Kinder Morgan to purchase El Paso for approximately $38B to form largest natural gas pipeline network and largest midstream energy enterprise in North America
Kinder Morgan, Inc. (KMI) and El Paso Corporation on Sunday announced a definitive agreement whereby KMI will acquire all of the outstanding shares of EP in a transaction that will create the largest midstream and the fourth-largest energy company in North America with an enterprise value of approximately $94 billion and 80,000 miles of pipelines. The total purchase price, including the assumption of debt outstanding at El Paso Corporation and including the debt outstanding at El Paso Pipeline Partners, L.P. is approximately $38 billion.
The combined company will be the largest owner and operator of natural gas pipelines and storage assets in North America with approximately 67,000 miles of natural gas transportation pipelines. Pipelines are connected to many important natural gas shale plays including Eagle Ford, Marcellus, Utica, Haynesville, Fayetteville and Barnett. Other attributes of the combined company are:
Largest provider of contracted natural gas treating services and significant other midstream gathering assets.
Largest independent transporter of petroleum products in the United States, transporting approximately 1.9 million barrels per day of gasoline, jet fuel, diesel, natural gas liquids and crude oil through more than 8,000 miles of pipelines.
Largest transporter of CO2 in the United States, transporting 1.3 billion cubic feet per day. Carbon dioxide is used in enhanced oil recovery projects.
Second largest oil producer in Texas, producing more than 50,000 barrels per day.
Largest independent terminal owner/operator in the United States. Liquids terminals have capacity of 107 million barrels and store refined petroleum products, ethanol and more. Dry bulk terminals are expected to handle over 100 million tons of materials in 2011, including products like coal.
Only oilsands pipeline serving the West Coast. The Trans Mountain pipeline system transports 300,000 barrels of crude oil per day to Vancouver, B.C., and Washington state.
This once in a lifetime transaction is a win-win opportunity for both companies. The El Paso assets are primarily regulated interstate natural gas pipelines that produce substantial, stable cash flow and have access to key supply regions and major consuming markets. The natural gas pipeline systems of the two companies are very complementary, as they primarily serve different supply sources and markets in the United States. The transaction is expected to produce immediate shareholder value (upon closing) through strong cash flow accretion and offers significant future growth opportunities.
We believe that natural gas is going to play an increasingly integral role in North America. With the recent development of shale resources, there are now abundant domestic supplies of natural gas, which are being used increasingly to generate electricity and are environmentally friendly. If America is serious about reducing carbon emissions to benefit the environment, and reducing its dependence on foreign oil, natural gas is absolutely the best readily available option. We are delighted to be able to significantly expand our natural gas transportation footprint at a time when it seems likely that domestic natural gas supply and demand will grow at attractive rates for years to come.—Kinder Morgan Chairman and CEO Richard D. Kinder
The consideration to be received by the EP shareholders is valued at $26.87 per EP share based on KMI’s closing price as of 14 Oct. 2011, representing a 47% premium to the 20-day average closing price of EP common shares and a 37% premium over the closing price of EP common shares on 14 Oct. 2011. The offer consists of $14.65 per share in cash, 0.4187 KMI shares (valued at $11.26 per EP share) and 0.640 KMI warrants (valued at $0.96 per EP share) based on KMI’s closing price on 14 Oct. 2011.
The warrants will have an exercise price of $40 and a five-year term. EP shareholders will be able to elect, for each EP share held, either (i) $25.91 in cash, (ii) 0.9635 shares of KMI common stock, or (iii) $14.65 in cash plus 0.4187 shares of KMI common stock. All elections will be subject to proration and in all cases EP shareholders will receive 0.640 KMI warrants per share of EP common stock. The receipt of shares and warrants by EP shareholders in the transaction is intended to be tax free for US federal income tax purposes. Upon closing, KMI shareholders are expected to own approximately 68% of the combined company and EP shareholders are expected to own the remaining 32%.
The transaction has been approved by each company’s board of directors. KMI has a commitment letter from Barclays Capital underwriting the full amount of cash required for the transaction. Prior to closing, the transaction will require approval of both KMI and EP shareholders. The transaction is expected to close in the second quarter of 2012 and is subject to customary regulatory approvals.
The transaction is expected to be immediately accretive to dividends per share at KMI, distributions per unit at KMP, dividends per share at Kinder Morgan Management and distributions per unit at EPB. Part of these benefits will be driven by cost savings, which are expected to be approximately $350 million per year, or about 5% of the combined system’s EBITDA. Following is a summary of the plans and benefits for each entity:
KMI. Following the closing of the transaction, EP will become a subsidiary of KMI. KMI intends to sell the exploration and production assets of EP. EP’s net operating loss carry forwards will offset taxes associated with this sale and the resulting cash raised will substantially reduce the debt borrowed to fund the cash portion of the transaction. KMI also intends to sell (drop down) all of EP’s natural gas pipeline assets to KMP and EPB over the next few years. Each of these transactions will be subject to approval by KMP’s or EPB’s independent directors, who are expected to obtain independent advisors to assist them in their analysis.
