Kinder Morgan Consolidates: Opts for Simplifying the Business

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Update: When Richard Kinder did not get the CEO job at Enron, he put together a deal to acquire Enron’s pipeline assets. The resulting company, Kinder Morgan Energy Partners LP, was a master limited partnership as its predecessor had been, and the company remained so for the next 17 years. That will all change by the end of this year.

In what can only be described as a surprise move, Kinder Morgan Inc. (NYSE: KMI) CEO and founder, Richard Kinder, said on Sunday that the company will pay $40 billion in stock and $4 billion in cash for Kinder Morgan Energy Partners LP (NYSE: KMP), Kinder Morgan Management  LLC (NYSE: KMR) and El Paso Pipeline Partners LP (NYSE: EPB) and consolidate the companies under Kinder Morgan Inc. KMP, the master limited partnership (MLP) that was one of the first pipeline companies to adopt the structure back in the early 1990s, will soon be history.

In Sunday’s announcement, Kinder acknowledged the single, most essential issue facing an MLP: how to maintain growth. Pipeline companies, once totally absent from virtually all consumers’ minds, have been brought closer to the front by the battle over the proposed Keystone XL pipeline. Now, no one wants to let any company build a new pipeline (unless it’s in Texas, Louisiana or North Dakota), so the only way for pipeline companies to grow is to buy existing pipeline companies. Kinder Morgan operates more than 80,000 miles of pipelines.

According to Kinder, a consolidated Kinder Morgan “will allow us to further expand the reach of the kind of projects we can do.” What that means for investors is that the company can continue to raise its dividend payments, which Kinder said would rise to a projected level of $2.00 a share in 2015 from an expected dividend payment of $1.72 this year. Kinder also said that the company expects to grow the payout by about 10% a year from 2015 to 2020.

Unitholders of KMP will receive 2.1931 shares of KMI stock and $10.77 in cash for each common unit they hold. That works out to nearly $90 per unit and a premium of 11.4% based on Friday’s closing price.

Shareholders in Kinder Morgan Management will receive 2.4849 shares of KMI stock for each KMR share they own. That represents a per share price of about $89.75 and a premium of 15.4% based on Friday’s closing price.

Kinder Morgan will exchange 0.9451 KMI shares and $4.65 in cash for every El Paso Pipeline Partners common unit. That works out to around $38.79 per unit, or a 15.4% premium based on Friday’s closing price.

Unitholders in KMP and El Paso will be allowed to elect cash or KMI stock subject to proration.

According to Kinder:

This combined entity will be the largest energy infrastructure company in North America and the third largest energy company overall with an estimated enterprise value of approximately $140 billion. Additionally, we will have a leading position in each of our business segments and operate in the rapidly growing North American energy infrastructure sector.

Further, we believe that KMI will be a valuable acquisition currency and have a significantly lower hurdle for accretive investments in new energy infrastructure. In the opportunity-rich environment of today’s energy infrastructure sector, we believe this transaction gives us the ability to grow KMI for years to come.

Of the $140 billion in enterprise value, about half is debt, another hallmark of the MLP structure. Whether or not shareholders will be able to sleep at night with higher-than-usual debt ratios remains to be seen. Of course, MLP unitholders are used to it and won’t even notice. The transaction is expected to close by the end of this year.

Kinder Morgan also noted that it expects to maintain an investment grade rating based on preliminary reviews with the debt rating agencies.

Shares of Kinder Morgan (KMI) are up more than 20% in pre-market trading Monday at $43.50, well above the top of the 52-week range of $30.81 to $38.30.

KMP’s common units are up more than 28% to $103.05, again well above the 52-week range of $71.32 to $84.98.

KMR’s shares are up more than 36% at $105.00 above the 52-week range of $66.28 to $80.10.

El Paso’s common units are up nearly 32% at $44.30, also above the 52-week range of $28.87 to $43.15.

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