Why Kinder Morgan's Tanker Acquisition Makes Sense

Kinder Morgan Energy Partners (NYSE: KMP  ) recently announced an acquisition that some might criticize as outside its core competency. The operator of oil and gas pipelines and storage facilities will enter the oil tanker business in a meaningful way. This could be a confusing decision in light of the fact that the boom in oil and gas production in the United States is right in line with Kinder Morgan's existing business model. As a result, many tanker companies that focus on global oil shipping are struggling.

It's reasonable to question whether Kinder Morgan would have been better off investing its capital in additional production capacity, but at the same time, it appears management may have made a shrewd move after all.

The wrong place at the wrong time?
Kinder Morgan announced it will buy two separate oil tanker companies for a total of nearly $1 billion from private equity firms. The fleet consists of 9 tankers in all. Unfortunately, since oil and gas production in the United States is ramping up, this has come at the direct expense of global oil tankers. This has widely afflicted operators of oil tankers, including Frontline Ltd. (NYSE: FRO  ) . Frontline recorded a net loss in both the third quarter and through the first nine months of the year. Its business continues to deteriorate at an alarming rate: Frontline's net loss soared from $66 million through the first three quarters last year to $177 million in the same period in 2013.

Perhaps even more disturbing is that Frontline management doesn't see a light at the end of its tunnel. The company's Board of Directors stated that "it may take some time before a reasonable market balance is restored and sustained recovery of the tanker market occurs" in its third-quarter results. This is due to ongoing difficulties in market rates. Going forward, should the United States truly embark on an era of energy independence, it would mean even less demand for oil imports. This is what makes Kinder Morgan's acquisition slightly confusing at first glance.

However, some context is important. Kinder Morgan's $1.2 billion bet is focused on domestic marine transportation of crude oil and refined products. As a result, a key difference of this deal is that it will serve to complement Kinder Morgan's existing transportation business. Plus, it's helpful to consider that Kinder Morgan got these tanker companies at cheap prices. Kinder Morgan will pay 8.4 times earnings before interest, taxes, depreciation, and amortization (EBITDA) for these assets. This is what compels management to believe the transaction, upon closing early next year, will be immediately accretive to investors.

Moreover, holders of Kinder Morgan Energy Partners should be encouraged that its general partner, Kinder Morgan, (NYSE: KMI  ) , will waive its incentive distribution rights in the amounts of $16 million in 2014, $19 million in 2015, and $6 million in 2016. This will help facilitate the deal, and means less money out of Kinder Morgan Energy Partners' pockets.

The bottom line
It's true that many global oil tanker companies aren't doing well right now. This is particularly true since domestic oil and gas production is ramping up, meaning less overall demand for importing oil. This is evident by the lackluster results of many oil tanker operators that focus on international shipping, including Frontline.

However, investors need to know that the companies being acquired engage in domestic transportation. Moreover, Kinder Morgan got these shipping assets on the cheap, so investors should take solace in the fact that it didn't over-pay. As a result, while the effectiveness of these investments remains to be seen, Kinder Morgan investors shouldn't be overly concerned.

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10/29/2014 4:02 PM
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Kinder Morgan CAPS Rating: *****
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