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# El Paso Corp. Message Board

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• enronbuddy enronbuddy May 10, 2012 1:33 PM Flag

## Something smells like stinky fish....

KMI Dropdown Math-Good for EP

Here is how it works. KMI goes out and buys itself a nice pipeline. Let’s just assume, it has a price/ free cash-flow ratio of about 7. So they pay \$100 for the pipeline, and it generates about \$14 of cash-flow a year. If the remaining life of the pipeline is 20 years, that would be \$5 a year in depreciation, and let’s just say \$2 a year for overhead…hopefully enough to pay for some top notch accountants and chip in a few pennies for Rich’s annual salary. So the profit on this pipeline would be \$7 a year, less some interest expense, say \$3…rates are low, so a net of \$4.
But, being ever so generous and magnanimous, Rich decides that rather than keep all of this money to himself, he would like to share it with his LP buddies at KMP/KMR. So, he decides to let them in on the deal by selling them the pipeline into the brilliant structure that is the MLP. First off….at what price? At book value? \$100? That doesn’t sound fair….after all, poor Rich put a lot of effort into acquiring this pipeline….how about \$102 (he did have to get down on his knees after all-at least that’s what I read). This sounds fair right? So KMI sells the pipeline to KMP for \$102…of course, since KMI has a 2% ownership in KMP, they pay their share…about \$2. They take the \$100 from the MLP, and pay off the debt incurred to purchase the pipeline in the first place.
So…now what does the math look like for KMI? As 2% owner in ~\$14 of free cash flow a year, Rich takes his \$0.28 a year and buys a lollypop…right? Well of course not. As GP, he is entitled to about half of that. So He gets his \$7, but depreciation is negligible as is interest expense….he’s only in for \$2 after all. By transferring the assets to the LP, KMI has actually increased their cash flow over had they simply held onto the pipeline by transferring all of the cost to the LP, yet still hanging onto half of the cash flow. That Rich Kinder is such a magnanimous bastard….that’s why you all love him right?
Sure…why not…let's look at KMP’s income statement now and see why you love him. KMP now owns the same pipeline, but is only entitled to \$7 of free cash flow.(That pushes our ratio from 7-“pretty good”, to 14-“are you stupid really?” Subtract out the depreciation and some interest expense and yep….no profit. But that’s ok…nothing else they own is profitable either….”profit isn’t important…We are an MLP” as in “More Lube Please??”…that is what it stands for right? All it takes is some pretty simple math to see that even with the tax advantages of an MLP, with a 50% IDR tier like Kinder Morgan, all assets would be better off in a standard Corporate structure. Sure…Uncle Sam might get 35% of your profit (oh right…there is no profit), but that is far better than what is effectively a 50% tax on cash flow…regardless of profit. One day, a professional analyst capable of elementary school math is going to take a look at KMP/KMR and call it what it is…. A mechanism to let Rich Kinder legally bone his LP patsies. Yes…that means you KMP/KMR.