Kinder Morgan, which operates some 80,000 miles of oil and gas pipelines through a network of separate entities strung together by its billionaire chairman and chief executive, Richard Kinder, is consolidating under one corporate roof. In a deal valued at $71 billion, the parent company will fully acquire three companies it already has partial stakes in: Kinder Morgan Energy Partners, Kinder Morgan Management, and El Paso Pipeline Partners. Think of it as fusing a disparate collection of pieces into one, functioning whole—kind of like building a pipeline.
The deal simplifies a complicated corporate structure that carried big tax benefits for its partners while also resulting in higher borrowing costs. The new corporation should generate more cash for investors and for buyouts. And it will also make Kinder Morgan the fourth largest-energy company in the U.S.
The market seems to approve of the largest energy deal since Exxon bought Mobil in 1999 for $74.5 billion. Kinder Morgan shares jumped 11 percent by 2 p.m. Monday, Aug. 11, boosting Richard Kinder’s net worth by $1 billion in one day.
Richard Kinder co-founded Kinder Morgan in the late 1990s after losing out to Ken Lay to be chief executive of Enron, and Kinder proceeded to cobble together a bunch of cast-off assets from Enron. In doing so, he pioneered the master limited partnership (MLP), a corporate tax structure that has come to dominate the pipeline industry.
The basic premise of an MLP is that instead of organizing as a corporation, pipeline companies were a collection of limited partnerships. Like corporations, MLPs still have thousands of investors and trade publicly. But under the law, stakes in MLPs trade as units, not shares—and that technically makes their investors partners, not shareholders. The IRS counts each stake in the profit as income, allowing the company to sidestep the 35 percent federal corporate tax.
Over the past 15 years, Kinder Morgan Energy Partners became one of roughly 90 tax-free, publicly traded MLPs in the pipeline industry. As brilliant and innovation as it was, Kinder Morgan had started to outgrow the benefits of the MLP. The tax benefits were slowly being eroded by higher costs. Its cost of capital had risen to about 11 percent, according to Jason Stevens, an energy analyst at Morningstar. To justify that higher cost, Kinder Morgan was having to move into lower-profit, higher-risk ventures, such as buying oil tankers.
Investors had been clamoring for the change, especially since it will boost dividends. Kinder Morgan plans to raise its 12-month dividend by 16 percent next year, to $2 a share, and to raise the payouts by 10 percent annually through the end of the decade. Richard Kinder, who takes a $1-a-year salary and earns no annual bonus from any of the four companies, will increase his annual pay from dividends by more than $100 million, according to Bloomberg. His ownership take from all the companies earned him $380 million in dividend payments in 2013.
The deal comes as the pipeline industry is scrambling to build new projects to tap new sources of oil and gas in such remote places as North Dakota, Canada, and West Texas. By unlocking cash to invest more directly in new projects, the deal should usher in a wave of consolidation in the pipeline industry, Morningstar’s Stevens says. It should also help push those profits back to more investors through higher dividends. “This gives the industry another tool to funnel the economic profit of putting all that steel in the ground back to investors,” says Stevens.