Kinder Morgan's (KMI) CEO Steve Kean on Southern Co's Strategic Venture (Transcript)

| About: Kinder Morgan, (KMI)
This article is now exclusive for PRO subscribers.

Kinder Morgan Inc (NYSE:KMI) Kinder Morgan Inc and Southern Co Strategic Venture Conference Call July 11, 2016 8:30 AM ET

Executives

Rich Kinder - Executive Chairman

Steve Kean - President and CEO

Kimberly Allen Dang - VP and CFO

Analysts

Kristina Kazarian - Deutsche Bank

Shneur Gershuni - UBS

Jean Ann Salisbury - Bernstein

Gabe Moreen - Bank of America, Merrill Lynch

Jeremy Tonet - JPMorgan

Ted Durbin - Goldman Sachs

John Edwards - Credit Suisse

Craig Shere - Tuohy Brothers

Paul Patterson - Glenrock

Becca Followill - US Capital Advisors

Steve Fleishman - Wolfe Research

Harry Mateer - Barclays Capital

Brandon Blossman - Tudor, Pickering, Holt & Company

Ross Payne - Wells Fargo

Matthew Russell - Goldman Sachs

Operator

Thank you for standing by and welcome to Kinder Morgan Conference Call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session [Operator Instructions]. This call is being recorded. If you have any objections, you may disconnect at this point.

Now, I'll turn the meeting over to your host, Mr. Rich Kinder, Executive Chairman of Kinder Morgan. Sir, you may begin.

Rich Kinder

Thank you, Nicole. Good morning, everyone. Let me make a few brief comments before turning this over to Steve Kean, our CEO.

Yesterday, we announced, what I view as a very important transaction, the sale of 50% of our SNG natural gas pipeline system to Southern Company. This includes a strategic partnership that commits the partners to expand the system over the next few years. This is actually accretive to KMI in terms of distributable cash flow and EBITDA over the medium term, while allowing us to substantially improve our balance sheet, and therefore, and most importantly, get measurably closer to being able to return more dollars to our shareholders, through either increased dividends or buying back stock in KMI.

So we're very pleased with this transaction, think it provides both short-term and long-term strategic benefits. And with that, I'll turn it over to Steve.

Steve Kean

Okay, thanks. Good morning, everybody. As Rich said, the transaction is expected to be accretive in the medium term, and it's only very slightly dilutive between now and then. That's unusual for a transaction where the cash proceeds are being used to pay down debt.

It's happening here, as a result of specifically identified opportunities for asset additions and expansions that we'll be pursuing, and starting to bring on as soon as 2017.

We're confident that this joint venture with Southern Company enhances the value of SNG going forward. In fact, this is a transaction we were exploring a year ago, even before all the volatility in the mid-stream sector kicked in. Southern Company is SNG's largest customer and we're delighted to have them buying this asset and help us growing. At the 4.15 billion enterprise value, which includes $1.2 billion of existing debt at SNG, the 2015 EBITDA multiple is 10.4 times. So with the value enhancements committed-to by the JV, we expect the multiple to be a couple of turns higher ultimately. And that's what makes this deal worthwhile from our perspective.

In addition to its commercial merits, the transaction significantly advances our effort to enhance our balance sheet and moves us closer to the time when we can return value to our shareholders, by increasing the dividend or repurchasing shares. As a result of this transaction, we now expect to end 2016 at an debt to EBITDA ratio of 5.3 times, which is nicely ahead of our 2016 budget expectation of 5.5 times. Now, the full year metric is slightly higher than the 5.3 times when the EBITDA impact is annualized.

We've discussed the transaction with the rating agencies and they view it as the significant credit positive, so we do not anticipate a rating change. Instead it's expected to further secure our existing investment grade rating. The transaction requires HSR approval, but no other regulatory approvals are needed to create the joint venture.

In summary, we believe this is a value enhancing transaction, simply on its own commercial merits and it has the added advantage of significantly enhancing our balance sheet. We will continue high-grading our backlog and enhancing the returns on the capital we deploy, including through select joint ventures. But this transaction gives us the flexibility to be even more patient and selective in those efforts.

And with that, we'll open it up for questions.

Rich Kinder

Okay Nicole.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question is coming from the line of Kristina Kazarian from Deutsche Bank. Your line is now open.

