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Insull to Kinder to Chance

By Igor Greenwald on December 15, 2015

If we pull on the somewhat tangled string of causes and effects leading up to Kinder Morgan’s (NYSE: KMI) dividend cut, we get in short order to the credit rating downgrade warning by Moody’s just six days earlier, which put Kinder on notice that it couldn’t take on much additional debt without losing its barely investment-grade rating.

Kinder’s stock promptly went into a tailspin that made equity issuance prohibitively costly, leaving the dividend as the most practical alternative source of funding for growth projects the company considers essential.

The negative outlook from Moody’s, in turn, was prompted by Kinder’s assumption of an increased stake in the National Gas Pipeline Company of America (NGPL). Which is more than a little poetic because NGPL connects not only the natural gas fields along the Gulf coast to gas consumers in and around Chicago but also links the recently humbled Kinder founder Rich Kinder to the godfather of energy infrastructure, Samuel Insull.

Their stories share certain similarities that seem instructive and very relevant to the current midstream energy environment.

Insull came to the U.S. from England in 1881 to serve as private secretary to Thomas Edison, whom he idolized. Five years later he was placed in charge of an Edison machine works plant, and six years later, after a spell as a General Electric executive, he took over an ailing Chicago power plant serving 5,000 customers.

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Samuel Insull on the cover of Time, 1926

Innovations like off-peak rates, steam turbines and electrical appliance giveaways helped Insull turn that modest foothold into a regional giant of a utility with 500,000 customers by 1920. He consolidated numerous competitors to build his empire.

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GE steam turbines at Insull’s Fisk Street Chicago plant, 1907

Insull’s embrace of innovation extended to financial engineering. He became a pioneer propagator of holding companies, essentially fundraising vehicles on behalf of far flung operating affiliates that often managed these affiliates’ purchasing and engineering in exchange for a healthy chunk of their profits. It was the “incentive distribution rights” scheme of its day.

“Earnings of his companies kept increasing throughout the 1920s, and dividends to his stockholders fueled the hysteria as stock prices rose dramatically. The stock-market boom of the 1920s was tailor-made for Insull, as he issued more and more shares in his many companies.”

— From “Panic in the Loop: Chicago’s Banking Crisis of 1932,” Raymond B. Vickers, Lexington Books, 2011

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Source: Chicago’s Financial Firsts, slide presentation by David Baeckelandt

It was Insull’s people who planned a 1,000-mile pipeline from Texas to Chicago in 1926 to bring north the cleaner burning natural gas with a higher and more valuable energy content than the manufactured coal gas his companies were distributing at the time. The result was the NGPL, widely known as “the Chicago pipeline,” which was built in 1930-31 by a consortium that also included Standard Oil of New Jersey.

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NGPL today

By the time gas deliveries on the NGPL began in the fall of 1931 Insull had further leveraged his already heavily leveraged empire to fend off a hostile takeover, and was taking out new loans to make interest payments on the old ones.

The bankruptcy filing by his corporate interests the next spring would unleash a banking crisis and spark a probe that revealed a long-term pattern of influence-peddling and preferential insider dealings.

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Insull went overseas, was charged with embezzlement, mail fraud and violation of bankruptcy law, eventually extradited, tried three times and acquitted in each case. He died in 1938 of a heart attack suffered in the Paris metro. Despite having collected what was reported at the time as a $21,000 annual pension from several Chicago-area utilities – the equivalent of $353,000 today – Insull left behind an estate with $1,000 in cash against personal debts of $14 million.

The Public Utility Holding Company Act of 1935 forbade holding company chains with more than a single layer of subsidiaries until its repeal in 2005. The pyramid structures that prevailed during the 1920s allowed investors like Insull to control long trains of affiliates with relatively small stakes in the foremost holdco.

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President Franklin Roosevelt signing the Public Utility Holding Company Act, 1935

There is no evidence that Rich Kinder has engaged in any illegalities, and many of Insull’s excesses are no longer permitted thanks to reforms adopted following the 1929 market crash. But what ties those two men together, besides the love of empire-building and regulated profits, is their high tolerance for leverage.

Repeatedly selling equity to finance growth is a tactic Insull pioneered. When the distributions on all the equity Kinder Morgan sold became too onerous, Rich Kinder opted to buy out the equity of his limited partners using debt. The trouble with leverage is that it tends to turn from an asset to a liability at the most inconvenient time, suddenly and unpredictably.

As the former chief operating officer at Enron, Rich Kinder should know that. Yet he appeared to have been blindsided by Moody’s decision to “proportionally consolidate” NGPL’s debt with Kinder Morgan’s.

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Richard Kinder

NGPL profits aren’t what they used to be with cheap gas from the Marcellus increasingly displacing Gulf shipments in the Midwest. Moody’s called the pipeline’s capital structure “untenable” at a debt/EBITDA ratio above 10, which is why it believes NGPL will require a near-term capital infusion from Kinder Morgan.

The credit rating agency expected Kinder, which acquired its initial stake in NGPL nearly 20 years ago, to borrow the needed money initially. But Kinder Morgan’s own debt/EBITDA is worrisomely high at nearly 6. That doesn’t leave a lot of wiggle room for the unforeseen, such as when the outside investors in a historic pipeline you operate but mostly don’t own opt not to put in any more of their own money.

 

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