How High Can El Paso Fly?

Shares of El Paso (NYSE: EP  ) hit a 52-week high yesterday. Let's look at how it got here and whether clear skies are ahead.

How it got here
The obvious thing to point to for El Paso's new highs this year is the pending acquisition by Kinder Morgan (NYSE: KMI  ) . The pipeline titan is buying El Paso for a deal that is valued at $38 billion.

The recent move has little to do with earnings in the first quarter, when profit rose 39%. It has more to do with the rise in Kinder Morgan's price and the structure of the deal. Shareholders had three options in the buyout -- a $25.91 cash payment, $14.65 in cash and 0.4187 share of KMI, or 0.9635 share of KMI. At its current price, the last option represents $34.10 per share for El Paso, so it's no surprise that El Paso's share price has largely mirrored Kinder Morgan in recent months.

EP Chart

EP data by YCharts

El Paso Pipeline Partners (NYSE: EPB  ) and Kinder Morgan Energy Partners (NYSE: KMP  ) are subsidiaries of the two respective companies, and assets will be pushed down to these tax-advantaged units in the future.

Clearing hurdles
Part of the gain recently has been due to hurdles passed by the companies on their way to a merger. El Paso announced a deal to sell its exploration and production company for $7.15 billion. The Federal Trade Commission also approved the deal on the condition that Kinder Morgan sell three U.S. natural gas pipelines. This clears the way for an acquisition that will probably take place during the second quarter.

What's next?
The rise in Kinder Morgan's price is driving El Paso higher, and as the deal moves closer their values will converge. Since there were three buyout options for shareholders, it makes the trade a bit more complicated, but shares should continue to move higher and move closer to 96.45% of the price of Kinder Morgan's shares. El Paso shareholders have until May 23 to decide which buyout option they want, and at this point there is no point in choosing anything but stock.

For those so inclined, there is also an arbitrage trade available by going long El Paso and short Kinder Morgan into the buyout.

Interested in reading more about El Paso? Click here to add it to My Watchlist, and My Watchlist will find all of our Foolish analysis on this stock.

Fool contributor Travis Hoium manages an account that owns shares of Kinder Morgan. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

Motley Fool newsletter services have recommended buying shares of El Paso Pipeline Partners. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (2) | Recommend This Article (2)

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 May 04, 2012, at 1:58 PM, Hammer19 wrote:

    Travis, if you owned 500 shares of EP @ $11/share, what would you do? Convert to straight KMI or sell the EP outright?

    Thanks

  • Report this Comment On May 06, 2012, at 11:18 AM, mm5525 wrote:

    I agree there is no real choice other than to convert into KMI. I am long EP, and I have already elected the Stock Election. Also, don't forget the warrants. To me, that's the sweetest part of the deal. The exercise price for the 5-year warrants is a mere $40, and KMI is already at $35.

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