Is This Company a Scam?

Imagine a company whose CEO was the former president of Enron and a college buddy of former Enron founder/CEO and convicted fraudster Ken Lay. Now imagine that the same company has an incredibly complicated corporate structure that consists of three different (though interrelated) publicly traded classes of stock-like securities.

And on top of that, what would you think if the very same company got its start by buying assets off Enron's books? As if that weren't enough, what would you think if a long-term industry analyst consistently panned the company, citing things like "misleading accounting"?

Would a company like that pass your initial sniff test?

Truth is as strange as fiction
You can actually find a corporate group with the somewhat dubious honor of matching all those criteria. Far from how it may seem on the surface, it's actually a successful player in its industry. What is it? It's the Kinder Morgan group of companies, one of the largest energy pipeline businesses around.

Richard Kinder, who acts as CEO of most of the companies in the Kinder Morgan group, was Enron's president and a college friend of Ken Lay, but their paths diverged about the time Kinder was passed over for the top spot at Enron in 1996. Kinder was more interested in the old-school, asset-heavy natural-monopoly of the pipeline business than the newfangled energy-trading empire Lay was supposedly building at Enron. As history showed, Kinder certainly got the better end of the deal.

And as for Kurt Wulff, the analyst with the concern on Kinder Morgan's accounting? Well, part of it seems more like a long-standing personal feud, while the rest seems to be about the way cash is shuttled around the various entities within the complicated company.

About that complexity ...
The group's primary business, Kinder Morgan Energy Partners (NYSE: KMP  ) , is structured as a limited partnership. That gives it tax advantages, as the partnership passes on much of its tax costs to its partners. The structure also allows its general partner to exert complete control over the business, since limited partners provide financing but have no say in the company's ongoing operations.

That partnership structure drives much of the complexity, although the Kinder Morgan group adds an additional twist to the standard partnership setup. It's hard to keep all the moving parts straight without a scorecard, so here's one you can keep for future reference:

Specific Entity Shares Represent
Kinder Morgan Energy Partners Direct ownership of limited partnership interests
Kinder Morgan (NYSE: KMI  ) Indirect ownership of general partnership interests
Kinder Morgan Management (NYSE: KMR  ) Indirect ownership of limited partnership interests; alternative to Kinder Morgan Energy Partners shares

Shares of Kinder Morgan or Kinder Morgan Energy Partners give you exposure to part of the general partnership interests or limited partnership interests, respectively. That leaves Kinder Morgan Management. Owning Kinder Morgan Management shares is similar to owning the standard Kinder Morgan Energy Partners limited partnership units; the management company's dividends are based on the limited partnership's distribution rate, although the management company pays its dividends in additional shares rather than cash.

There are two key reasons that Kinder Morgan Management exists, despite the complexity it creates; one that favors investors and the other that favors the company.

Investor: Since Kinder Morgan Energy Partners is a partnership, it can generate something called "Unrelated Business Taxable Income" (UBTI). That makes it tough for investors to own the limited partner in their IRAs, because it means their otherwise tax-advantaged IRA may not only owe taxes on the UBTI but may also have their entire tax-favored status put at risk. Kinder Morgan Management has been set up specifically to avoid generating UBTI. That setup makes it easier for IRAs to own.

Company: From the company's perspective, the Kinder Morgan Management setup enables the business to hold onto and reinvest some of the cash that would otherwise be paid out as distributions to the limited partners.

As is true of most public energy partnerships, the general partner gets the better end of the distribution growth these days as the company has matured. Still, the limited partners have little to complain about. With their current yield around 6.2% and a per-unit distribution that has been regularly increased for more than a decade, the limited partners have been and continue to be comfortably compensated for their investment.

So what's wrong?
Complex or not, Kinder Morgan Energy Partners' distribution growth has been slowing down lately. A big part of that is driven by the fact that its giant Rockies Express pipeline isn't performing all that well, thanks in large part to fracking enabling shale gas to be produced so cheaply. That cheap, more locally produced natural gas means that long-haul pipelines like Rockies Express aren't needed to move as much gas as originally envisioned.

