The price of Kinder Morgan and Terasen shares soared on Tuesday following the announcement late Monday that Kinder Morgan Inc. (KMI) would buy the British Columbia gas utility and pipeline company for $3.1 billion in cash with $2.5 billion in assumed debt.
Kinder Morgan shares spiked from about $88/share the previous week to a high of $98.45 on Aug. 2 before calming down to just above $93/share on Friday. Meanwhile in a matter of a few days Terasen shares soared to more than C$36 from C$29.50 and ended the week at $35.90.
KMI plans to buy Terasen for about C$35.91/share, a 20% premium to a 20-day average of Terasen share prices as of Friday July 29, and a price Terasen CEO John Reid said he simply couldn't refuse.
Despite the potential growth ahead of Terasen even on a stand-alone basis, Reid said the premium price and top-notch operation at KMI were too attractive to pass up. "Ultimately it comes down to a value proposition and we felt this was a very attractive price," he said.
The move also was lauded by analysts. "We expect Kinder to apply its cost-conscious approach and top-notch management skills to the Terasen assets and believe cost and operational synergies will be meaningful," said Anatol Feygin of Banc of America Securities. "Kinder also brings a strong balance sheet and technical expertise rivaled by few in the industry in our view."
It came with an optimistic forecast from both Kinder Morgan and Terasen. CEO Richard Kinder said during a webcast that it is "rare to find these three things in one transaction: it is immediately accretive on an earnings per share and cash flow basis; we think the assets are such that they have low downside risk; and we think we have great upside potential."
Kinder Morgan came to Terasen with its eyes set on the tremendous oilsands production growth upstream of Terasen's petroleum pipeline business, Kinder said, but it also came away with an attractive and stable gas utility operation in British Columbia. Terasen's pipeline segment, which includes 2,800 miles of pipelines that carry 680,000 bbl/d of petroleum and products, currently represents about 35% of its earnings. The company's regulated natural gas distribution business, which serves 850,000 customers in the province, represents the lion's share of the balance, earning an allowed rate of return of 9%. Terasen also has a water utility and water treatment services business.
The combined entity will have 9,000 employees. It will have 13,000 miles of refined product and oil pipeline, and gas utility operations that serve a total of 1.1 million customers in British Columbia, Nebraska, Colorado and Wyoming. Kinder Morgan will remain the second largest owner of gas pipelines and storage assets in the United States, transporting 14.2 Bcf/d of gas through 25,000 miles of pipe and holding 384 Bcf of working gas storage capacity. And it also will remain the largest terminal operator in the United States, handling more than 80 million tons of coal and other dry bulk materials and having liquids storage capacity of 72 million bbl.
Kinder Morgan said the deal should be 6-8% accretive for KMI shareholders on a pro forma basis to recurring earnings per share in 2006, which is expected to be the first year of combined operations. For 2006, recurring earnings per share are expected to be US$5, and cash flow is expected to be almost US$800 million. Kinder Morgan said it expects an annual dividend of US$3.50 per share in 2006, up from its current rate of US$3/share.
In light of the expected prospects for the combined company Kinder Morgan expects to continue to grow earnings per share and the dividend at 10% annually without any acquisitions at KMI or KMP.
Richard Kinder cited the awesome potential for expanding Terasen's petroleum transportation. He said the growth of oil production from the Alberta producing region over the next five to seven years is expected to be equivalent to the current crude oil production out of the Permian Basin (one million barrels), the largest onshore producing basin in the United States. Terasen already has identified $2.5 billion in expansion projects, he said.
Oilsands production will continue to flow as long as West Texas Intermediate crude oil prices stay above about $25-$30/bbl, Kinder said. Canadian oilsands producers fetch about a 30% discount to WTI futures. However, there is no sign that crude oil won't remain nearly double that price.
Canadian oilsands producers already are expecting to invest about $50 billion in the next five years, doubling production there to about two million barrels per day.
Kinder said that today Kinder Morgan Inc. is thought of as sort of a two-legged stool in which Kinder Morgan Energy Partners (KMP) produces about 50% of its earnings before interest, taxes, depreciation and amortization (EBITDA) while Natural Gas Pipeline Company of America produces about 41%.
"Post this transaction...we would see reincarnated KMI as a four-legged stool: KMP's share of EBITDA will decrease to about 36% but still be the largest single segment; NGPL will be about 30%; retail gas distribution in the U.S. and Canada will be about 23% and the petroleum pipelines coming out of Alberta will be about 8%; with other assets being about 3%. And we would see that petroleum pipeline growing as we make substantial expansions of those pipelines coming out of the oilsands play." He said total EBITDA would grow by $0.5 billion after the transaction.
Citigroup analyst John Tysseland said that even though Kinder Morgan seemed to have paid a full price for Terasen, the deal was a strong addition to its fee-based cash flows. "We believe the transaction provides better asset diversification since Kinder Morgan will have a larger collection of midstream energy assets and a broader geographic footprint," Tysseland said.
However, Standard & Poor's Ratings Services placed the ratings of KMI and its master limited partnership, KMP, on CreditWatch with negative implications. "The negative CreditWatch for KMI is prompted by plans to noticeably increase the company's financial leverage to fund the purchase," said S&P. "KMP, which has carried a negative outlook since February of this year, joins its general partner on CreditWatch since it has legal, strategic, and business ties to KMI." KMI and KMP have about $3 billion and $5.2 billion of debt, respectively and KMI's debt to capital ratio following the transaction is expected to be 56%. KMI intends to finance the transaction predominantly with additional KMI debt and the assumption of Terasen's more than $2 billion of debt.
"For KMI, we will consider the effect of greater leverage and whether it will outweigh the benefits to its business risk from adding a low-risk, regulated gas distribution utility and a stable, but growing, petroleum pipeline business to its portfolio of businesses," said credit analyst Todd Shipman. "KMP is not directly involved with the Terasen purchase, but its ratings are currently constrained by KMI's credit quality and could be affected by any rating action on KMI."
Moody's Investors Service affirmed the ratings of KMI debt and supported obligations with a stable outlook. However, Moody's also placed under review for possible downgrade the debt ratings of Terasen Inc. and its LDC subsidiary Terasen Gas Inc. The project finance ratings of its subsidiary Terasen Pipelines (Corridor) Inc. and its equity investments Express Pipeline Limited Partnership and Express Pipeline LLC are affirmed with stable outlooks.
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