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  • enronbuddy enronbuddy Aug 16, 2012 9:38 PM Flag

    Dropdown Math Fail

    John, Thanks again for the discussion.
    So perhaps a house is not the best example…nor is anything related to tax depreciation which is it’s own animal….let me elaborate. A house is a very unique asset. Of my $80k house, a good chunk of that market value is simply the value of the land…which of course does have a rather infinite life…give or take a few years:) Some parts of the home itself also have a very long life. The slab, the frame, wiring, pipes, sheetrock and windows….all could be expected to last a good 50-100 years with a little luck. A good roof, on the other hand, may last 25 years and cost $5k to replace. A refrigerator may cost $1k, and have an expected life of 10 years. So, we can probably agree that a houses actual life…say 100 years, and it’s depreciable life per the IRS at 27.5 years are out of whack. That’s why I ignored it in the cash flow analysis…I suppose I should not have brought it up at all. So I have about $1k a year in regular maintenance costs.. a fence last year, a water heater just a few weeks ago (technically capital...per KMP logic...these would be considered capital and would not reduce dcf...food for thought)though any year now, I could get hit with an additional 5k to replace an AC and 1K to replace a fridge. To answer your question, I do not carry a mortgage, but I suppose it would be around $400 a month at current rates.
    A pipeline, however is a very different animal. Every hour of every day, corrosion….admittedly just a tiny bit, is encroaching both from the earth on the outside, and the not so environmentally friendly products being carried through them. The earth is expanding and contracting, and those 30 year old welds made in 1982 by a guy with a mullet are being stressed daily at a microscopic level. Sure, you can pump it full of chemicals, monitor it with XRAY PIGS and protect it with cathodic protection, but in the end…it will become more costly to maintain than to simply replace…especially if the volumes available to be shipped have decreased since the pipeline was put into service…which is usually the case.
    So let’s ignore depreciation expense for tax purposes and instead think about depreciation simply as the spreading of an assets cost over its useful life. I would then argue that a pipeline is more like, say a car, owned by a rental company. This car is a cash generating asset. It will be leased to customers and let’s just say that net of maintenance, taxes ect, this $22k car will generate 5k in positive cash flow per year. In year 1-4, the company can say…look at us…we are generating 5k of cash flow per year….and distribute that to owners. At the end of year 4, the car’s useful life as a rental is over, and it is sold to auction for $2k. So over its life, one could honestly say that the car generated 22k of cash flow….but zero profit. Without profit…there simply is no point…you could have obtained the same 22k payout by putting the cash in a box, and pulling it out each year as you needed it…with none of the risk. Now, any car company operating in this manner probably wouldn’t last very long before these accounting absurdities came to light. A pipeline, on the other hand, with its much longer life cycle (though still quite finite) can keep up this charade for decades…covering up bad deal after bad deal with more debt, more shares, and more bad deals.

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    • continued...
      This is exactly what is going on at KMP. Depreciation isn’t just a tax dodge to minimize taxes…it represents the true cost to put an asset into service for its useful life. If there is no profit after depreciation…then it isn’t worth doing. By ignoring depreciation…you are pretending that a pipeline is a house….that it will have the same or greater value in 20 years than it does today and that simply is not a realistic assumption. We may disagree on the remaining life of these assets…if you have reason to believe there are 40 years of life remaining, it would be legitimate to reduce the depreciation accordingly…but to simply ignore it is just bad analysis. In time…whether it is 10 years, or 20 or 30, KMP will start retiring these pipelines. They (the partnership) will never last that long, but let’s just say they did.
      The year is 2032, and let’s say a $1B pipeline is deemed unsafe for operation….or perhaps the eagleford play is simply done….and has but a trickle of gas is left to transport so it’s simply unprofitable to operate. Now, you have a huge problem….because first of all, it’s going to take a lot of money, now, and in the future to shut this guy down with no future revenues….and uh oh….you have $500M of bonds due next month…directly related to the 2012 acquisition. So that asset you have been pretending is still worth $1B by ignoring depreciation now has zero revenue, is going to take tens of millions to shut down, and worst of all…..you have an immediate need to come up with $500M to pay off the loans you never bothered to pay off…. Because you had to make your “distributions” I don’t know the answer….but you LP owners better be sure you aren’t on the hook when they can’t roll the debt….just sayin….you might want to know for sure.

 
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