Why the Kinder Morgan Merger Makes It One of the Best Stocks in America

The Kinder Morgan empire of companies includes Kinder Morgan Inc (NYSE: KMI  ) and its three subsidiaries: Kinder Morgan Energy Partners (NYSE: KMP  ) , Kinder Morgan Management (NYSE: KMR  ) , and El Paso Pipeline Partners (NYSE: EPB  ) . Over the last three years Kinder Morgan has under performed many of its large peers and the market in general, stoking fears that America's fourth largest energy company will fall prey to the law of large numbers and see growth permanently slow. 

KMI Total Return Price Chart
KMI Total Return Price data by YCharts

In the past I've written about how Kinder Morgan's $30.4 billion in current and potential expansion projects will be enough to ensure strong distribution growth and market outperformance for decades to come. I've also written about how a potential Kinder Morgan merger could greatly increase growth, should it ever occur. Well on Sunday night news broke that Kinder Morgan was consolidating all its MLPs under its parent company in the second largest energy merger in history (the 1998 Exxon and Mobil merger worth $110.1 billion in 2014 dollars remains the largest).

Terms of the deal
The $71 billion deal is composed of $40 billion in Kinder Morgan Inc shares, $4 billion in cash, $27 billion in assumed debt. 

Existing shareholders of Kinder Morgan's MLPs will receive the following premiums for their units (based on friday's closing price):

  • Kinder Morgan Energy Partners: 12%
  • Kinder Morgan Management: 16.5%
  • El Paso Pipeline Partners: 15.4%
Existing unit holders of Kinder Morgan Energy Partners and El Paso Pipeline Partners are allowed to choose to receive payment in both cash and Kinder Morgan Inc shares or all cash. 

The new Kinder Morgan

Source: Kinder Morgan Merger Presentation

With 80,000 miles of pipeline and 180 terminals, the merger will create the third largest energy company in America by enterprise value ($140 billion) or fourth largest by combined market cap ($92 billion) -- behind only ExxonMobil, Chevron, and ConocoPhillips. The deal is set to close by the end of the year pending regulatory and shareholder approval. 

Why the deal is great for investors
There are three reasons why existing shareholders should be overjoyed by this deal.

First, it greatly lowers Kinder Morgan's cost of capital by eliminating El Paso Pipeline Partners and Kinder Morgan Energy Partners' incentive distribution rights and structurally subordinated debt. It will also save Kinder Morgan about $20 billion in taxes over the next 14 years. 

The second reason to celebrate this merger is that Kinder Morgan plans on turning on the growth engine in a big way, with plans to "to pursue expansion and acquisitions in a target-rich environment," according to founder, chairman, and CEO Richard Kinder.

In fact, there are a combined $1.5 trillion in potential acquisition and investment targets for Kinder Morgan to pursue through 2035 including over 120 MLPs with total enterprise values of $875 billion and $640 billion in expected midstream infrastructure investments. 

Organic growth projects and accretive acquisitions are the name of the game when it comes to growing dividends and distributions, and that is where this merger should make income investors happiest. 

Dividend growth restored
Kinder Morgan has announced its intentions to raise its 2015 dividend by 16%, with subsequent 10% annual raises through 2020.

Source: Kinder Morgan Merger Presentation

As seen above, Kinder Morgan's new dividend growth plan outperforms all but Williams Companies, whose growth is coming from its own megamerger and investment binge. With a current 4.7% yield and a long-term 10% dividend growth rate, income investors could reasonably expect around 14.7% total returns from Kinder Morgan through 2020. Given the stock market's long-term average compound total return of 9.2%, this expected total return should put Kinder Morgan on every income investor's radar. 

However, Kinder Morgan isn't just for dividend seekers. Because of management's long-term dividend visibility, we know that Kinder Morgan's dividend is expected to be around $3.22/share at the end of 2020. This provides an 8% future yield that is likely to see shares appreciate in value perhaps faster than dividend growth. 

In fact, strong capital gains are likely due to the fact that Kinder Morgan has met or exceeded its dividend/distribution guidance in 18 out of the last 19 years.

