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KN Energy Board Hands Reins to Kinder Morgan

KN Energy Board Hands Reins to Kinder Morgan

Recent basement-dweller KN Energy electrified the energy industry Friday, announcing what one analyst called the deal of the decade - a marriage with the brains and bucks of Houston's Kinder Morgan Inc. KN's Chairman Larry Hall immediately resigned, Kinder Morgan Chairman Richard D. Kinder, credited with helping build Enron's underpinnings, was named heir apparent, and KN's stock price soared nearly 55% in one day.

Kinder told a teleconference he plans to "get the car out of the ditch and get it going down the highway." One industry veteran was excited to hear "Kinder's rejoining the industry," after leaving Enron in 1996 when Chairman Ken Lay announced he would lead the company for another five years.

It was less than three weeks since KN's proposed $6 billion merger with Sempra Energy fell apart. The new alliance will create a massive midstream energy company with 30,000 miles of gas, petroleum products and liquids pipelines, and an enterprise value of $8.5 billion.

According to the agreement, KN Energy would issue 41.5 million shares of KNE stock in return for all of the outstanding shares of Kinder Morgan, Inc. (ENP). Considering share prices at the time of the announcement Thursday, the deal would be valued at $654 million, including $140 million in debt.

Kinder had been a board member of KN until just a few weeks ago. Upon closing he will be named chairman and CEO of the combined entity, which will be known as Kinder Morgan Inc. Stewart Bliss, an independent member of the KN Energy board, has assumed the chairman and CEO positions on an interim basis. A KN spokesman said the transaction and subsequent executive changes were KN "board decisions."

"Larry was instrumental in growing the company's assets from $300 million to $8 billion in the '90s," said Bliss. "He built a strong asset base, and we are confident that Rich Kinder has the industry expertise, vision and leadership to take the combined entity to the next level and position the company among the leaders in the energy industry." Kinder has 20 years experience in the industry, 16 of which were spent at Enron and six of which were spent as Enron's president and COO.

Something drastic was needed at KN after two warm winters, continued struggling with integration of the MidCon's assets purchased in December 1997, significant underutilization of Natural Gas Pipeline Co.'s capacity and the failure of the Sempra merger.

Bliss said the deal will be immediately accretive to earnings. "[It] deleverages our balance sheet by reducing our debt to total capitalization ratio from 72% to approximately 65%, enhances the quality and stability of future earnings, improves cash flow to fund future growth, strengthens our already strong midstream asset base, and provides outstanding leadership from Rich Kinder, an industry veteran with a proven track record." KN and Kinder Morgan expect to close the transaction early in the fourth quarter. The closing is subject to regulatory and shareholder approvals.

The marriage stunned analysts. "I'll be honest with you. I really didn't anticipate this one," said Dain Rauscher Wessels' analyst Mark Easterbrook. "I thought it would be a long recovery for KN, at least 12 months. This is a win-win situation for both Kinder Morgan unit holders and KN shareholders. It will bring KN shareholders back from the doldrums. These guys have been slaughtered in the last 12-18 months and now things are starting to look up. They are bringing in one of the premiere pipeline operators in Rich Kinder to run these pipelines that have not done well."

Merrill Lynch's Donato Eassey was awestruck following the announcement. "This is an absolute home run. If it's not the transaction of the 1990 decade, I don't know what will be," he said.

"Any time you get a situation where a stock is beat up and so out of favor as this one [KNE] was, smart people are going to figure out where the value is. Certainly one of the best in the industry figured it out in a hurry and took full advantage of it. It truly is a transaction that stands out. It's very unique. It is not complex. It borders on genius," said Eassey.

"Richard Kinder and Bill Morgan, these are smart guys and they know those assets well. Kinder used to run some of those assets when he was at Enron. In my view Kinder had a great deal to do with building an extremely solid foundation at Enron, and he'll take that same expertise with these assets and build them very nicely," he added. "They are getting [KN] at the very bottom potentially."

During a conference call, Kinder said he resigned as a KN board member after the Sempra deal collapsed "because I thought there was some possibility of putting together a transaction. We started meeting and with the help of the leadership of KN we were able to put together this arrangement. I think one of the real positive things that I have believed all along is that people ought to put their money where their mouth[s are], and when this combination is completed Bill Morgan and I will own about 30% of the stock of the combined company. I personally will own a little over 22% of the company so you better believe I am going to be focused like a laser on shareholder value."

KN has a long way to go however. Back-to-back warmer than normal winters took a big bite out of KN earnings and coupled with the cancellation of the Sempra merger have crippled KN share prices. Hall announced last month the company expected to experience a loss of $0.20-$0.25 per share in the second quarter of 1999 and likely would break even or post a modest gain of $0.10 per share for the year. That compared with analyst's forecasts of $1.07/share. KNE shares have plummeted from a 52-week high of near $40/share to $12.19/share July 5. On Friday they rocketed to nearly $19/share.

"Kinder won't take [warm winters] as an excuse for no earnings," said Eassey. He has had a very successful track record since taking over Enron Liquids Pipeline (renamed Kinder Morgan Energy Partners LP) in February 1997. The company has provided a 209% total return to shareholders since that time. It had $17.7 million in net income in 1997 and expects $170 million in net income this year.

Taking Advantage of the MLP

Kinder Morgan Energy Partners LP is the nation's largest pipeline master limited partnership. The MLP is considered by many investment bankers and major pipeline companies to be a smart method of growing a pipeline business because it avoids a significant tax burden and more of the cash generated falls to the public unit holders. Several other major energy companies are taking advantage of those benefits, including Enron with Northern Border, Duke Energy with Teppco and El Paso with Leviathan. Kinder was ecstatic about the prospect of putting an MLP pipeline and a traditional pipeline corporation under one roof.

"This is a unique combination. You are putting a major MLP together with a major midstream regular corporation because you are able to take assets [some of KN's assets] and put them down tax free at fair market value into that MLP. That MLP is a very advantageous owner of the assets because it does not pay tax," said Kinder. "We think there are going to be significant assets in the KN family that will qualify for and fit the MLP. We can't identify those yet. But when we do that, we'll get the same price as if it were sold to a third party but because we own the general partner, we'll get the general partner's share of that MLP revenue, which in the case of Kinder Morgan is about 30%.. And you are still controlling the asset. It's a wonderful combination that I think is going to work very well for the combined company."

The companies announced that management intends to focus on expanding KN's asset base, selling non-strategic assets to reduce KN's level of outstanding debt and making strategic acquisitions, both on its own and in conjunction with Kinder Morgan Energy Partners. In addition, the combined company will contribute assets to Kinder Morgan Energy Partners in exchange for cash and/or publicly traded limited partnership units. Any transfers of assets will be made for fair value and only on an accretive basis, the companies said. The combined company will continue to share in the earnings of these assets through its limited and general partner interest in Kinder Morgan Energy Partners.

Kinder Morgan Energy Partners LP has an enterprise value of $2.5 billion. It owns and operates one of the largest product pipeline systems in the U.S., serving customers in 16 states with more than 5,000 miles of pipeline and over 20 associated terminals. It also operates 24 bulk terminal facilities which transload over 40 million tons of coal, petroleum coke and other products annually. In addition, Kinder Morgan owns 51% of Plantation Pipe Line, 20% of Shell CO2 Co. Ltd. and a 25% interest in an NGL fractionator.

KN, based in Lakewood, CO, is the nation's sixth largest integrated gas company with more than $8 billion in total assets and is one of the largest pipeline operators with more than 25,000 miles of pipe. It has operations in 16 states.

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