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Kinder Morgan's takeover of El Paso under scrutiny

One of Kinder Morgan’s corporate mottos is "keep it simple". Yet its planned take-over of El Paso is proving anything but. NJ Watson reports

Kinder Morgan’s $21 billion take-over of El Paso, agreed in October, will create the largest oil and gas pipeline operator in the US. As well as being the fourth-largest energy firm in the country, the new entity will have an enterprise value of $94 billion, controlling almost 130,000 km of pipelines. Few were in any doubt, however, that such a huge tie-up would be subject to the most intense regulatory scrutiny.

A dominant new firm

"The deal would create a dominant new firm … controlling around thousands of kilometres of gas pipelines in every significant production region of the US," noted IHS Global Insight. Chairman and chief executive Richard Kinder has argued there is little overlap between the two companies’ pipeline networks, but admits there is some in the Rocky Mountains. Some analysts point to potential competition issues involving pipeline networks in eastern Colorado, western Kansas, Nebraska and Wyoming.

And there is also regulatory precedent: a 2001 deal between Coastal and El Paso’s predecessor, El Paso Energy, was approved by the Federal Trade Commission (FTC) only after the latter agreed to sell its interests in 11 gas-pipeline systems, covering a total of 4,000 km. On 7 December, the FTC made a second request for information on the deal. Both firms confirmed they were complying, adding that they still expect to close the deal in the second quarter.

Separately, to fund the acquisition Kinder Morgan must offload El Paso’s oil and gas exploration and production (E&P) unit, which holds acreage in Texas’s Eagle Ford and Wolfcamp shales, as well as what it calls "a solid international footprint in Brazil and Egypt". At the end of 2011, El Paso’s estimated reserves stood at about 4 trillion cubic feet of gas equivalent (cfe), and production to have risen to nearly 840 million cfe/d in 2011, up from 782 million cfe/d in 2010.

Kinder Morgan had hoped to sell the whole E&P division, estimated by BNP Paribas to be worth $8.1 billion and by Tudor Pickering Holt at more than $9 billion. An 18 January Reuters report claimed private-equity firms Apollo Global Management and Riverstone Holdings had teamed up to bid around $7 billion for the upstream assets. Other reports suggest Kinder Morgan is prepared to offer up to six packages of E&P assets to different investors. Indications of interest are reportedly due by mid-February.

Before the agreed take over, El Paso had been preparing to spin off its E&P division, which forms the basis of a lawsuit filed by shareholders against Goldman Sachs, which advised the company to abandon the spin-off in favour of the deal with Kinder Morgan, in which it owns a 20% stake. The $21 billion Kinder Morgan agreed to pay for El Paso combined cash, stocks and warrants to deliver a 37% premium over the market-close price before the deal. But the Wall Street Journal reported in October that "numerous shareholders have sued over the inclusion of warrants to pay for the deal and what they consider a low valuation, among other issues".

Run by shareholders, for shareholders

Another of Kinder Morgan’s mottos – companies run by shareholders, for shareholders – is also debatable, if the share price is anything to go by. In February 2011, Kinder Morgan priced its initial public offering at $30 a share, although in the months following the deal the share price spent much of the time languishing below the issue price, at one point falling as low as $23.51. Over the past month, shares have climbed past the $30 level and were trading at a 52-week high of around $33 in mid-January.

Investors have been cheered by the firm’s improving financial performance, which is putting money back in their pockets. On 18 January, Kinder Morgan reported fourth-quarter cash available to pay dividends of $243.1 million, bringing the full-year total to $835.3 million, exceeding its annual budget of $820 million. It represents a dividend of $0.31 a share, or $1.24 annualised, up by 7% from the declared dividend of $0.29 announced when Kinder Morgan went public in February 2011.

Rising dividends

It expects to declare dividends of $1.35 a share for 2012, up by 8.9% from the 2011 annualised dividend. The projection does not include the effect of the El Paso acquisition – and had the transaction had closed on 1 January (rather than in the second quarter), it would have expected to pay around $1.45 for 2012.

The growth at the holding level is being driven by Kinder Morgan Energy Partners (KMEP), which accounts for about 98% of the cash distributions that Kinder Morgan, the owner of the general partner of KMEP, receives.

KMEP, with an enterprise value of about $33 billion, is one of the largest independent owner/operators of refined products pipelines in the US. A significant transporter of natural gas in Texas, the Rocky Mountains and the Midwest; and one of the largest carbon-dioxide (CO2) marketers and transporters in North America; it’s also one of the largest independent storage operators in North America.

KMEP reported fourth-quarter net profit of $475 million, up by 16% from the same period a year ago, although full-year returns of $1.26 billion were down from 2010’s $1.32 billion. "The continued emergence of shale-gas plays, liquids and growth of the [CO2] business in the Permian basin, increasing demand in our coal-export business, customers that want to export refined products, primarily diesel, from the Gulf Coast – this is the most diverse set of opportunities in any time in Kinder Morgan’s history," said Kinder.

New projects

New KMEP projects include its increased shareholding in the Battleground Oil Specialty Terminal (Bostco) project to 98%, following the purchase of an additional 50% stake from TransMontaigne Partners. In December, Kinder Morgan started construction of the first phase of the $430 million Bostco oil terminal, on the Houston Ship Channel. Plans include 52 storage tanks, with an estimated capacity of 6.6 million barrels. The firm has terminal-service agreements and letters of intent for the majority of the capacity.

KMEP plans to start building a $210 million, 2.4 million barrel storage facility at Edmonton, Alberta, next year; and is to build, own and operate a $130 million condensate-processing facility near its Galena Park terminal on the Houston Ship Channel. Scheduled for completion in January 2014, the facility will initially produce 25,000 barrels a day (b/d), rising to 100,000 b/d.

"Both projects will add to the top line and a rising stock price as we approach the completion dates," said a trader at Investment Underground, an independent firm of equity traders, who declined to be named.

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