With Kinder Morgan's dividend growth plan expected to result in $2 billion in excess dividend coverage by 2020, an anticipated six-year coverage ratio of 1.1, and a 94.7% success rate of meeting or beating distribution/dividend growth guidance, actual dividend growth may prove to be higher than advertised. 

Foolish takeaway
Kinder Morgan's exit from the MLP industry it helped pioneer is a surprise, but one that's very likely to benefit current investors in both Kinder Morgan Inc and all its MLPs. The new Kinder Morgan is likely to achieve sustained and strong dividend growth that will not just generate strong income over the next decade, but also strong capital gains should Kinder Morgan live up to its historical precedent of beating dividend growth expectations. Long-term investors of all kinds should consider this bluest of energy infrastructure blue chips for their portfolio. 


Read/Post Comments (27) | Recommend This Article (60)

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 11, 2014, at 3:53 PM, bdh2067 wrote:

    Thank you for this great summary, Adam. And thank you, Motley Fool, for the tip a year ago on KMI. I bought after a little investigation. Then bought more on a dip. Then more when I saw Rich Kinder was buying tons of his own company's stock (always a good sign when the CEO believes enough to want to own more of it).

    I now wish I'd bought more (and held off on the TCS tip from MF, but that's a separate post...). I'm confident, though, KMI's ample and growing dividends, reinvested, will add up over the long term.

    Anyway... thank you.

  • Report this Comment On August 11, 2014, at 6:43 PM, ezchair wrote:

    I own both kmi and kmp. Happy times! Mötley fool recommends selling El Paso shares.

    What would be the best move with KMP shares? Sell them or wait and let the conversion happen. The kmp shares are hel in an IRA.

  • Report this Comment On August 11, 2014, at 8:33 PM, AdamGalas wrote:

    Not sure about the EPB sell recommendation but at this point, at least in my opinion, I wouldn't recommend selling KMP, KMR, or EPB and here's why:

    No matter which you own if you hold onto your units you'll get cash and KMI shares come January.

    KMP and EPB are MLPs, so almost all your previous distributions are tax deferred return of capital.

    That is deducted from the cost basis for tax purposes and you only pay those taxes if and when you sell.

    Thus, if you never sell the units that distribution income is permanently deferred. The merger is a unit for share swap, so as far as I can tell, holding onto your units will save you a bunch in taxes.

  • Report this Comment On August 11, 2014, at 10:26 PM, Cadyrn wrote:

    I've only been investing for approx 4yrs. anything I learned was through MF. I purchased the shares of KMP and EPB for my 94y/o mothers portfolio thereby tripling her income for the amount of money invested. I bought the two MLP's specifically for the income, the tax advantage, & the stepped up basis when inherited; thereby continuing the tax advantage and delaying any tax payment.

    This move by KMI, as I currently understand it, will mean that the MLP units vs stock will no longer have a tax advantage or a stepped up value on inheriting.

    I hope that you are correct & that the government will consider this a swap with no taxes due. Any idea when we will find out?

  • Report this Comment On August 11, 2014, at 11:45 PM, AdamGalas wrote:

    Based on the Kinder Morgan Merger presentation, page 11, the merger is a taxable event with an estimated tax cost of $12.39-$18.16/unit in tax cost, depending on tax bracket.

    That seems rather steep but the fact remains that Richard Kinder is a bright guy and wouldn't have agreed to the merger if it wasn't in the best interest of the company and therefore shareholders (of whom he was 24% owner of KMI and will now retain 10%).

    The event seems likely to trigger some amount of tax cost selling but the fundamental strengths of the company remain and still make Kinder Morgan a buy on any dips, including those caused by tax selling.

  • Report this Comment On August 12, 2014, at 2:59 PM, scostello1965x wrote:

    Great summary Adam. I have January 2016 call options with a strike price of $85. The options are for KMP and are currently valued at around $11.24. Being somewhat new to this, what does one do with these? Sell at $11. Buy the stock now at $85? Or just wait for the merger to go through? Would I then have options on the new stock (stock symbol unknown)? Or will these options basically disappear in the next few months?

