After years of uncertainty, Kinder Morgan (NYSE:KMI) decided to abandon its controversial Trans Mountain Pipeline expansion in late May after agreeing to sell the entire system to the government of Canada for 4.5 billion Canadian dollars ($3.4 billion). While the company's management team made it clear on the second-quarter conference call that they plan to use the cash it receives from the sale to pay down debt, it's not that simple, since the money will remain within its publicly traded Canadian subsidiary, Kinder Morgan Canada Limited (TSX:KML). That leaves it with a big decision to make in the coming months.
Drilling down into the issue
In May 2017, Kinder Morgan finalized its funding plan for the Trans Mountain Pipeline expansion by completing an initial public offering (IPO) of a company (Kinder Morgan Canada Limited) that would own all its assets in Canada. Kinder Morgan sold a 30% stake in that business in the IPO, which raised the cash it needed to get the project started. However, since that entity now owns the pipeline system, it will be the recipient of the cash infusion from the government of Canada.
Because of that structure, Kinder Morgan can't simply take the cash and use it to pay down debt. Instead, it needs to figure out the best way to deploy that money for all Kinder Morgan Canada investors.
It can't just sit on the money
Once the sale of Trans Mountain closes later this year, Kinder Morgan Canada will consist of some pipelines and terminal assets in Canada and CA$12 per share in cash, which is more than 70% of the company's current market cap. While that large cash balance is a nice problem to have, "We generally don't view it as attractive to Kinder Morgan Canada shareholders for us to sit on a big pile of cash while management hunts around for a transaction to use it on," said to CEO Steve Kean on the second-quarter call. Because of that, the company strongly indicated that it intends on looking for the best way to return that cash to shareholders.
It has several options, including:
- Paying a special dividend.
- Initiating a stock repurchase program.
- Taking Kinder Morgan Canada private.
- Selling Kinder Morgan Canada to another company.
While paying a special dividend would be the quickest way to distribute the cash equally to all shareholders, it would have tax consequences for investors. A stock buyback, likewise, has its pros and cons. On the plus side, it could boost the value of the company and allow investors to choose whether they want to cash out or to continue holding. However, on the downside, Kinder Morgan might not be able to maintain its current 70-30 ownership split if not enough public shareholders tender their stock. Or, it might find that most want to give up their shares, which could lead them to take the company private. That option would likely utilize a large portion of the cash proceeds -- which Kinder Morgan had hoped to use to reduce its debt -- unless it offers a combination of cash and stock.
Meanwhile, a sale of Kinder Morgan Canada to a third party is also a possibility. On the call, Kean stated that the entity owns "an attractive set of midstream assets" in Canada that "does fit well with other entities." As a result, the company is looking at "all the alternatives, including strategic combinations," which it could still do even after distributing the cash proceeds to investors.
A good problem to have
One thing management made clear on the call is that it's focused on handling the cash infusion in the "best way for shareholders," according to Kean. Management is taking "some time to think about tax impacts for shareholders who would receive cash or receive it in the form of buybacks" since "there are some differences there." However, they aim to deploy the money to benefit all investors as fairly and equally as possible. Overall, it's a "very good problem to have" and one the company is looking forward to addressing in the coming months as it seeks out the best way to maximize value for all investors.