Kristina Kazarian

Good morning, guys. Can you help me just frame it up a little bit? So, this transaction is a little bit different from some of the strategy on the more recent ones we've talked about. Can you talk about what the deviation was there, and what we've been seeing, as well as, when I'm thinking about growth opportunities off the system, I think last year at the Analyst Day we talked about $300 million-ish of projects relate -- associated with SNG. Is this like the right ballpark, or should I be thinking about more opportunities beyond that?

Steve Kean

I think, there will be opportunities we believe beyond that, because of this transaction specifically. And there are some things that the competitions we have to have with third parties and there is some commercially sensitive information. So we’re going into detail about the individual one. But they are specifically identified, and for the most part even pre-negotiated. Meaning, we have the terms worked out. So these are the incremental opportunities that we’re seeing on this asset.

Kimberly Allen Dang

And Kristina, with your respect to your question on the strategy, I think Steve mentioned in his opening remarks, this was something that, Southern approached us about over a year ago. And so this was started separate and apart from any debt reduction opportunities. And we think it makes sense, separate and apart from that, but it has the added benefit of giving us incremental debt reduction and moving us closer to our five times target.

Kristina Kazarian

Kim, and just a quick follow on that. When I'm thinking about that 5.3 times number that Steve mentioned, does that include both the -- using the proceeds to paying down debt as well as deconsolidating the $1.2 billion of SNG debt? And then, once I get to that, how do I think about Rich's answer to something we talked about last call, which is 5 times maybe being that bogey for when I can start to grow again. Is that like maybe an end of ’16 conversation or early ’17?

Kimberly Allen Dang

Again, we’re not going to comment on specific timing about when we think we’ll get to the five times. But we’ve mentioned once we get there, I think, we will evaluate what to do with the excess cash flow that we expect to have at that point in time. Well, in excess of any CapEx needs.

Operator

Thank you. Our next question is coming from the line of Shneur Gershuni of UBS. Your line is now open.

Shneur Gershuni

Thank you. Good morning, everyone. Congratulations on this transaction. Just a couple of quick questions here, I guess, as kind of a follow-up to Kristina's question, or I guess a clarification. So it sounds like in your prepared remarks what you're saying is that this project, or this JV, basically is going to create new opportunities. Just wanted to understand, if I understood that correctly, so and maybe if you can characterize it as, you have a backlog, you have a shadow backlog. Does this transaction add to either of those buckets over time? Or when you are saying pursuing opportunities, it's just meaning moving something from shadow into full steam ahead of project?

Steve Kean

These are separate and apart from anything that we’ve articulated in the back log. So that it’s incremental.

Shneur Gershuni

And then as I guess as a follow up, this is, I guess, the second transaction we've seen you do in a couple of weeks, although obviously this is a lot larger. Can we expect just continue to see some of these JVs that you’ve talked about in the past? Obviously, it sounds like this one was contemplated well before the volatility in the market place. Or this is enough for now and so forth?

Steve Kean

Well, look, this is an unusual one, because it's an existing asset, right. We’re going to continue to look at selective JV opportunities where they make sense and continue to look at them on some of our major projects. But this one is a bit unusual. Other than really, what I would call a few isolated kind of non-core asset dispositions, I don’t think you should reasonably expect us to be looking at a JV of an existing fairly core assets.

The reason it makes sense in this case is what we have done talking about here this morning, and in the release, which is we’ve got incremental opportunities that come along with this. So, even on its commercial merits this was a JV of an existing asset that was worth us doing. So we will continue to look at selective JVs. We’ve made a lot of progress here with what we’ve have announced so far. And as I said, this can make us be a lot more patience and selective about the other things that we look at. So we continue to look at JVs. This one is a bit unusual in terms of being a core asset, but justified certainly by the value enhancements that we see here.

Shneur Gershuni

And just one last follow-up question, with this sale, do you expect it to be taxable at all? Will there be any tax leakage? Or did the simplification process with KMP and EPB, a few years ago, reset your tax bases up, so that there will be minimal tax leakage?

Kimberly Allen Dang

There’ll be a taxable gain here. But we’re in an NOL for the foreseeable. And so, we won't have any cash tax impact in the near-term from them.

Operator

Thank you. The next question is coming from Jean Ann Salisbury of Bernstein. Your line is now open.

Jean Ann Salisbury

Just a couple of quick ones, one is that it looks like SONAT has had stable volumes, flattish EBITDA according to Berg for the last five years, right around $400 million. That's good, 90% utility demand. I know that the strategic partnerships are going to lead to some growth. But should we think about 10.4x is kind of the going rate for flattish pipelines?