  • Report this Comment On August 12, 2014, at 3:49 PM, nahag wrote:

    As I understand your article, owners of KMI do NOT receive any money, is this a correct assumption?

    Thank you.

  • Report this Comment On August 12, 2014, at 4:12 PM, AdamGalas wrote:

    As far as I know KMP options won't roll over to KMI and so you'd have to sell before the merger closes, which is by the end of the year.

    If you sell now, you're locking in the time value of the options which will decay every day you hold them.

    Selling the options will trigger a taxable even, but as mentioned above, the merger is itself a taxable event.

    If you call the option early then you'll still end up paying taxes on the value of the KMI shares you receive (and cash).

    In my opinion the best thing to do in such a situation is sell the option, then buy shares of KMI.

    This will create one taxable event (locking in gain from call option) but avoid another, (receiving KMI shares and cash if you bought KMP after selling the call).

    As to Nahaq's question, you are correct, KMI shareholders benefit not one lick from this merger, other than a soaring stock price, a much stronger company and faster dividend growth:)

  • Report this Comment On August 12, 2014, at 8:01 PM, EvanBuck wrote:

    So how does this deal affect people who do not own shares of any of these stocks currently but are interested in potentially investing? What is the best way to profit off of this deal?

  • Report this Comment On August 12, 2014, at 8:18 PM, EvanBuck wrote:

    Because I'm thinking just buying KMI shares would be the best bet here.

  • Report this Comment On August 12, 2014, at 8:58 PM, AdamGalas wrote:

    Absolutely, KMI is the way to go.

    Buying one of the MLPs will trigger a taxable event when the deal closes and the shares/units swap is executed.

    With no more than 2 tax deferred distributions left before the merger closes there is simply not enough of a benefit to owning KMP, KMR, or EPB over KMI at this point.

  • Report this Comment On August 13, 2014, at 9:23 AM, RedandBlack wrote:

    I'd suggest the "Theorem of a Large Denominator" or the "Slower Growth/Mega Market Cap Rule" instead of the "law of large numbers." The LLN is a statistics rule and doesn't apply to what's described by slower growth from a larger denominator.

  • Report this Comment On August 13, 2014, at 6:51 PM, AdamGalas wrote:

    Indeed one thing that people fail to realize is that bigger companies can put together bigger deals and usually with cheaper costs of capital.

    The new Kinder Morgan is going to become the Berkshire Hathaway of midstream companies and start buying up some big assets.

    I've heard analysts mention Targa Resources and MarkWest as possible buyout targets.

  • Report this Comment On August 14, 2014, at 6:43 AM, VerySERIus wrote:

    As far as growth....that is the primary reason for the consolidation....there exist major acquisitions that can be pursued as a larger company at lower cost. KMI will be the GOOGLE of the energy sector.

  • Report this Comment On August 14, 2014, at 8:36 PM, AdamGalas wrote:

    I agree, within 10 years Kinder Morgan will be bigger than Exxon.

  • Report this Comment On August 15, 2014, at 1:33 PM, docdocatl wrote:

    It would have been helpful to have conversion units of each MLP in the article, so here goes, from an article on Yahoo Finance:

    KMP: 1 share = 2.1931 KMI + $10.77/share in cash

    KMR: 1 share = 2.4849 KMI but no cash

    EPB: 1 share = 0.9451 KMI + $4.65 in cash

    And, in another article (on another finance website), a Wells Fargo analysis states these sobering facts of the final effects of the conversion, because converting MLPs operate as a sale, therefore triggering tax events.

    Wells Fargo states the after-tax benefit -- or loss -- for each holding:

    KMP: - 4% (yes, that's a loss)

    KMR: + 21% because conversion does not trigger

    a tax event

    EPB: + 7%

    I own shares of KMP and am now at a loss as to what to do.

    Sell KMP and buy KMR before conversion?

    But selling KMP now triggers tax event

    And KMR is priced higher than KMP

    So what to do?

