Two decades ago, Richard Kinder helped start a boom in reorganizing large U.S. companies so they’re exempt from corporate income tax. Yesterday he said he’s through with the idea.
Kinder plans to buy up two companies he controls, known as master limited partnerships, for a combined $44 billion, consolidating his oil and natural gas pipeline empire under a single, taxable corporation known as Kinder Morgan Inc. The change will lower investor payouts, leaving heft to beat rivals on new projects or buy them up, he said.
The rest of corporate America is going the other direction. Everyone from phone companies to container-board makers are exploring ways to organize parts of their business outside the corporate income tax system, using MLPs or another tax-advantaged format known as a real estate investment trust. Low interest rates have fueled demand for high yielding investments and Kinder’s partnerships are among the highest.
In a way, Kinder, whose stake in Kinder Morgan made him Houston’s richest man, may be a victim of his own success -- which may also explain why he says few other companies are likely to follow his lead this time.
“Let me just say, this is in no way a swipe at MLPs in general,” Kinder said on a conference call with analysts to explain his plans yesterday. “We had a unique confluence of factors here.”
Investors in U.S. corporations typically face two levels of tax: first the corporation pays tax on any profits it earns, then shareholders pay tax again on any dividends or capital gains from their investment. Partnerships skip the corporate level of taxation by making the investors responsible for their share of companies’ earnings.
MLPs are large partnerships that trade on exchanges, like stocks, and typically own assets like pipelines, oil wells or fuel terminals. They distribute most of their earnings to their investors each year, making them attractive to individuals looking for steady income. They typically have no employees and pay another company to manage their affairs for a fee.
To encourage profitable managers, MLPs typically promise to boost management fees to the extent their own investors’ cash distributions increase.
Over the years, Kinder’s MLPs have raised distributions time and again, leading Kinder Morgan to get a bigger and bigger slice of their cash flows in the form of management fees. Since Kinder Morgan is a corporation, that means that about half of the cash generated by the partnerships ended up flowing to the parent, where it was taxed anyway.
“It’s not like we are going from a zero tax structure to a 100 percent tax structure,” Kinder said on the call. “We’re going from 50 percent to a 100 percent.”
Many of Kinder Morgan MLPs’ peers have lower management fees, or don’t face taxation at the management company level, or both. Houston-based Enterprise Products Partners LP stopped paying those fees altogether in 2010, when it acquired its management company; Enbridge Energy Partners LP, also based in Houston, will pay about 18 percent in fees this year, Morgan Stanley estimated in a research note Aug. 10.
Considering other factors that made the MLPs less financially efficient, and the complexity of managing all the different entities, Kinder said that it wasn’t worth preserving the MLP structure.
Kinder’s reversal suggests that inside each huge master limited partnership “behemoth” is a corporation wanting to emerge, Bank of America Merrill Lynch analyst Gabe Moreen wrote in a note to clients.
“It provides a template for a somewhat graceful exit from a structure that can prove long-term unwieldy as an MLP grows,” Moreen added. “We expect significant interest in potential MLP consolidation candidates.”
Companies that are large enough to be publicly traded are generally prohibited from being taxed as partnerships under a 1987 law. Congress made exceptions for a handful of industries, including energy and natural resources, investing, and real estate. A different break, for real estate investment trusts, offers similar benefits.
Over time, companies from prison operators to fertilizer makers to document storage firms have sought to lower their tax bills using these breaks. Last month, telecommunications stocks rose after an Arkansas phone carrier, Windstream Holdings Inc., disclosed it got approval from the Internal Revenue Service to place some of its fiber and copper networks into a REIT, which doesn’t pay corporate tax. A hedge fund is pressuring container-board makers including International Paper Co. to explore becoming MLPs.
The Joint Committee on Taxation, a nonpartisan arm of Congress, estimates that the MLP tax break for energy and mining companies will cost $6.3 billion in forgone revenue to the U.S. Treasury between the 2014 and 2018 federal fiscal years.
On the conference call, Kinder said he wouldn’t rule out the possibility of using the MLP structure again if conditions change.
“We would have the option to do that certainly in the future, if we want to do,” he said. “That’s not our present plan.”