Pipeline giant Kinder Morgan is joining up with El Paso in a new consolidation effort. What's inside the deal, and how will it impact shareholders?
The deal isn’t exactly new (the $21 billion deal -- $38 billion if you include El Paso’s outstanding debt -- was announced in October 2011) but now that the tumblers have fallen into place and the air has cleared, investors have a clearer picture what the merger will look like. The air from here looks pretty good, especially to Kinder Morgan and its shareholders.
For starters, Kinder Morgan now becomes the fourth-largest energy company in the U.S., as well as the largest midstream company in the country. It’s also well positioned for the presumed natural gas boom here in the U.S.
“We are delighted to close the El Paso transaction and we are very excited about the natural gas footprint that we now have in the United States with the addition of approximately 44,000 miles of natural gas pipelines from El Paso,” Richard D. Kinder, chairman and CEO of Kinder Morgan said on May 25.
“We are bullish on the future of natural gas and believe that it will be the fuel of choice in America for many years to come. It’s domestically abundant, clean and cheap. As the largest transporter and storage operator of natural gas in the United States, we have many growth opportunities across the country, and we are eager to get to work to leverage these assets for the benefit of our customers, our shareholders and our employees.”
You can’t blame Kinder for getting pumped over the company’s future. He already knows the deal has brought with it a sweetener for shareholders -- a dividend increase of $1.40 per share, up from $1.35, and an expected an $0.35 per share dividend for the second quarter of 2012. The company will take the money for the dividend boost out of the anticipated cost savings of $400 million annually, savings directly attributable from the El Paso acquisition (up from a previously announced savings figure of $350 million per year).
Zacks Investment Research has the inside scoop on the deal. The firm says the largest obstacle overcome in getting a deal done was Kinder Morgan’s decision to divest El Paso’s exploration and production business (for $7.15 billion). The move, Zacks says, was key in allowing Kinder Morgan to “lower the debt incurred to fund the acquisition.”
“The El Paso assets are primarily regulated interstate natural gas pipelines that produce substantial and stable cash flows, and have access to key supply regions and major consuming markets,” says Zacks in a research report out this week. “Kinder Morgan will be able to leverage these strengths and expects cost savings in excess of $400 million per year, which is $50 million higher than the previous forecast.”
Zacks says that natural gas is a great business to expand into for companies, and investors therefore might want to take a good, long look at post-acquisition Kinder Morgan. “Despite record low prices, we believe the demand for natural gas will gradually increase because of its clean burning nature,” says the report. “The increasing government regulation to reduce the emission of greenhouse gas will also make power generators shift to natural gas or commission new units based on natural gas. We believe the combined entity which has its pipeline spread over the major generation areas will stand to benefit from the gradual rise in demand of natural gas.”
Zacks has posted a “hold” on Kinder Morgan stock. It counters the benefits of the El Paso merger with an acknowledgment that the company’s pipeline segment is experiencing weak demand, especially for jet fuel, diesel and gasoline -- all segments were down in the first quarter of 2012.
One thing both companies have going for them is a growing consensus among the credit ratings agencies that the deal brings financial stability for both Kinder Morgan and El Paso.
In a May 24 release, TEXT S&P affirmed a “BB” corporate credit rating for both firms, and a “BBB” rating for Kinder Morgan Energy Partners, and “BBB-“ for El Paso Pipeline Partners L.P.
This from TEXT S&P:
We base our affirmation of KMI's corporate credit rating on our view that following the El Paso purchase it will have a "satisfactory" business risk profile balanced by worsening financial measures that will result from the transaction. We affirmed our ratings on KMI when it announced the deal in October 2011 and all events thus far have been in line with our expectations. The combination will create the fourth-largest energy company in North America, with the largest natural gas pipeline network by a significant margin.
And this from the report’s “Outlook” section:
Kinder Morgan Inc. -- Our outlook on KMI's ratings is stable. KMI's pro forma size and improved cash flow profile balance the material amount of acquisition debt and degradation in credit metrics. Execution on KMI's deleveraging plan may ultimately lead to a higher rating, although we would not expect a positive ratings action for at least 12 months. The likelihood of a downgrade is low because we believe that the 'BB' rating appropriately captures the risk of a somewhat delayed deleveraging plan.
El Paso Corp. -- Our outlook on El Paso's rating is stable. The company will be a wholly owned subsidiary of KMI, and its corporate credit rating will be in line with KMI's. KMI's management will exert significant control over El Paso, especially regarding its financial policies and growth projects.
Nobody is saying that either company’s stock is getting a trampoline-like bounce immediately after the merger announcement. KMI has largely remained in a $31-$33 band since the deal was formally announced, while EPB has also traded in the same range for the last week of May.
The conventional wisdom is that Kinder Morgan and El Paso need to work the kinks out, get some help from natural gas prices, and take a steady, long-term approach to improved profits.
That will take time, but if one has patience, some keen market watchers think the Kinder Morgan/El Paso deal should work out well for shareholders.