Steve Kean

No, as I said, when you take into account the value enhancements here, we think it's really a couple of turns higher ultimately. Now, we have to get some of those transactions done and we’ll announce them as we do. But so at a pure 10 times multiple, we would not have been doing this transaction. It's really -- the value enhancements and what they do to the underlying value of the assets that makes it work for us.

RichKinder

Look, I think if you look at the overarching parameters of this transaction, we’re just happy to partner with Southern Company. And they have, I think, a similar outlook on the world as we do that we’ve been harping on for so long that natural gas is the future for electric generation though. And this just positions us much better in the most prolific natural gas usage area for electric generation in the southeast. So we’re delighted to do this transaction. Steve is absolutely right. We would not have done it if it hadn’t had additional opportunities to grow the system over the next few years.

Jean Ann Salisbury

Okay, that makes sense. And one quick follow-up, Sabal Trail, the pipeline by Spectra, NextEra and Duke, is coming online next year. It looks like it may be competitive with part of SONAT, and that it also brings new gas into Southern Georgia and Florida. Is that creating any pressure on your renewal rates, or is it completely new?

Steve Kean

No, it’s primarily serving their P&L. So yes, there are some overlaps, but no we're not seeing any impacts on our renewals. In fact, we expect to continue those renewals at the same levels and term as we have been in the past.

Operator

Thank you. The next question is coming from the line of Gabe Moreen of Bank of America. Your line is now open.

Gabe Moreen

Just a couple of quick ones for me, I just want to make sure that the Elba Island project and pipeline of this transaction really does not impact any of those projects.

Steve Kean

Right, it has nothing to do with Elba, no impact.

Gabe Moreen

And I guess, not directly related to the transaction, but while we're on the subject of long-haul interstate gas pipes, I assume everyone saw the DC circuit court ruling on the rate case with SFPP that never seems to go away. Kinder Morgan having ties just now being a corporation. is that something where you guys are just -- income tax policy does not concern you at all at this point in terms of the pipes -- the channel right now?

Steve Kean

That's a fair statement as you look going forward being a c-corp tax payer. The ultimate outcome and who knows what that will be, but the ultimate outcome has less bearing on us. I think where it has some impact and even that impact remains to be seen as this saga continues to unfold, it's on the historical period where SFPP was in a partnership forum and the income tax allowances repeatedly been permitted by FERC.

And may yet continue, I mean, it's been remanded and so we consider it. Certainly, they found the basis to grant it in the past. But we're really talking about historical period and impacts there. Also I mean who knows they may end up looking at it on a pretax basis or in some other basis that makes the whole debate irrelevant. That remains to be seen. But we're talking about a historical period for SFPP.

Operator

Thank you. The next question is coming from the line of Jeremy Tonet of JPMorgan. Your line is now open.

Jeremy Tonet

Couple of housekeeping questions to start off with, the $1.5 billion you received. Is that going to be all cash that you guys get there?

Steve Kean

Yes.

Jeremy Tonet

And on the credit side, are there cross guarantees to SNG? Does this deal impact how that stands?

Kimberly Allen Dang

Yes, we expect that the cross guarantees between SNG and KMI will be related.

Jeremy Tonet

I think you said SNG was the largest customer, SNG and AGL. Do you have a sense for how big that is for within, the revenues for Southern and AGL, how big that is for SNG? Just thinking through how meaningful these growth opportunities could be, given the existing relationship there?

Steve Kean

So Southern Company and AGL combined and the customer of SNG is a little less than half, so largest customer really by credit margin.

Jeremy Tonet

And then just one last one, if I could, thinking about divestitures and seeing how some companies with CO2 assets, EOR assets, trade at similar multiples to what you guys trade at seems like these days. Just wondering about the appetite for any asset swaps there -- if you could swap out those assets against pipes that they own. Or just any updated thoughts there would be great.

Steve Kean

There're really no updated thoughts. Again, we, in our CO2 business, we get good returns for the capital that we invest, both the SNP and the enhanced oil recovery as part of the business are still attractive businesses to us. And so no real updates.

Operator

Next question is coming from Ted Durbin of Goldman Sachs. Your line is now open.

Ted Durbin

So just coming back to the growth capital that you expect, what kind of returns would we look for on those projects in the next few years?

Steve Kean

That give us specific returns like the color that we can provide is, again, it helps the overall multiple of the transaction by couple of turns.

Ted Durbin

And then what sort of regulatory things would you need to get through? I assume you're selling into regulated utilities at Southern and AGL. I assume you need state approval?