    Am welcoming comments/advice, and thanks in advance


  • Report this Comment On August 15, 2014, at 2:02 PM, captr18 wrote:

    I now have a cosiderable number of KMP shares and will have to select cash, or KMI shares or some of each! I've had KMP for over 5 years some in my trust, and some in my Roth IRA

    Which would be in my best interest:

    Tax wise?

    Net money now?

    Futurer benefits for my estate?

    the choise that's best for my Roth IRA?


  • Report this Comment On August 15, 2014, at 7:00 PM, AdamGalas wrote:

    KMI and KMR are best to have in tax deferred accounts because MLPs earn some UBTI, which if over $1,000/year results in you having to pay taxes, even out of a tax deferred account like a Roth.

  • Report this Comment On August 17, 2014, at 3:45 PM, captr18 wrote:

    thank you for the quick reply,but!

    I don't understand your reply!

    33% of my current shares of KMP are in my Roth IRA account!

    Should I sell the Roth IRA shares now and buy KMR ,or KMI with the proceeds? ( which one to buy)

    Should I hold my KMPshares that I have in my Trust Acct, and let the transaction disbursment take place!


  • Report this Comment On August 18, 2014, at 7:00 PM, AdamGalas wrote:

    My apologies for the misunderstanding. I am not a tax expert and you should definitely consult with one if you're Roth IRA position is large enough to incur UBTI.

    From what I do know, UBTI is the biggest problem with Roth IRAs and MLPs. The merger's conversion, though a taxable event, may not create UBTI and so you may not need to sell your KMP units at all.

    As to the trust? Well I won't even attempt to address that, as its way above my pay grade.

  • Report this Comment On August 21, 2014, at 3:04 PM, kbyrne6 wrote:

    What is the risk that this proposed transaction does not proceed?

    As I understand it, the KMP holders have to vote on it and many seem to be upset over the tax consequences. Could there be enough of them to scupper the deal ?

  • Report this Comment On September 01, 2014, at 7:59 AM, AdamGalas wrote:

    I think the odds are great that the deal goes through. Richard Kinder's blessing will go a long way to alleviate concerns about the deal and though the tax consequences might be painful the promise of a 16% dividend hike and 10% growth through 2020 will be too much to pass up.

    After all 10% dividend growth is double what KMP was guiding for, in terms of distribution growth.

  • Report this Comment On September 03, 2014, at 6:18 PM, dspreeuw wrote:

    so it looks like since KMR is an LLC, and there's no cash involved, it's just a swap: shares of KMI for shares of KMR……not a taxable event?

  • Report this Comment On September 03, 2014, at 6:42 PM, dspreeuw wrote:

    also, you mention that KMI will save $20b in taxes over next 14 years due to this deal….….how will that happen?

  • Report this Comment On September 26, 2014, at 2:21 PM, simplemark wrote:

    on Aug 12 2014 Adam Glass wrote

    ""As far as I know KMP options won't roll over to KMI and so you'd have to sell before the merger closes, which is by the end of the year."

    Is this so??

  • Report this Comment On October 15, 2014, at 11:59 AM, DirtyDog wrote:


    As a T.A. guy, what are your thoughts that the 100 year rise in oil prices are over?

    Using Elliott Wave (oil prices) patterns, the structure is clearly a 5 wave(motive wave) in a parallel upsloping trend channel. We are in the c wave of the correction of the 8 wave pattern.

  • Report this Comment On October 18, 2014, at 12:27 PM, DirtyDog wrote:

    Adam..KMI, KMR, EPB, and KMP

    The daily Bollinger Bands with the SMA(20) are showing M7's in all of the above. As you know M7's formations are typical in right-shoulder patterns in actual head and shoulders tops. I feel we are now in the throwback rally's that will bounce off the neckline's and create a W1's or W2's. A downside bias is coming with a series of W's. jmo

    Using KMI..The head 8/20/14 @ H-41.82

    The last wave's 50% retracement is 38.51, a good place to sell as it bounces off the neckline area.

    As heard on the web.. Point Capital's new energy expert James Carroll has recommended the deal to his new bosses...a fool at foot! jmo

    Now I know why you have been silent lately.

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