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Author: obreck3 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 177  
Subject: Kinder Morgan's I shares- Reason to worry? Date: 9/3/2002 4:22 PM
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Here is a tidbit about Kinder's shares from a friend. Are I shares a reason not to invest?

OK, you're right that Richard Kinder is smart and that the MLP idea is good. Here is the problem with Kinder Morgan (KMP) and El Paso (EPN) and soon, Enbridge. They have issued I-Shares. These I-Shares are held in a Trust and are more or less equal to the existing partnership shares except that they pay their dividends only in stock, (more I-Shares, that is), and not in cash. The reason for the issuance of I Shares is that cash dividends on "normal" MLP partnership shares are subject to a nasty tax called UBTI (unrelated business taxable income), if they are held in a Tax-free account like a pension fund, retirement plan, or IRA. So these institutions don't want to own or buy KMP partnership shares or any other MLP shares.
Now, KMP like any MLP has to raise money to do more deals and it wants to access the institutional market, where all the money is,
rather than go to picky people like me, so some smart banker at Goldman, (God, the damage these guys can do), thought up the idea of selling I-Shares, which pay stock dividends and are therefore not subject to UBTI taxation. If the institution wants to get an annual return, (to cash in its 8%), it just sells the I-Shares. Actually, KMP had an earlier issue of I-Shares, of which it just revised the terms, which worked OK. See below.
These I-Shares pay what amounts to a stock dividend based on a
percentage of the cash dividend of the enterprise as a whole. If KMP
has $100 million of cash to pay out, the I-Shares and the ordinary common shares get "equal" treatment. The "Normal" partnership shares get a cash dividend proportionate to the amount they own of the enterprise. (Currently the Kinder Morgan I-Shares (KMR) own 25% of the equity and KMP holders are people like me and we own 75%). The I Share gets a dividend of more I-Shares calculated as their percentage of the cash divided by the average price of I-Shares for a period of days prior to issuance, on a formula, in effect.
Since the I-Shares own 25% of the equity, that same percentage of cash is not paid out and is held back by the partnership to do more deals. It's a neat form of continual equity issuance to support KMP's growth.
It is also a time-bomb, I fear. Why? There is no way for the I-Share holder to ever get cash without selling his dividend. If the I-Share stock price (KMR) falls, he will, it is true, get more I-Shares as a dividend, but as he sells that dividend (those shares) the price can drop further, and KMR can go into a death spiral. No way out. Every quarter more I-Shares will have to be issued and sold, etc. Where this can end I don't want to know.
This can end up with the I-Shares owning most of the equity of the enterprise as more shares are issued and sold. This is not good for the "conventional" KMP shareholder.
There used to be a conversion privilege on the old KMP I-Shares
whereby a KMR I-Share holder could switch at any time, if he wanted,
into KMP. That has been removed. There is now no option to get cash except to sell I-Shares. And as I have said, what happens in the event the KMR shares fall sharply? And don't tell me they can't. I have seen too many smart deals come off the rails. There is no "there" there with these I-Shares, no hard cash, no hard anything.
I talked to Goldman's analyst who said "Not to worry, if that
happens they'll fix it". Really? Well, Goldman managed the IPO so what
do you expect. I talked to the company itself, Kinder Morgan, whose PR
personsaid "Oh, you're talking about Armageddon". At Paine Webber the MLP analystsaid I was right but that it was all very unlikely. But I have a creepy feeling this could all unwind and create a horrible mess. There is nothing wrong with the company itself, it is well run and the asset side of the balance sheet is great. But this capitalization worries me. And eventually the I-Shares, which will grow at 7.5-8% a year, will increase their percentage ownership and swallow up the whole capitalization. What happens then? No cash to pay out. Of course, Kinder Morgan doesn't care, because it's 1%/50% comes off the top. Talk about conflict of interest ...
I don't want to own any MLP with an I-Share outstanding that does not have either a direct conversion privilege or at the least an option to get cash instead of more I-Shares as a dividend. So I am now buying NBP,PAA, WEG, VLI, KPP, PXX, TPP, SGU, SXL etc. Combined they yield over 8%,more than KMP, and I don't worry. I just hope they don't all issue dangerous I-Shares.
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