Steve Kean

We don’t need any approval beyond HSR to form the joint venture itself. But there will be on certain of the value enhancements here there will be some additional regulatory approvals.

Operator

Thank you. The next question is from John Edwards with Credit Suisse. Your line is now open.

John Edwards

Just on the magnitude of the added opportunities, I mean, you’ve said a couple of turns. What's the timing on this, on additional opportunities? And any other quantitative you could add to that?

Steve Kean

No further color on the quantification. Overtime it start as soon as 2017 and then a few years thereafter.

John Edwards

And then on accounting for this, going forward, with 50/50, are you going to be using equity method here going forward? And will that also help you take the remaining debt off the balance sheet? And then remind me, maybe you said this but is Southern -- they're going to assume the share of the debt on the pipeline or are they paying you some cash for that?

Kimberly Allen Dang

So from an accounting perspective, John, we would expect that SNG will -- we will use equity method accounting going forward. And that we would be consolidating that associated with SNG.

John Edwards

And then are they assuming the debt that's on the pipe?

Kimberly Allen Dang

The entity, the debt will be at the SNG entity. There’d be -- neither Southern nor Kinder Morgan will be deemed to control from a GAAP perspective, I do not think that is our expectation. And so I would not expect either companies to consolidate this debt on their balance sheet.

John Edwards

And then on the 5.0 times target here. Is that -- that's the marker you're looking at for evaluating the dividend, whether to restart growth, or -- I mean all these other things you're talking about for returning cash. Is that -- that is the marker that you're looking at, correct, Kim?

Steve Kean

Yes, and that’s consistent with what we’ve talked about before. At that point, we’ve got options to consider and we’ll evaluate the time what the best option is.

John Edwards

And then just on the contracts -- were there any changes in contract durations or commitments from Southern that was part of this deal that, I mean, did they give you anything back in that regard? And then were there any things here, anything required here in order to secure these commercial opportunities that you felt you had to go into this transaction? If you could give any color there would be helpful.

Steve Kean

Yes, and look John, just not able to give additional detail there right now. And because, as I said, there is some commercially sensitive information here and some conversations with third parties that we need to have. What I can express to you is that we’re confident that these are coming through. They’ve been specifically identified. They’ve been negotiated in just about every instance already as part of the transaction. So we’ve got confidence. But we will roll those out as they emerge.

Operator

Thank you. The next question is coming from Craig Shere of Tuohy Brothers. Your line is now open.

Craig Shere

In terms of when this turns accretive, did I understand that you thought at least some of the incremental growth projects might hit by year-end 2017 and that it would be net accretive by that point and more so going forward?

Steve Kean

Yes, what we said is in the medium term. And so it’s a few years out, you’ve got to have a couple of these things come through to turn it accretive. But it’s only slightly dilutive even the debt that we expect to pay down given the opportunities starting to come on. But it’s really a few years to turn it accretive.

Craig Shere

And in terms of the impact on cash tax obligations, is there any update and outlook on when you might be running down your NOLs, and starting to pay cash taxes of any meaningful amount?

Kimberly Allen Dang

No, update from what we gave you at the conference, which was into 2023, I believe. And I don't think this transaction changes that 2023 date just because we have taken some bonus depreciation. And so I think you are still looking at 2023 at least, until we’re a cash taxpayer.

Operator

Thank you. The next question is coming from Paul Patterson of Glenrock. Your line is now open.

Paul Patterson

Most of my questions have been answered. But could you elaborate a little bit more about why Southern Company is bringing you so much more opportunity for SNG? What is it, just because they're a customer, or is that how we should think about it? Is it right to wait with some -- if you could just elaborate slightly more on that?

Steve Kean

They are a huge customer in a market where the demand for natural gas or power generation is growing. And really that’s the sum and substance of it. They are, I think, 44,000 megawatts of installed generation across all their assets, 9 million customers that includes all of their customers at the -- across their assets and not everything in the southeast, the 9 million customers in the -- both gas and electric retail markets, so there are a significant participant in the market that is growing for gas used for power generation.

Paul Patterson

So, they can steer basically -- the projects could be -- okay, I think I follow you. Thank you very much.

Operator

Thank you. Next question is coming from Becca Followill of US Capital. Your line is now open.

Becca Followill

Can you guys help me out on the 5.3 times debt to EBITDA at year end? What is that assuming a full year loss of SNG? And is that deconsolidating the SNG debt?

