Kinder Morgan (NYSE:KMI) scrapped plans to joint venture its Trans Mountain Pipeline expansion project this week, choosing instead to raise cash for the project via an IPO. It's a decision that has ramifications for investors in both the short and long term because it might alter the company's dividend growth potential. However, with this decision settled, investors now have a better idea of what might lie ahead.
Going public with its decision
Kinder Morgan initially filed the preliminary prospectus for an IPO of its Canadian assets last month. At the time, the company detailed that if it proceeded with an IPO, it would not only package its Trans Mountain Pipeline in the deal, but it would carve out the rest of its Canadian assets and house them in this entity. Those assets include several terminals and other product pipelines in the western half of the country.
Those assets will now form the backbone of a larger Kinder Morgan Canada, which the company will sell a piece of to the public by the end of this month. The pipeline giant plans to offer between 79.5 million and 92.1 million restricted voting shares of this entity at a price between 19 Canadian dollars and CA$21 per share, according to the filing. That would raise around CA$1.7 billion ($1.3 billion) for the company to help finance its CA$7.4 billion ($5.4 billion) Trans Mountain Pipeline expansion. If it's successful in raising the full amount, Kinder Morgan's Canadian IPO would be one of the five largest in that country's history.
Why this route?
There are several reasons why the company decided to proceed with an IPO instead of a joint venture. First, by moving ahead with the IPO, Kinder Morgan will retain a greater interest in its largest expansion project, which will enable it to collect a higher portion of the significant cash flows it should generate when it enters service in late 2019. In addition, the company will also retain a more favorable governance structure and greater certainty on the timing of the project.
Another reason it chose an IPO is that it just didn't get a better offer from any of the parties interested in forming a joint venture to finance a portion of the project's costs. According to a report by Bloomberg last week, several private equity companies, including ArcLight Capital Partners, Brookfield Asset Management (NYSE:BAM), and IFM Investors were among the final bidders for a stake in the project. However, Australia's IMF Investors reportedly decided to pull out of the bidding. Meanwhile, Brookfield Asset Management, which through its infrastructure arm co-owns the Natural Gas Pipeline Company of America with Kinder Morgan, is more of a value-based investor. That's not exactly what Kinder Morgan was looking for in a partner, considering that it was hoping to get paid a hefty premium on top of the financing commitment to compensate it for the value created in progressing the project thus far.
Finally, British Columbia, which is the Canadian province where Kinder Morgan will construct the bulk of its expansion project, recently held elections. While the Liberal Party that supports the project narrowly won the election, it no longer holds the balance of power. Because of that, it will need the support of the minority Green Party, which is not in favor of new energy projects in British Columbia. That election result could have swayed the remaining joint venture bidders that the risk was too high for the potential reward, especially when adding in the cost of any premium paid to Kinder Morgan.
What lies ahead for Kinder Morgan
With its mind made up, Kinder Morgan's next step is to launch its IPO and hope demand is high enough that it can raise the full amount it's seeking. That would give the company a good head start on the financing it needs to begin construction. It's also worth noting that it has already secured a CA$4 billion ($3.2 billion) credit facility to help finance construction. That means it will still need to come up with about CA$1.7 billion ($1.3 billion) in cash over the next two years to finance the balance of the construction costs, assuming there are no additional changes or delays to the project as a result of the election.
For a company that expects to generate $4.46 billion in distributable cash flow this year, or $3.3 billion after its current dividend, it shouldn't have any problem financing that capital internally. However, that could mean it won't be able to allocate as much excess cash toward a dividend increase unless it raises additional money in the future via secondary offerings on the Canadian market.
For investors, this is a glass-half-full outcome. On the positive side, by holding on to a larger interest in the project, Kinder Morgan will retain more of its future cash flow, which potentially sets it up to pay higher dividends once the project enters service. However, the trade-off for that upside is that company might need to allocate more of its cash flow over the next two years toward capex, which might mean a smaller dividend increase in 2018 than investors had hoped. We'll know more about those plans when Kinder Morgan unveils its revised dividend policy later this year.