By the end of 2015, KMI expects its assets to consist almost exclusively of its general partner interests in KMP and EPB, and the ownership of KMP units, KMR shares and EPB units. At that point, well over 80% of KMI’s cash flow is expected to come from the general partner interests and essentially all of the remainder from its limited partner interests. KMI expects to continue to determine dividend payouts based upon this ultimate set of assets and cash flows. In the interim, KMI will be generating more cash flow than necessary to support the expected dividend stream and will use the excess to pay down debt. Incorporating this approach to determining dividends, the transaction is expected to be immediately accretive to KMI’s dividend per share.
While KMI will be assuming a significant amount of incremental debt as a result of the transaction, the sale of EP’s exploration and production business, dropdown transactions to KMP and EPB, and excess cash flows should allow for a rapid reduction in debt levels. KMI expects its ratio of debt to distributions received will be lower than its current level of about 2.5 times by the end of 2013 and that the ratio of consolidated net debt for the entire enterprise (including debt at KMP and EPB) to consolidated EBITDA will return to a little over 4 times by the end of 2014.
KMP and KMR. KMP is expected to purchase a significant portion of EP’s natural gas pipeline assets over the next few years at attractive prices. These assets will enhance KMP’s already very stable cash flow stream and will provide significant additional growth opportunities. For 2012, the KMP distribution per unit and KMR dividend per share are expected to be a little less than $5.00, up from a budgeted $4.60 for 2011. Over the next several years, the average annual growth rate in KMP distributions per unit and KMR dividends per share is expected to be around 7%, higher than the prior estimate of 5% annually, with the increase being driven by the expected dropdowns resulting from this transaction.
KMP expects to fund the asset acquisitions with a combination of equity and debt, consistent with its past practices. The equity will be in the form of both KMP unit and KMR share issuances, with KMI taking a small portion of the issuances. KMP expects it will reduce its debt to EBITDA ratio consistently over this time period down to around 3.3 times, which will continue to represent a very strong balance sheet, especially considering the strength of its assets and the stability of its cash flows.
By virtue of the issuance of KMR shares to fund a portion of the dropdown transactions and the continuation of the payment of KMR dividends in shares, quarterly automatic issuance of KMR shares is expected to increase significantly over this time period. As a reminder, KMP must generate distributable cash flow to support the KMR dividends, but then retains that cash as the dividends are paid in shares. This significant increase in total KMR dividends will have some very positive impacts on KMP and KMR. First, KMP may be able to completely fund the equity portion of its annual investment programs (expansion capital and acquisitions) through the KMR dividends, eliminating the need to raise equity in the capital markets, except in the case of large investments. Second, to the extent the KMR dividends are greater than the required equity to fund the investment program, KMP could use the excess cash flow to repurchase KMR shares on the open market. Thus, KMP would be unique among MLP’s for its ability to fund itself, and KMR would have a natural, consistent source of demand for its shares.
EPB. EPB is also expected to purchase EP pipeline assets from KMI over the next few years at attractive prices. EPB’s asset base will continue to consist completely of stable, high quality interstate natural gas pipelines.
Kinder expects EPB to be able to grow its distributions per unit at an average annual growth rate of about 9% through 2015 as a result of the transaction, and expects EPB’s debt to EBITDA ratio to remain around 4 times, which he characterized as appropriate for the strength of the assets that it owns and is expected to acquire.
Once the transaction is completed, Kinder will remain chairman and CEO of the combined entity. The parent company will be named Kinder Morgan, Inc. and its corporate headquarters will remain in Houston, Texas. Two members of EP’s board of directors will join the KMI board of directors. The transaction will require the approval of both KMI and EP shareholders who will vote at special meetings expected to be held by January 2012. Both the boards of directors of KMI and EP are recommending that shareholders vote in favor of the transaction. EP has agreed not to solicit competing transactions and to pay a termination fee of $650 million to KMI under certain circumstances.
Evercore Partners and Barclays Capital acted as financial advisors and provided fairness opinions to KMI and Weil Gotshal & Manges LLP and Bracewell & Giuliani, LLP acted as legal counsel to KMI. Morgan Stanley acted as financial advisor and provided a fairness opinion to EP in connection with the KMI transaction, Goldman Sachs also acted as financial advisor to EP in connection with its previously announced spin-off transaction and related matters in connection with the KMI transaction, and Wachtell, Lipton, Rosen & Katz acted as legal counsel to EP.