Kimberly Allen Dang

Becca, the 5.3 is just a partial year impact of the EBITDA loss. As Steve said, we would expect, on a full year run rate basis, so annualizing the loss to EBITDA that you would be slightly higher than the 5.3 times. And yes, it does assume that we'd be consolidating the SNG debt.

Becca Followill

So, if you consolidate the SNG debt and have another full year basis, what does it take into?

Kimberly Allen Dang

You probably get, probably 0.1 turn, somewhere in that neighborhood.

Operator

Thank you. The next question is coming from Steve Fleishman of Wolfe Research. Your line is now open.

Steve Kean

My questions were answered, thank you.

Operator

Thank you. The next question is coming from Harry Mateer of Barclays. Your line is now open.

Harry Mateer

Could you just tell us what debt KMI is going to be looking to pay down? I know you had some revolver borrowings, you have upcoming maturities. Is that what you're focused on using the proceeds for?

Kimberly Allen Dang

We haven't specifically identified which debt we would exactly pay down in this transaction. But I anticipate two things; one, all the proceeds will go to pay down debt; and two, that it will primarily be used to pay down long-term debt.

Harry Mateer

And then, just on the topic of the cross guarantees being released. Is it fair to say you would not look to do additional transactions in which cross guarantees with the pipeline subs would be released unless they are similarly deleveraging like this transaction is?

Kimberly Allen Dang

Look I think Steve commented on that a minute ago that, generally, as part of our deleveraging, we have not targeted to sell down stakes in existing pipes. And as we said at the beginning of this call, this was something that we started pursuing prior to all the turmoil in the energy market. And so, generally what we have targeted in terms of the deleveraging is selling down interest and to be constructed pipes and projects that are in our backlog.

Operator

Thank you. The next question is from Brandon Blossman of Tudor, Pickering, Holt and Company. Your line is now open.

Brandon Blossman

Just quick ones for me -- Steve, I'll ask the same question in a slightly different way. On the projects, is there any prototypical or stereotypical project that you're looking at? Or were you talking generally, it's all laterals to new generation projects, increased capacity to LDCs, or new lines to LDCs or something different than that?

Steve Kean

Yes, and I use the term both asset additions and expansions. But really I am not going to go into further detail until we have them fully bedded and announced.

Brandon Blossman

And this is a nuance, but is there any management fee for you guys continuing to operate the asset or being responsible for that, either on new project development or the existing assets?

Steve Kean

No, we're operating. Of course, there's an allocation of G&A to the joint venture, but we're operating this asset at cost.

Operator

Thank you. The next question is coming from Ross Payne of Wells Fargo. Your line is now open.

Ross Payne

Quick question and it looks like you can get to 5 times leverage or below in 2017, based on GAAP. Moody's and S&P have said that they would upgrade you if you get to 5 times on an adjusted and sustainable basis. Is that something that you want to do in addition to buying in shares and increasing the dividend? Or are you comfortable where you are? Thanks.

Kimberly Allen Dang

I think as we’ve said Ross, when we get the five times, we’ve got additional decision that can make us to whether we further reduce leverage or return money to equity holders through dividends, our dividends, or share repurchase or some combination thereof.

Operator

Thank you. The last question is coming from Matthew Russell of Goldman Sachs. Your line is now open.

Matthew Russell

Just a couple of quick last ones here, in terms of SNG leading the cross guarantee group, I assume that's going to require some amendment to your credit facility to get that done. Do you expect any additional changes to the size of the revolver, or anything else on the cross guarantee structure based on that?

Kimberly Allen Dang

It does not require an amendment to the agreement in SNG. SNG will be released from the cross guarantee at the close; and KMI, we expect would be released from the cross guarantee approximately 90 days thereafter.

Matthew Russell

And then in terms of looking at the SNG debt, I assume you should look at it in similar context to the NGPL debt on a deconsolidated basis. Is that the message that you're getting from the agencies as well, that they may take different approaches to looking at your leverage on an adjusted basis?

Kimberly Allen Dang

I think the message from the agency is that they have used this transaction as a credit positive for KMI. I think from SNG’s perspective, we expect that SNG might have an upgrade. But I think that remains to be seen. And I think they view the KMI as further securing our existing rate.

Operator

Mr. Kinder, at this time, there are no questions in queue.

Rich Kinder

Okay. Well, thank you Nicole, and thanks everybody for calling in, and so early in the morning. And have a good day and a good week.

Operator

Thank you. That concludes today’s conference. Thank you for participating. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!