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Hedgeye Tilts at Kinder Morgan

By igreenwald on September 5, 2013

Sometime on Tuesday, a 26-year-old man with a fancy title and very limited work experience is going to elaborate claims he made yesterday that the largest US midstream MLP, founded by an industry legend, is “a house of cards.”

But in the meantime, investors rushing for the exits Wednesday on his fact-free say-so dropped roughly $4 billion at the turnstiles.

This is modern “investing” at its most pathetic and absurd, in which unsophisticated income seekers interested only in yield flee for the presumed safety of cash at the first hint of trouble. This has made hinting at trouble profitable in the extreme. There are now opportunities aplenty to pick up other people’s loose change, provided you’re not the type to drop yours because someone tweeted something.

The company in question is Kinder Morgan (KMI) and its affiliated master limited partnerships, Kinder Morgan Energy Partners LP (NYSE: KMP), Kinder Morgan Management LLC (NYSE: KMR) and El Paso Pipeline Partners LP (NYSE: EPB). Together they control 80,000 miles of pipelines and have an enterprise value exceeding $100 billion.

CEO Richard Kinder is a master strategist who’s parlayed a $40 million investment in an Enron castoff into a continent-spanning energy conglomerate. For this skill and foresight, Kinder commands the lordly compensation package, inclusive of salary, bonus, stock and option grants, of $1, opting to base his wealth instead on a large equity stake he never sold.

Kinder Morgan eschews corporate aircraft, sponsorships, luxury boxes and other boardroom perks. The flagship partnership, KMP, has delivered an average annual return of 24 percent to shareholders since 1997. It can only be described with reference to cards as a full house, kings over aces.

None of which has made much of an impression on one Kevin Kaiser, senior energy analyst at Hedgeye Risk Management. Kaiser is on record that MLPs are a bubble on par with housing during the prior decade, and this for him is not a theory but dogma.

He would be just another click-bait headline on a blogging network were it not for the fact that he happens to be the guy who attacked Linn Energy (NYSE: LINE) earlier this year, first anonymously via Barron’s and then directly, before it suffered the indignity of two lousy quarterly reports and a Securities and Exchange Commission inquiry into its accounting and pending merger.

And because we’re all about very recent results, Kaiser’s an authority on MLPs, which he undoubtedly studied while playing for the Princeton Tigers hockey team four years ago. Leon Cooperman, who was making major money for his investors before Kaiser was born, has more than $200 million invested in Linn. Kinder owns a $8.1 billion slug of KMI, including the $17.9 million he spent to buy his company’s shares less than three months ago. But Kaiser, having already explained to his own satisfaction where Cooperman’s gone wrong, will soon clarify exactly how Kinder’s been misleading us.

I’m not a fan of appeals to authority. Old guys can be wrong (or merely self-interested) and inexperienced newcomers brilliant. Kaiser had some smart insights into Linn, and I’d much rather be discussing the specifics of his complaints about Kinder Morgan than comparing track records. But the track records are all we have today, because unlike serious firms that let their research speak for itself, Hedgeye and Kaiser chose to promote their conclusion six days before bothering with any facts. There is no logical explanation for this course other than a preference for publicity over credibility and the intent to scare rather than inform.

Hedgeye is the latest in a parade of short promoters with catchy names like Muddy Waters and Citron.  Muddy Waters even took down the sizeable Chinese fraud Sino-Forest, embarrassing famous hedge fund billionaire John Paulson in the process. All Hedgeye has at the moment is its run at Linn, along with its founder’s checkered rep. Check out Keith McCullough’s recent value added here or just mark the number of finance pros who’ve blocked him on Twitter.

Kaiser’s actually tipped his brushback of Kinder Morgan on his Twitter feed, apparently taking aim at the conglomerate’s maintenance spending allocation, acquisition-driven strategy, commodity hedging and one-time charges. In other words, it’s looking like a grab bag of quibbles not unlike the one thrown at Linn.

It’s impossible to address these without seeing the specifics, and Deutsche Bank’s attempt to do so Wednesday in defense of Kinder Morgan only confirmed that it’s hard to refute a case that hasn’t been made.

What’s not hard to see is that KMI, KMP, KMR and EPB are paying out $4.5 billion this year in dividends and distributions comfortably covered by the steadily growing cash from operations, mostly from long-term, fixed-fee transportation contracts. Like almost every MLP, Kinder Morgan has borrowed to expand via acquisitions and organic projects. But KMP’s 24 percent return on equity and 13.6 percent return on investment suggest the borrowed money has been well spent. So do the spectacular total investor returns the partnership has produced over the last 17 years.

Nothing Kaiser presents next week will change the fact that surging volumes of crude, natural gas and natural gas liquids will need transporting from newly developed basins to distant processing plants for the next decade or longer. Nothing he says can change the fact that crude is already costly and natural gas likely to grow more so in the years ahead as more of it is exported, making energy transport that much more lucrative. And nothing he claims can change the cost of capital advantage enjoyed by MLPs, because investors value the exemption from corporate income tax and the chance to delay their own tax payments while building capital.

The real question here is how best to take advantage of this opportunity, and the easy answer is to buy early and often shares of general partner KMI, which got slammed disproportionately and where Kinder has concentrated most of his investment in the conglomerate. KMI is likely to see lots of insider buying in the days ahead. There is no need to wait for next week’s presentation, because any credibility contest between Richard Kinder and Kevin Kaiser is unlikely to last long.

The riskier but potentially more immediately rewarding tack is to consider what a loss of Hedgeye’s credibility in a frontal assault on Kinder Morgan might do for Linn and its depressed unit price.

Just because Linn has had two lousy quarters and some nitpicking from the SEC doesn’t mean it will never prosper again. At this point, the unit price and the 13 percent distribution yield seem to be discounting endless disappointment and the collapse of Linn’s deal to acquire Berry Petroleum (NYSE: BRY).

Yet even if the merger does fall through, Linn could gradually increase its distributable cash flow over the next year or so to catch up to its distribution. And if the SEC were to conclude its investigation without serious penalties, as it might in the next month or two, Linn’s unit price would likely jump back over $30.

Linn remains too risky and volatile a play to be included again in our portfolios. But for speculators with a big risk appetite, it may be time to look at it again now that its most visible detractor has risked his credibility on a much harder target.

But the safer course is just to go buy KMI, which is entitled to ever more lucrative incentive distribution rights from KMP and EPB. That’s what the billionaire founder will be doing soon, now that a 26-year-old critic has tweeted out his issues with MLPs.

We continue to recommend KMI below $42 and KMP below $86. There is now no better buy than KMI in the MLP Profits portfolios.

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