Lawsuit Unlikely to Thwart Kinder Morgan/El Paso Deal

I obviously can't climb inside the head of Chancellor Leo E. Strine Jr., the Delaware chancery court judge who Thursday heard arguments from El Paso (NYSE: EP  ) shareholders wanting to block the planned acquisition of their company by Houston neighbor Kinder Morgan (NYSE: KMI  ) . But -- given my tendency to mix a host of metaphors -- I am willing to crawl out on a limb and predict that the planned marriage of the two big midstream companies ultimately will occur as expected.

Predicting the judge's ruling
I've been surprised before, and may be in this case as well, but in attempting to read into some of the comments made by the clearly entertaining Judge Strine, along with considering the time element involved in a potential thwarting of the planned acquisition, it appears likely that the combination, which was announced in October, will be wrapped up during this quarter.

El Paso shareholders have raised issues of potential conflicts of interest on the parts of both Douglas Foshee, their company's chief executive officer, and Goldman Sachs (NYSE: GS  ) . It appears that, prior to receiving an offer from Kinder Morgan, the powers that be at El Paso had planned to spin off the company's exploration and production unit. After the sale to Kinder Morgan was agreed upon, Foshee and Kinder Morgan CEO Richard Kinder briefly discussed the possibility of Foshee heading up a management buyout of the unit.

A secret chat
Foshee admits that he failed to discuss what appears to have been largely a trial balloon with his board. El Paso shareholders have contended that Foshee's interest in accomplishing a buyout of the exploration and production units, and his consequent interest in remaining in the good graces of Kinder Morgan, kept him from pushing for the full value for El Paso in the buyout. However, El Paso's attorneys have argued that, given his status as a major shareholder of El Paso, Foshee's interests were not dissimilar to those of the company's other shareholders.

Kinder Morgan agreed last fall to pay $26.87 per share in cash, stock, and warrants for El Paso, pegging the transaction at about $21.1 billion, or close to $38 billion with the inclusion of related debt. The result would be a combination of North America's two largest pipeline companies.

Beyond that, El Paso's U.S. E&P assets, which have been tentatively valued at up to $7 billion, are located in the Eagle Ford shale of South Texas, the Haynesville shale in Texas and Louisiana, the shallow waters of the Gulf of Mexico, and the Rocky Mountains. Internationally, the company operates in Brazil and Egypt. Kinder Morgan has intended from the beginning to sell these assets as a means of raising funds to be used in reducing the debt that will be incurred with the deal.

Goldman looks silly in all those hats
Contentions of Goldman Sachs' conflicts of interest stem from the number of roles the firm has played in the takeover scenario. Prior to Kinder Morgan's offer, the investment bank was serving as an advisor to El Paso on facilitating the sale of its E&P unit. It received a $20 million fee for that and other counsel it provided to the company. At the same time, its private-equity funds hold a 19% stake in Kinder Morgan and have two seats on the company's board.

Among the colorful comments that emerged from Strine during the six-hour hearing was his observation that, "Shareholders of El Paso can simply say 'It's a shady, stinky deal. I'm not going to do it'. You want me to enjoin the stink, but only until June 30 and then you still get the stink." And while the judge termed the alleged conflicts "disturbing," his general tenor indicated a reluctance to enjoin the shareholders' vote.

The judge promised to rule on the plaintiff's motion by the March 6 shareholder vote at El Paso. Assuming he chooses not to prevent the transaction from going forward, there remains the possibility of an award of damages following the deal's consummation. And if the deal is completed successfully, Kinder will gain control of El Paso's midstream assets and, at least temporarily, its E&P operations. Following the likely sale of the E&P assets, the remaining midstream assets would be sold to Kinder Morgan Energy Partners (NYSE: KMP  ) and El Paso Pipeline Partners (NYSE: EPB  ) , both of which would then be units of Kinder Morgan.

The Foolish bottom line
At the risk of appearing cavalier, I must note that deals of the size of the pending combination of Kinder Morgan and El Paso frequently include litigation initiated by disgruntled parties. In this case, I believe it's in the best interest of Fools to watch the situation emerge -- ideally by adding Kinder Morgan to your version of My Watchlist. Then, when the deal is concluded peacefully, you might carefully consider acquiring shares of this unusually solid midstream company.  

Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group and El Paso Pipeline Partners. 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. Fool contributor David Lee Smith doesn't own shares in any of the companies named in this article. The Motley Fool has a disclosure policy.


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