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Kinder Morgan Energy Partners Message Board

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  • enronbuddy enronbuddy Aug 16, 2012 1:46 PM Flag

    Dropdown Math Fail

    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.
    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:)