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.
But… But…But…. Rich has made me a lot of money. Just look at the 10 year returns? True… I will grant that Rich Kinder is really good at one thing…and it’s not running pipelines. Nobody, not even Ken Lay or Bernie Madoff has been more successful at finding idiots to spend billions of dollars on what appears to be worthless and unprofitable securities. Again…yes, I am talking about you…. Anybody who owns this stock clearly lacks the ability to read a financial statement, or even do elementary school level math. Don’t be too ashamed….very few can do both. I have no doubt that this insanity can continue for at least a few more years, but it will collapse in the end (when is Rich retiring??). Shares outstanding and debt continue an upward trajectory, and yet profits are elusive. Simply put, there is no mathematical reason for KMP to exist. You have no rights, protections, or recourse against the GP’s blatant conflicts of interest, and only half of the cash flow from assets, even though you pay 98% of the cost…. All nicely divulged in the annual report you have never bothered to read. You couldn’t stop these dropdowns from happening even if you wanted to any more than you could have stopped the construction of REX, or any of the other terrible investments your beloved GP has made on your behalf. He could force you to buy the same pipeline for $150…$200…$1000…. regardless of its value (maybe $40). Some day…when the market runs out of morons willing to soak up the $billions of new shares issued each year to keep this crap box afloat, it will sink like a rock. Then….. Rich’s buddies at the bank….you know the ones who you owe $16.7 Billion as of 1Q2012…. (and billions more as you overpay for dropdowns over the coming years) Those guys will be the new owners of your unprofitable pipelines. Fortunately for them you put up 50% equity….they might not even lose a dime. Wanna guess who they will hire to run them? Probably the same guy who helped them rack up billions in fees skimming profits off gullible and powerless MLP owners. KMP/KMR owners…welcome to MATH…it’s a kinda great invention!!