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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.
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.
"Because the MLP must distribute almost all profit to the unit holders by law,"
There is no such law. You are thinking of REITS. Most MLPs do distribute much of the cash flow, however they don't have to distribute anything.
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.