Is This Popular High-Yield Investment Headed for Extinction?


Pipeline construction. Source: Kinder Morgan.

Investors have struggled for years to squeeze income from their investment portfolios, with low rates on bank CDs and bonds forcing even conservative investors to consider more aggressive ways of putting their money to work. As a result, money has flowed into high-yield investments in the stock market, and many companies have taken steps to emphasize their income-generating potential by taking advantage of favorable tax laws to restructure their operations. In particular, in the red-hot energy industry, master limited partnerships have created an investing frenzy, with investors jumping at the chance to earn high yields with favorable tax characteristics and with dozens of major companies forming new MLPs to meet investor demand.

Yet a big move from one of the largest companies in the midstream energy industry flew in the face of that trend toward greater use of MLPs. That move has called the entire future of MLPs into question and has many investors asking whether they'll have to look elsewhere for high-yield opportunities.

The Kinder Morgan MLP bombshell
Earlier this week, Kinder Morgan Inc  (NYSE: KMI  ) made a huge announcement, saying that it planned to restructure its network of master limited partnerships and consolidate its operations into a single publicly traded entity. Before the move, Kinder Morgan Inc stood at the top of a web of different businesses, acting as general partner of MLPs Kinder Morgan Energy Partners (NYSE: KMP  ) and El Paso Pipeline Partners (NYSE: EPB  ) . In addition, Kinder Morgan Management (NYSE: KMR  ) was a separately traded corporate entity that holds units of Kinder Morgan Energy Partners, with Kinder Morgan as its parent as well.

With the deal, Kinder Morgan will spend $44 billion to buy out investors in its three subsidiaries. Unitholders of the two MLPs and shareholders of Kinder Morgan Management will have a choice to receive a combination of Kinder Morgan stock and cash in exchange for their interests in those entities.


Source: Kinder Morgan.

The move has a number of benefits for Kinder Morgan and its investors. With a single dividend policy, investors will no longer have to decide which entity is best suited to their income needs. Simplification also played a key role, with complicated arrangements like the incentive distribution rights that Kinder Morgan received from its subsidiaries effectively disappearing.

But perhaps most surprisingly, Kinder Morgan argued that the move will save it huge amounts in taxes. Over the next 14 years, the company thinks it will pay $20 billion less in tax than it would have under the previous structure. The reason: By marking up the value of the pipelines and other assets that the entities own, Kinder Morgan will reset the clock on depreciation, allowing it to take larger tax deductions than it currently enjoys.

For investors, though, the news on the tax front isn't nearly as good. Because the MLPs will be deemed to have sold their assets to Kinder Morgan, MLP unitholders will owe capital-gains taxes on the excess of their value over their current depreciated tax basis. According to company estimates, taxes could cost some investors in Kinder Morgan Energy Partners roughly $12-$18 per unit, or as much as 20% of their current value.


Source: Kinder Morgan.

Will MLPs still be around?
Because Kinder Morgan was instrumental in leading the revolution toward master limited partnerships, the company's about-face is notable. Some analysts speculated that other large energy entities might try to do similar consolidations of MLP assets into a single corporate structure.

Yet this isn't the first threat that master limited partnerships have faced. In the past, concerns among lawmakers about the use of MLPs to avoid corporate-level tax had led some to fear that Congress would eliminate the favorable tax provisions governing their use. More importantly, the IRS has temporarily stopped issuing private letter rulings approving the use of the MLP structure for new entities, citing the need for clearer and tighter standards on their use. A stronger move from the Canadian government almost a decade ago led to the end of the similar Canadian royalty trust system, forcing entities set up as high-yield royalty trusts to reincorporate and start paying taxes. That in turn led to reductions in dividends and hurt yields to shareholders.

At least for now, though, the rest of the industry is still embracing the master limited partnership concept. Once companies grow as large as Kinder Morgan, it becomes harder for them to find new opportunities that remain consistent with the MLP structure without raising costs of capital. For smaller companies, though, the popularity of MLP investments makes the structure their best way to attract investors.

Given their high yields, master limited partnerships aren't likely to disappear anytime soon. The biggest threat remains that the IRS and lawmakers will kill the tax benefits that MLPs enjoy, but that process will take time and is far from a certain outcome right now.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.


Read/Post Comments (1) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 18, 2014, at 11:06 AM, EugeneSpud wrote:

    Another reversal of recommendations. This should kill MLP's for the day at least.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3072333, ~/Articles/ArticleHandler.aspx, 9/23/2014 4:46:53 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 17,055.87 -116.81 -0.68%
S&P 500 1,982.77 -11.52 -0.58%
NASD 4,508.69 -19.00 -0.42%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/23/2014 4:00 PM
EPB $40.01 Up +0.63 +1.60%
El Paso Pipeline P… CAPS Rating: *****
KMI $38.21 Up +0.71 +1.89%
Kinder Morgan CAPS Rating: *****
KMP $92.91 Up +1.72 +1.89%
Kinder Morgan Ener… CAPS Rating: *****
KMR $93.37 Up +1.78 +1.94%
Kinder Morgan Mana… CAPS Rating: *****

Advertisement