Now that the dropdown details have been announced, we can do some analysis. Since I know that all KMP/KMR owners are dumber than a box of rocks….I have decided to do the math for you…to once again show you how much of a moron you have to be to continually let Rich have his way with you.
So, from the release, the sales price is 6.22B which is 8X EBITDA (I assume for the partnership in total…not for KMP/KMR…very important distinction). So annual EBITDA will be $777.5M. If remaining life of pipelines is 20 years, we have depreciation of 311M, and since this will be funded roughly half by new debt at let’s say 3.5%, we will add 105M a year in interest expense. The GP will take the ~50% of cash flow he is entitled to, leaving the LP with $246M in cash flow and $25M in profit.
So this nice little acquisition has a PE of 246. You could almost beat this “performance” By sticking $100 in a safe and pulling out $5 every year for 20 years. Of course…KMP hasn’t actually made a profit in what…over a year now, so I’m pretty sure $100 in a safe will outperform KMP/KMR.
The math on KMP is extremely simple. If you truly think that “earnings don’t matter” well….you just aren’t thinking very hard. You can only squeeze so much cash from any pipeline, and when you have to give half to a GP upfront, there just isn’t very much value left. The burden of the GP far exceeds any income taxes you have been fooled into thinking you are avoiding. Income taxes require profit after all….and KMP has none.
Wake up fools!! KMP/KMR only exist so Rich can skim all the cash off the pipelines while you are on the hook for all the debt, and the massive dilution from the billions of new shares issued each year.
This dropdown allows Rich to sell you an asset for 98 cents on the dollar…and yet keep 50% of the cash flow for himself. It’s an incredible deal for him….for KMP…it is borderline criminal. If you really want to know how bad you are getting it…go to scribd.com and search for: kinder morgan summary analysis
KMP owns a local pipeline that was built in the 1940s. It transports gasoline. I would guess its initial cost at somewhere under $2M and the annual capex for maintaining it is over $10M today per KMP. They get a cash flow for transport of some $18M a year on this chunk of pipe.
Bottom line is transport pipe can go on virtually forever if you do enough maintanance. Demand is always there and they would cost big $$ to replace. Certainly gathering and processing systems are different, but there is always going to be a LTerm need to transport commodities from point to point and a line if maintained (and often bebuilt piece by piece) can last indefinately.
All this about sustaining capital. I think one large point has been missed. Because you don't have 2 competing piplines next to each other each one is somewhat monopolistic. KMP I belive has rolled up contracts 3% per year. So a pipeline with 15-20 years of 3% compounding growth sould have maintenance well covered as a % of revenue.
Look…without a doubt…a pipeline can be made to last more than 40 years…. You may have not caught this part in my initial post
“….if you think these already aging pipelines are still going to be around in 25 years…without a significant capital infusion”
The mistake you, and a lot of people seem to be making is mingling the cash flows from future capex with cash flows with the initial investment…and then ignoring the cost of both. Right now…we, or at least I…am only talking about this 6.2B dropdown. I can understand how this might be confusing, but when evaluating capital projects, you must identify and segregate cash flows and assign them properly to the capital expenditures that produced them.
So let’s think about this 6.2 B purchase as a single project….I am exchanging 6.2B in cash today…that is -6.2B…for future cash flows of around $246M a year. Lets say that after 10 years…I start needing to do some more aggressive maintenance to stay ahead of the curve. Pumps need to be replaced, maybe I need to cut out and repair some damaged portions at the rate of $100M per year above the initial run rate. Not to worry…the GP just puts these costs in the “expansion” capital bucket and thoughtfully excludes that from the DCF calculation…thus increasing both his payout, and your payout. Of course…it has to be paid for…so $50M of shares and debt are issued, and voila…DCF is maintained.
However….if you are an honest analyst…you have to recognize that part of your DCF…still 246M now rightfully belongs with your expansion capital project…the 100M….not the original 6.2B of project capital. So while I have managed to keep my pipeline going, and through some creative accounting maintained my DCF…the cash flow attributable to the El Paso dropdown continues to decrease as more and more of that cash flow…even if stable is attributable to additional capital expenditures…each which need to be examined in their own right. It is simply bad analysis to include the benefits of future capital projects…yet ignore those costs…This is the same faulty logic that would have you believe that buying undiscounted cash flow at 25X is not somewhat insane.
The Alaskan pipeline was built in 1977 in some of the most challenging geology, weather and supply line conditions conceivable and is still in production today 35 years later. It has had leaks and maintenance along the way.
For those interested in reading about an actual pipeline, rather than speculation, Wikipedia has an entry that discusses the maintenance issues and methods, as well as remediation concerns and history here:
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.
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.
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:)
Don't blame Rich for everything. Every since GS showed things seem to me to be different. I don't know and it is just my opinion, but. There are examples at people in the know say to look at.
Rich and I go way back...though I doubt he would remember little ol me. Actually I really hope not because he'd probably have me whacked:) This is all on Rich.. it's his baby after all..Goldman is just the money...though they do have little miss Kim keeping an eye on him...
It does appear that the only way to sustain distributions is perpetual acquisition/capex. What I don't understand is why in the latest 13F's Third Point, Paulson and Soros all loaded up on KMP. These people are not run-of-the-mill incompetent analysts. What gives?
Small correction...the PE is actually 248, not 246...itchy math finger.
Just had a chance to do some more Kinder (garten??)-calculus. Using numbers from above….this turd of a dropdown takes 25 years to reach payout (6.22B/246M annual cash to LP)…. In all my years in this industry…I don’t think I have ever seen anyone intentionally pursue a project with a projected payout more than a hair over 11…(long story). Yet here we are….discussing a 6.2B transaction that takes 25 years…just to reach payout.. On the other hand…it’s probably better than REX…which will probably never payout… Here’s a hint….if you think these already aging pipelines are still going to be around in 25 years…without a significant capital infusion (perhaps a few more billion of debt and equity issuances)… then you might just be dumb enough to own this stock. Rich should just start selling KMP $100 bills for $200 bucks a pop and quit this crap about pretending to be a pipeline business...