As a result, Kinder Morgan and its partners on the pipeline, Sempra Energy (NYSE: SRE  ) and ConocoPhillips (NYSE: COP  ) , aren't seeing the returns they had hoped for. It has been so weak that ConocoPhillips has been trying to unload its stake in the pipeline, but recently had to defer that sale due to lack of interest.

So while Kinder Morgan is certainly not a scam, some of the bloom has fallen off this particular Texas rose. I still consider Kinder Morgan Energy Partners to be a core stock worth owning, but I'm not expecting the growth of years past to return.

At the time of publication, Fool contributor Chuck Saletta owned shares of Kinder Morgan Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (18)

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 March 16, 2011, at 11:12 AM, DividendDude wrote:

    I see somebody got up from the wrong side of the bed this morning. I kind of hope Kinder Morgan sees this article and sues you for being such a vindictive, insulting Fool.

  • Report this Comment On March 16, 2011, at 5:38 PM, TMFBigFrog wrote:

    Hi DividendDude,

    I didn't at all get up on the wrong side of the bed this morning. I've been a fan of Kinder Morgan since before I first started writing for the Fool. In fact, it was the subject of my first ever article, back in 2003: http://www.fool.com/news/foth/2003/foth030131.htm . Also, I own shares in Kinder Morgan Management, one of the three publicly traded stock like securities associated with the company.

    Quite often when I write about it, though, my email, the comment section, or both get flooded with people talking about how the company is a scam or a rip off or a bad investment or or or or... And usually, it'll be some combination of recycling Kurt Wulff's stuff (which is generally pretty good except when he writes about Kinder Morgan -- I seriously wonder if it's more personal than business), of expressing concerns about the GP/LP payment split or other business complexity, or of wondering whether the company is actively making bad investments (as evidenced by the lousy performance of the Rockies Express pipeline).

    So I figured I'd take the opportunity to address all those folks by publicly asking the very same question they ask me and then explaining why I firmly believe that the company is most certainly NOT a scam.

    -Chuck

    Disclosure: I still own those shares of Kinder Morgan Management.

  • Report this Comment On March 18, 2011, at 10:01 PM, tlc8386 wrote:

    My understanding of the Ken Lay, Richard Kinder deal is that Ken Lay didn't need nor want the pipeline business so he sold it off to Richard. This is called Hard assests, not a ponzi scheme that Ken Lay was involved in whether he knew it or not.

    As for the pipeline business vs. shale. Shale has it's own problems and the lawsuits are piling up. Natural gas is polluting drinking water. http://www.weitzlux.com/shale-fracking_1961354.html

    It's totally fine to question any company but reporting both sides is as important too.

    Kinder has real earnings not dreamed up ones if you don't believe that then sell them.

  • Report this Comment On March 18, 2011, at 10:05 PM, tlc8386 wrote:
  • Report this Comment On March 18, 2011, at 10:08 PM, tlc8386 wrote:

    Kinder Morgan Energy Partners, L.P. (NYSE:KMP - News) is a leading pipeline transportation and energy storage company in North America. KMP owns an interest in or operates more than 28,000 miles of pipelines and 180 terminals. Its pipelines transport natural gas, gasoline, crude oil, CO2 and other products, and its terminals store petroleum products and chemicals and handle such products as ethanol, coal, petroleum coke and steel. KMP is also the leading provider of CO2 for enhanced oil recovery projects in North America. One of the largest publicly traded pipeline limited partnerships in America, KMP has an enterprise value of over $33 billion. The general partner of KMP is owned by Kinder Morgan, Inc. (NYSE:KMI - News). Combined, KMI and KMP have an enterprise value of approximately $55 billion. For more information please visit www.kindermorgan.com.

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