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Kinder Morgan Energy Partners, L.P. Message Board

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  • john_be_quicker john_be_quicker Aug 16, 2012 11:22 AM Flag

    Dropdown Math Fail

    The problem with your math is the usual error - KMP does not distribute earnings - it distributes cash flow. The depreciation is part of cash flow. Although the pipeline may be depreciated over 20 years for tax purposes, it has a much more than 20 year life, so for a business with a lot of depriciation the depreciation is "profit" from a practical (and distributable) point of view.

    As a more simple example - my well built brick house is 90 years old. IRS allows you to deperciate a rental house over 27.5 years. If my house had been rented out for the last 90 years it would have been fully depreciated 3 times over if ownership were transfered every 30 years. Depreciation has almost nothing to do with the actual life of the asset as long as the asset is maintained. This is why PE is not meaningfull for MLPs with high depreciation - the depreciation is profit from a practical application, yet it is excluded from the PE calculation, which lowers the reportable profit, but not the actual cash generated by the assets.

    I am in it for the cash, not some BS number for the IRS.


    JBQ

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    • John…I appreciate the debate… Thanks you!! Here is my reply.
      The problem with your analysis is your assumption that these pipelines will have an effective infinite lifespan. They most certainly do not. A brand new pipeline, like say REX may have a good 15 or 20 years of effectively maintenance free operation. But pipelines are made of steel, and at some point, maintenance cost starts to creep up and risk of failure(hopefully not catastrophic) does as well. All else equal, one would expect the annual cash flow from a pipeline to decrease year after year as maintenance and downtime trend upwards over time. So while in theory, a pipeline may have an indefinite lifespan, the economic lifespan for this vintage of pipelines is probably 35-45 years. This was a wild guess on my part, but I assumed an average age of the acquired pipelines to be 20 years….and that they would thus have about another 20 years before they are retired. If….you want to assume in your economic model that they actually have a good 100 years left in them, and that cash flow will remain constant or grow, and that no significant future capital expenditures will be required, than it is quite likely you would come to different conclusions about these dropdowns than I am.
      However….
      I do like your rent house analogy….let me build upon that. I actually have a few rent houses, so let me throw some numbers at you. I own one property that is about 10 years old, and has a market value of about $80k, which I rent for $1000 a month. Net of insurance, taxes, and maintenance costs, I pull in about $8k a year in positive cash flow. Depreciation…using IRS guidelines is about 3k per year, so my reported profit is about $5k a year (before tax) on $8k in cash flow. The payout on this little investment is 10 years (80k/8) Not great, but it’s better than a CD….admittedly a bit riskier as well. In another 20 years, when my house is fully depreciated, yes, it will still be here, but, in the meantime, I will have probably replaced the roof at least once, put in a couple new air conditioning systems, refrigerators, stoves, fences ect… and replaced the flooring four or five times….. That’s what depreciation expense is, an accounting estimate of wear and tear….and it is true cost, and a pipeline is no different. To ignore it means that you believe….in 20 years…KMP will be able to sell these ancient pipelines for the purchase price of 6.2B inflation adjusted dollars.
      I say not a chance in hell….by that time….many of them will actually be liabilities. I was involved once in accounting for liabilities associated with a pipeline that had been abandoned for some time….the company I was working for had a reserve on the books for tens of millions of dollars for future environmental remediation claims. Every time a contaminated site was found, a few a year, it cost a lot of money to dig up all of the contaminated soil, dispose of it properly, and replace with new soil. There is nothing special about Rich’s pipelines….they too will all end up as liabilities on somebody’s books at some point….it just won’t be KMP’s
      Back to this dropdown…you, the LP, are paying 6.22B for an annual cash payout of 246M, so it takes 25 years before the LP even gets his initial investment back…and that is assuming constant cash flows….I just don’t believe that for a minute. So in a very real way….you could have just instead purchased 6.22B in cash, and distributed it for 25 years and called it even. This goes back to our assumptions….if you believe that this cash flow will continue indefinitely…I guess you could come to a different conclusion…. But even that aside…can’t you at least see that you are getting a raw deal from the GP on this deal? You have essentially paid $200k for a house worth 80k (I would gladly sell my house to you….ping me:)

    • continued...
      Back to my rent house. Let’s say I converted it to an MLP, with myself as the GP and you as the LP. Up for grabs is $8k of cash flow….that’s a constant regardless of my business structure. The deal is….I sell my house to the partnership for $80k…but get to keep half of the cash flow. You…as the LP are paying 98% of the market value ($80k)…for $4k of cash flow. Why?? If an 8K cash flow is worth $80k, then a $4k cash flow is only worth $40k…. So in a very real way…Rich is selling KMP $100 bills for $200 a pop. This is the real key to the Kinder Morgan story….In the elderly, he has found a large pool of ignorant investors to dupe with a fairly complicated scheme most simply lack the industry specific and financial knowledge to analyze. But the math isn’t that complicated….this thing will collapse sooner or later. The KMP business model is purchasing cash generating assets for twice their value, then writing them off and pretending that “profits” don’t matter. My goal is to simply get the math down in the historical record so when that time comes…. You fools can’t play the “ but nobody told us” card. Just like with Enron, Madoff and Stanford….anybody with a spreadsheet and a bit of common sense can do the math on KMP and figure out where this train is headed….if you care to look.. Most won't, and will lose their life savings when this turd starts to sink.

      • 2 Replies to enronbuddy
      • So to keep using the rental house analogy...The maintenance cost is in the the $3k of expenses you deducted from the $8k gross rental receipts, not in the depreciation deduction. So I maintain that depreciation is just tax deferred profit, which skews the PE calculation, and therefore makes PE irrelavant to MLP valuation.

        I grant you that the pipelines do not last forever, but they are similar to the national highway system - you replace and re-surface them in sections as long as they are useful. The on-going cost of this rebuild is captured in the expenses, not the depreciation.

        I agree with you that the GP has a super sweet deal. Just like the bank that finances the rental property for you. How much of the gross rent goes to pay the mortgage? The bank never gets the broken pipe call in the middle of the night. The landlord does all the work, finds the tenants etc. and the bank gets paid first and gets paid a good size chunk of the gross receipts just for bringing cash to the table. It sucks, but people still finance rental properties because not everyone can be a banker, and they can still make money by buying rental property this way.

        Because the MLP must distribute almost all profit (notice i did not say "earnings") to the unit holders by law, it can never build up much capital to buy assets out right with. KMP does not really own the drop down assets they "bought", Just like the landlord does not really own the rental property - the bank owns it.KMP did not really pay the money out of pocket for the drop down. It is all financed one way or another. KMP makes profit by borrowing at a lower rate than it can earn with the borrowed money. Yes it is all leverage, and leverage has its risks, that is why KMP pays more than T-bills.

        JBQ

      • So quit complaining, sell KMP and buy KMI

 
KMP
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