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Requiem for a Wealth Builder

By Roger Conrad on April 5, 2010

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Whether it’s the stock market, business or the gaming tables, almost anyone can have a lucky streak. Only a handful, however, have the patience, intelligence and serendipity to extend their good fortune to build real wealth. And whether you’re an institutional money manager running billions of dollars or an individual living off their investments, those are the guys worth paying attention to.

Last week, Dan Duncan, one of the great all-time wealth builders passed from our midst. Best known as the founder of Enterprise Products Partners LP (NYSE: EPD), Duncan was born during the Great Depression in rural Texas. Raised by his grandmother who engrained in him his lifelong motto “do the best you can every day,” he spent time as an oilfield roughneck, in the US Army, and as a student at Massey Business College and South Texas College. Then, in 19687, he and his partners started Enterprise with two trucks and $10,000. The rest, as we say, is history.

During Enterprise’s early years, Duncan grew the business largely by leveraging the cash flow from his growing portfolio of pipelines. In 2004, he bought management control of the former TEPPCO Partners LP from Duke Energy (NYSE: DUK), which was then working down a prodigious debt load taken on during the 1990s and was willing to part with the assets for a fair price. Last year, he merged TEPPCO into Enterprise, creating the largest energy infrastructure partnership in America.

Today’s Enterprise owns nearly 49,000 miles of pipelines moving natural gas, natural gas liquids and petrochemicals on and offshore. It also holds some 200 million barrels of liquids storage and 27 billion cubic feet of natural gas storage capacity, as well as a wealth of related assets, including barges. And Enterprise continues to use its unprecedented scale to continue its rapid growth, announcing the purchase of $1.2 billion in natural gas gathering and treating systems in northwest Louisiana and Texas.

By the time he passed at age 77, Duncan’s own fortune–which includes stakes in the LP, the general partner and related MLP Duncan Energy Partners LP (NYSE: DEP)–had grown to more than $9 billion. That made him the richest man in his hometown of Houston. He was a noted hunter and philanthropist, and very much a family man.

It’s a testament to the wealth builder Duncan was that Enterprise units passed an all-time high over $35 per unit on news of the gas gathering acquisition, just days after the announcement of his death. That’s because, like all those who really build, he had put a management team in place that knows its business. That team has been executing his wealth building strategy since Duncan stepped down as chief executive in 1995.

Enterprise will miss Dan Duncan, though his heirs will continue to hold a large chunk of the ownership structure, which together generates an estimated $600 million in annual cash flow. Members of Duncan’s family, including his oldest daughter, have long been involved at the company and are likely to stay closely connected.

When a company’s major shareholder and founder dies his or her heirs often sell large pieces of the empire–to cover estate taxes on the state and federal level, for example. But the new managers will deem the fortune better off diversified. The result is a large chunk of shares come on the market and drive down the share or unit price in the near term, and in the long term wind up putting more of the float in less steady hands.

It doesn’t appear that will be the case with Enterprise. True, it would be hard to find a steadier hand than Duncan’s, who frequently bought more units whenever he felt they were cheap. But management has stated the Duncan family has no plans to unload units. For one thing, there’s plenty of cash to cover any state taxes, and 2010 is an oddity under the Bush tax cuts during which there is no federal estate tax. The family has also apparently decided there’s no need to sell Enterprise units for the sake of diversification, given the huge amounts of cash generated for reinvestment.

The longer-term concern for unitholders is, of course, whether or not Enterprise will lose its moxie without its founder. Here, too, however, the answer appears to be a definite “No.” Rather, the real testament to Duncan’s wealth-building skills was he was able to delegate authority as his empire grew. In fact, Enterprise today has its most formidable arsenal of tools and acumen in its history to carry forward a strategy of buying and building fee-generating assets. That ensures the current string of 22 consecutive quarters of meaningful distribution increases will endure for some time to come.

The new gas assets gather and treat natural gas produced from the Haynesville and Bossier shale plays in addition to the Cotton Valley and Taylor Sands formations. These are some of the most important areas of growth for shale gas in the US, and they’re woefully short on infrastructure at present. Management has already put plans in place to expand their capacity, including a potential tripling of one of the pipeline systems. And they’re on track to start adding to distributable cash flow in the second half of the year.

Like the vast majority of Enterprise’s assets, profits from these new systems are based on fees, not commodity prices. Accumulating high-quality assets of this caliber is what Dan Duncan did well repeatedly during his more than four decades of building wealth at Enterprise. And it’s what the management team he built is set to do in the years ahead, for the great benefit of Enterprise unitholders.

Thank you, Mr. Duncan.

Question of the Week

Every week I address a frequent query from readers. Here’s one I received several times over the past few days. Send your question to utilityandincome@kci-com.com.

