federal rate (depending on whatever tax bracket you are in).

     

    By the way, if the transaction happened the other way around (KMP bought KMI), guess who would have had to pay $2.5 billion in taxes?
    12 Aug 2014, 11:25 AM Reply Like
  • Gentle Ben
    , contributor
    Comments (13) | Send Message
     
    Agreed. For us short-term holders of KMP, like me; the capital gains tax will be a KILLER come tax time! It will wipe out all the benefits of working my tail off to finally expect to be in the highest tax bracket this year. I hate hate hate this merger. They could have at least WARNED KMP holders that it was coming before we bought units this year. Bad form, Kinder Morgan.
    12 Aug 2014, 02:33 PM Reply Like
  • Gentle Ben
    , contributor
    Comments (13) | Send Message
     
    It's even MORE punitive for short-term KMP holders, like me, due to the short term capital gains tax being even higher. Shame on Kinder Morgan for not warning new investors of this pending merger before we bought in 2014!!!

     

    I'm literally sick to my stomach because I worked my tail off to finally expect to be in the highest tax bracket come tax time, and what is my reward? To have it all taken away by short-term capital gains tax.

     

    The cash will nowhere come close to paying off what I will owe. Sure, the Kinder Morgan executives are making out great, but we KMP investors are getting the SHAFT!!!!!!!!!! Sad thing is, I see no other option but to take the looming hit, unless someone else has a good idea on how to avoid the looming short-term capital gains hit.
    12 Aug 2014, 02:47 PM Reply Like
  • PendragonY
    , contributor
    Comments (11184) | Send Message
     
    "It's even MORE punitive for short-term KMP holders, like me, due to the short term capital gains tax being even higher. Shame on Kinder Morgan for not warning new investors of this pending merger before we bought in 2014!"

     

    I don't believe its as bad as you fear. And even if it was, shame on you for buying something when you didn't understand the risks.
    12 Aug 2014, 03:24 PM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    etern/pendragon-

     

    Thanks for the followup comments, perhaps you could help with the example below. When I read S&Ps comments, it looks like the premium of $10.77 is already in the share price. KMI is proposing to purchase KMP shares at a price of $89.98/share.

     

    How much of the premium will KMP holders actually realize?

     

    For example, if you receive $8,998 for each 100 share lot and it is reallocated to 219 shares of KMI worth $8541 ($39/share?), then your premium is only $457.

     

    What am I missing here, because there is no way that this amount would cover the tax liability of a long term holder (5 yrs) who has been dripping the distributions. I am not against paying taxes on a gain, but would like it to be at a time of my choosing, which is the whole point of investing in the MLP structure... Wish they would roll this into 2015.
    12 Aug 2014, 06:01 PM Reply Like
  • PendragonY
    , contributor
    Comments (11184) | Send Message
     
    User,

     

    Kinder estimates that the tax liability will be between $12 and $18. So the $10 in cash will go a long way to covering that particularly for those who are not in the 35% tax braket.
    12 Aug 2014, 06:16 PM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    Pen- of course the premium does help, would certainly be more painful without it. I am not much beyond the 15% bracket, but that is enough to trigger cap gains tax. I think they could help a lot of KMP holders by doing this in Q1 2015.

     

    Is it correct though, that this is basically a sale at $89.98 a share? I am not certain I want to go right into KMI. Might want to reinvest in other MLPs or BDCs that I currently hold and revisit KMI later. Any downside to this? Thanks
    12 Aug 2014, 06:47 PM Reply Like
  • PendragonY
    , contributor
    Comments (11184) | Send Message
     
    I have KMR and KMI in my taxable account, so I plan to let it all roll over. I have just KMI in the IRA, so nothing to do there.

     

    As for what to do if you don't want to go into KMI (or not roll it all anyway), you have to look at the various tax considerations and what that means for a good price to sell some (or all) of the KMP. Remember there are wrinkles on the tax front if you don't sell all of the KMP units, so I think you need someone who knows tax issues to help you figure it out.
    12 Aug 2014, 07:18 PM Reply Like
  • Rudester
    , contributor
    Comments (3372) | Send Message
     
    Heard on CNBC this morning about certain "irregularities" in insider transactions on all Kinder shares/units, a day or two prior to the public announcement. Hmm.
    11 Aug 2014, 03:17 PM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    Hahaha... I can't remember the last merger where I didn't see a spike in options activity prior. Loose lipped investment bankers are why hedge funds get to charge 2/20.
    11 Aug 2014, 08:35 PM Reply Like
  • virginia long view
    , contributor
    Comments (174) | Send Message
     
    You can almost always guess which way earnings are going a day ahead of release by watching the stock price! Never be able to stop that, I guess, and hedge funds live off it!
    13 Aug 2014, 02:06 PM Reply Like
  • locutus49
    , contributor
    Comments (1057) | Send Message
     
    I have a small position in KMI at $31 a share, which I bought early in the year to avoid K-1 issues. I hope it remains K-1 free.
    11 Aug 2014, 06:08 PM Reply Like
  • Dividends#1
    , contributor
    Comments (4231) | Send Message
     
    Hi locutus49,

     

    As we know K-1's are for MLP's. This whole consolidation eliminated the MLP for the C-corp. NO k-1 to worry about.
    11 Aug 2014, 06:13 PM Reply Like
  • Gentle Ben
    , contributor
    Comments (13) | Send Message
     
    Come tax time next April, I predict a lot of investors will be angry with Kinder Morgan when they realize the cash they received to supposedly "make up" for the tax consequences of the merger, doesn't come close to covering the tax bill. ESPECIALLY if you are a short-term holder, like me.
    12 Aug 2014, 03:19 PM Reply Like
  • Gentle Ben
    , contributor
    Comments (13) | Send Message
     
