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What the Kinder Morgan (NYSE: KMI) Deal Means for Master Limited Partnerships

This is a syndicated repost courtesy of Money Morning. To view original, click here. Reposted with permission.

With its bombshell consolidation announcement on Sunday, Kinder Morgan Inc. (NYSE: KMI) has suddenly become the third-largest energy company in America.

In a $71 billion deal, Kinder Morgan is bringing all of its publicly traded companies under one roof as a single C-corporation.

This move has called into question the entire master limited partnership (MLP) approach.

That’s because Kinder Morgan largely pioneered these partnerships, creating what was by far the largest of them all, controlling much of the oil and natural gas that is transported daily in the United States.

So, does this massive consolidation mark the end of MLPs as a main driver in the energy sector?

Here’s my take on the matter…

Does the KMI Consolidation Signal the End for MLPs?

In a word, the answer is no.

Remember, MLPs rushed onto the scene to become the hot way to consolidate assets, primarily in the midstream transport of oil and gas. That meant taking ownership over pipelines and related terminals, feeder systems, storage, and gathering points.

KMIOver time, Kinder Morgan ended up being the granddaddy of them all.

The primary advantage of the MLP structure is the lack of a corporate taxing level. All of the profits flow directly to the private tax returns of the partners – much like an “S” corporation in the private sector. As the “S” approach became the leading vehicle for small business creation nationwide, the MLP emerged as the venue of choice to consolidate energy assets.

The MLP benefits the average retail investor in this way: When MLP partners float a portion of equities shares for general trading, they also move along to individual investors a portion of the flow-through profits.

In most cases, that translates into a much higher than average annualized dividend to go along with the appreciation potential of the resulting stock shares.

And with today’s low interest rates, high-yielding MLPs, especially those that pay dividends, are very attractive.

However, as the MLP universe expanded, some disquieting elements appeared, as follows…

First, for the general partners (the actual owners of the partnership), having the profits passed through directly looked great on paper. But for some of them, the resulting accounting problems intensified and the actual tax liability became an impediment.

For average folks, of course, having to pay more taxes simply because you were making more money sounded great. Most would have welcomed such a capital gains problem!

It was the second emerging problem that resulted in a more serious concern. Maintaining high dividends for many MLPs resulted in the need to keep acquiring new assets to put in the package.

Initially, that wasn’t much of a roadblock, since the new acquisitions added genuine additional value to the MLP. This was especially the case with its bedrock asset type – pipelines.

With pipelines, an MLP could profit in at least two ways.

If gas or oil had to be moved from point A to point B, the MLP was paid by the companies either extracting or processing the hydrocarbons. But there’s another side to this story. The volume coming out of the ground also needed to be stored in advance of the transport.

Pipelines offer a much more efficient (and profitable way) of storage over the construction of new underground or above-ground facilities. This is especially the case with natural gas. In many regions of the country, the absolute majorityof pipeline capacity is used for storage.

In fact, there has been more money spent on putting loops in existing pipeline networks than in building new direct lines for transit.

These loops increase the overall storage capacity. That’s the only reason they’re added. From the vantage point of transport, loops are inefficient (taking longer to get from one place to another simply adds to overhead expense).

In this case, it’s the “acquisition problem” that eventually prompted Kinder Morgan to break up its MLPs. Of the four companies to be separated, three are primary asset-based holdings: KMI, Kinder Morgan Energy Partners LP(NYSE: KMP), and El Paso Pipeline Partners, LP(NYSE: EPB).

Together, these three MLPs have more than $58 billion in market cap and pay very nice dividends: 4.7% for KMI, 6.9% for KMP, and a whopping 7.5% for EPB.

It was the cycle of acquiring new assets for such a huge partnership, thereby allowing for the continuation of such high dividends, that finally prompted KMI management to change direction.

Those assets were becoming too expensive, creating a drain on the partnership’s bottom line.

Of course, it will take some time to unravel this massive structure. Early indications from the market clearly point toward investors liking the new approach. Stock prices for all three zoomed yesterday (but will certainly settle back today).

Which leaves us with the question posed at the outset of today’s column…

The Demise of the MLP Has Been Greatly Exaggerated

Does the Kinder Morgan decision mean the end for MLPs?

Again the answer is no – not by a long shot.

In fact, we are already seeing a movement toward what I call MLP clones. These new entities are becoming the next generation of master limited partnerships. Rather than the KMI model (gobble up everything you can and become really big), the new profit center for MLPs involves consolidating strategically placed assets.

What I mean by this is a move to consolidate assets at important “pricing points” in the entire process. Most of these new partnerships are still in the midstream sector and relate to pipelines. But more of them are moving upstream (toward field production) and downstream (into processing, wholesale, and even retail distribution).

This is a new version of “verticalizing.”

Except these days, the goal is not to control each aspect of the overall sector or acquire as much as possible. Rather, the singularly important components are identified – those providing a service disproportionately crucial at which profits can be maximized – and those are prioritized for acquisition.

In fact, I have been recommending these types of partnerships to my Energy Advantageand Energy Inner Circlesubscribers, and the stock values have been increasing nicely, while maintaining their high dividends.

But unlike Kinder Morgan, there’s no need for these companies to become too big. Rather, it is the acquisition of strategic assets that allows for the continuation of the strong dividends.

In this case, it’s the positioning of the assets that accomplishes this, not the size of the holdings.

And we should expect more MLPs just like these to follow. That is really what the Kinder Morgan move is signaling to the markets.

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The post What the Kinder Morgan (NYSE: KMI) Deal Means for Master Limited Partnerships appeared first on Money Morning – Only the News You Can Profit From.

Wall Street Examiner Disclosure: Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. No endorsement of such content is either expressed or implied by posting the content. All items published here are matters of information and opinion, and are neither intended as, nor should you construe it as, individual investment advice. Do your own due diligence when considering the offerings of information providers, or considering any investment.

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