  • Telecom New Zealand (NYSE: NZT) is a New York Stock Exchange-listed company that yields more than 10 percent. Is it a good buy?

No. There were many stocks paying secure dividends and yielding more than 10 percent a year ago, and there are still some around now, particularly in Canada. Although this company has been around a while and operates in a high-percentage, secure industry, it’s definitely not one of them.

Telecom New Zealand’s problem can be summed up in a word: regulation. The 20-year price chart of the company that’s available on Yahoo! Finance actually tells the story very clearly. During the 1990s, the company thrived as New Zealand’s government privatized it and then provided a supportive environment for it to connect the country’s far-flung areas with wireless and wireline networks. The company also made a profitable investment in Australia, creating an attractive growth and income stock that ultimately peaked in the low 30s.

Australia was the first trouble spot, as a change in government brought in a more activist communications regulatory regime intent on so-called pro-consumer measures that eventually withered away profitability. By early in the following decade, it was becoming clear that New Zealand was following in that direction and the stock began a long slide toward its current level in the single digits.

The government has already forced the company to “functionally separate” certain parts of its business at great cost to the company, as well as to allow competitors to access its network at what amount to subsidized rates. It’s repeatedly put downward pressure on prices charged by wireless companies by threatening providers with regulated rate cuts. And it’s forced the ouster of executives deemed uncooperative with similar threats.

Last month it made its most aggressive move yet, releasing a plan to extend broadband service faster to rural New Zealand that would essentially require the company to pay for the construction of a rival network. The cost is currently estimated at NZD300 million and it will shave an estimated NZD46 million from Telecom’s annual earnings.

Say what you will about the activist policies of Obama Administration appointees to the US Federal Communications Commission or the often zealous officials at the European Union. But requiring the leading company of any industry to finance competition that will threaten its own cash flow and sales is a whole new ballgame of government intervention–and an entirely new level of threat to investors.

To be sure, Telecom New Zealand has crashed and burned in recent years. Its network is still the most valuable one in New Zealand and represents the country’s best hope for reliable 21st century connectivity. And there’s always the potential for a change in government that brings about more enlightened policies that actually encourage private capital investment.

At this point, however, there’s little sign that anything is going to improve anytime soon. In the meantime, earnings and dividends have been in a steady decline. The credit rating remains high at A (stable) from Standard & Poor’s and A3 (stable) from Moody’s. But it has also steadily moved lower in recent years and almost surely will be cut again the next time the government makes an aggressive move.

History shows that when government intervenes in an industry to help consumers, it often wind up doing precisely the opposite by discouraging investment. That’s been the case in New Zealand for some time now, as the company has been forced to curtail capital spending by lower profits and skeptical investors abroad.

The 10 percent dividend may indeed hold. But it’s already been cut several times over the past several years (the three-year annual growth rate is negative 19.8 percent). And as long as this regulatory environment persists, it will remain under pressure.

That’s a stark contrast to the environment for rural telecoms in the US such as Windstream Corp (NYSE: WIN). The company has a lower credit rating than Telecom New Zealand but covers its more than 9 percent distribution by nearly a 2-to-1 margin with free cash flow–that’s cash flow less capital spending on its network. US rural telecoms are also in line to grab a share of stimulus funds to speed what they’re doing anyway without government help: connecting far-flung US rural areas via broadband. In fact, Windstream has already put in for $238 million in such funds.

The broader lesson here is that not all high yields are created equal. If you’re going to shop for big numbers, you’d better be able to tell the Windstreams from the Telecom New Zealands.

You Cruise, You Win

Roger Conrad and his KCI Investing colleagues have been combing the globe for their next luxury investment cruise: Any ports of call must be ripe with investment potential, of course, but they must provide a rich slice of the world’s treasures and unique insights into human luxury. And after the brutal year we just finished, who couldn’t use some luxuriant down time learning how to prepare their portfolios for what this next decade has in store.

Save the dates: Thursday, October 21, through Monday, November 1, 2010. Explore the wonders of Turkey and the Greek Isles while learning about the newest investment strategies from Roger, Elliott Gue, Yiannis Mostrous and GS Early.

While you enjoy unfettered access to the finest minds in investing today, Seabourn Cruises will upgrade the way you think about luxury cruising as you are feted aboard the brand new Seabourn Odyssey. From its all-included open bar of premium liquor, wine and beer to its almost better than 1-to1 staff-to-passenger ratio, to its maximum capacity of only 450 passengers, you will understand why it immediately jumped to the top of the luxury cruise line ratings charts when it hit the water in 2009.

For those of you lucky enough to have sailed with this keen crew in the past, you know you are in for a meticulously planned journey into the business, investment and cultural offerings of the region. KCI in partnership with Joseph H. Conlin Travel Management is offering this journey solely to KCI subscribers and their friends.

For more information and reservations, please click here.

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