    I'd rather have the K-1 than to lose the tax advantage that KMP offered. Now, I'm wondering which MLP to exchange the KMI into, since KMP is no longer an option? I'm looking for the BEST yield. (My plan for KMP was to hold onto it until death to avoid the tax consequences, and live off the yield. Now, I've got an enormous short-term capital gains tax coming, sigh!) I am so upset about this merger. Wish I had known they were getting rid of KMP as an MLP before I bought into it this year. This ought to be against the law for Kinder Morgan to do this to unsuspecting new investors! I'm going to take a HUGE loss, even after the so-called "bonus" cash is deducted.
    12 Aug 2014, 03:19 PM Reply Like
  • TJ Schoenlein
    , contributor
    Comments (410) | Send Message
     
    Did the " shorts " take a kickin' in the touché yesterday? Oh ya!
    11 Aug 2014, 11:02 PM Reply Like
  • Gentle Ben
    , contributor
    Comments (13) | Send Message
     
    HELP! I'm a short-term holder of KMP in the highest tax bracket. The cash they are giving will not even come close to covering the tax bill due to switching from KMP to KMI units! Any way for me to avoid the enormous capital gains tax that is coming?
    12 Aug 2014, 02:34 PM Reply Like
  • PendragonY
    , contributor
    Comments (11184) | Send Message
     
    Sell it all now. You don't understand enough about it to have invested in it in the first place. So correct your error and get out of the position.
    12 Aug 2014, 03:25 PM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    Ben,
    Unfortunately, no one is going to feel bad for a guy whose taxable income is greater than $450,000 per year who is complaining because he has to pay taxes on all the money he made on an investment. You are paying a gains tax because you made money on KMP. Setting aside the fact that the federal securities laws prevent him from doing so and suppose Rich Kinder let the cat out of the bag about KMI/KMP merger. You wouldn't have been able to benefit from the huge run-up that you just saw. Now, you have the chance of pocketing a hefty gain in a short amount of time. Congrats on the good investment and congrats on being part of the 0.5% of people who ever get to make more than $450,000 per year. Life is good. It's much better to be part of the group that "should have made more" than the group that didn't make squat.

     

    On the other hand - paying 43.4% in taxes when you are fortunate enough to make money on an investment that happens to get bought out within 365 days of purchase totally sucks, especially when you can't deduct a huge loss that happens next year to offset it. You didn't make the choice to sell it. You shouldn't have to pay a punitive rate as part of the buyout. But your beef isn't with Rich Kinder - it's with the guy in the Oval Office (and he wants your money, you filthy hard-working 1%er).
    12 Aug 2014, 05:22 PM Reply Like
  • Pablomike
    , contributor
    Comments (4479) | Send Message
     
    But he is not "taking a loss" as he claims. You pay taxes on profits. As a short term holder he must have large gain plus the cash.
    Had they "pre announced " a buyout the stocks would have spiked, he wouldn't have bought and wouldn't have made money.
    13 Aug 2014, 08:29 AM Reply Like
  • sarichter
    , contributor
    Comments (587) | Send Message
     
    It isn't just this particular guy in the Oval Office. The government preceding this one has asked for the same.
    13 Aug 2014, 08:50 AM Reply Like
  • locutus49
    , contributor
    Comments (1057) | Send Message
     
    I know the feeling of Ben. I owned a large position in Heinz in my taxable account. Then one day Berkshire Hathaway buys HNZ outright, and I get a huge chunk of cash, with huge cap gains, and have to pay a huge tax bill.

     

    My issue was that I did not plan for the taxable event, it came from the blue. But, as you point out, I made good money. And I also own Brk so it went from one pocket to another.
    13 Aug 2014, 09:09 AM Reply Like
  • eternitus141
    , contributor
    Comments (521) | Send Message
     
    Huh? The tax top tax rate was 35% with cap gains at 15%. Both tax rates are more than 8% higher and makes success really sting a lot more than it used to. If you are talking about the fact that you get stuffed with a big tax bill on involuntary sales, agreed. I think it's a law that needs to be changed.
    13 Aug 2014, 09:57 AM Reply Like
  • user1416
    , contributor
    Comments (885) | Send Message
     
    Some tax followup- I went back and read the audio transcript. Kinder does not say that KMI is purchasing KMP for $89.98 as has been reported by some analysts.

     

    The transcript says that "the KMP unitholder will receive 2.1931 shares of KMI for every unit of KMP plus $10.77 in cash.. the implied consideration is based on the close on Friday, August 8th". Closing prices noted below;

     

    8/8/14 KMI $36.12
    8/8/14 KMP $80.34

     

    2.1931 shares of KMI = $79.21 share value + $10.77 cash = $89.98 deal value.

     

    If this is how it is structured, then it is positive for me. It means that my KMP shares are being converted almost on a 1:1 basis and that the cash is over and above the share conversion. I have been holding and accumulating since late 2008. I have calculated my tax liability at between $10 and $11 per share using a 17% marginal rate, 15% cap gains rate and 4.5% golden state rate.

     

    There will still be a reduction in dividend stream, but my cost basis will be stepped up with Kinder picking up a large portion of the tab. Hope this is the way it works out.
    13 Aug 2014, 05:29 PM Reply Like
  • Ruffdog
    , contributor
    Comments (3418) | Send Message
     
    I like the sound that shorts make when they are squeeeeeeeeeeeeeeeezed!
    17 Aug 2014, 10:08 PM Reply Like
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