Congrats, Mr. Kinder, You Solved the Growth Problem

With a huge $44 billion deal, Kinder Morgan solves its growth problem. For years,  Kinder Morgan Energy Partners has struggled to increase distributions to unitholders as rapidly as peers, but the burden of incentive distribution rights that shifted nearly half of cash payouts to its general partner has limited distribution growth to roughly half the rate of EBITDA growth. We've been waiting for Kinder to address this overhang for some time, but we had been focused on KMP buying out its general partner,  Kinder Morgan, Inc. (KMI), something the math just hasn't accommodated.

The deal announced Sunday turns this on its head and takes advantage of the relative discount the market had assigned to KMP and other Kinder family master limited partnerships: General partner KMI will acquire the outstanding stock of KMP,  Kinder Morgan Management , and  El Paso Pipeline Partners , consolidating the midstream family into a single corporation. As announced, the deal values KMP and KMR at $90, spot on with our $90 fair value estimates, and values EPB at $39 per unit, a 7% premium to our $37 fair value estimate.

Because this deal eliminates the incentive distribution structure entirely, we expect the combined KMI to be able to sustain more rapid dividend growth than our previous forecast, and we expect to raise our current $35 fair value estimate by 10%-15%. Because this is a majority-equity deal, we also expect to adjust our fair value estimates for KMP, KMR, and EPB to reflect a higher value for KMI. Our wide moat ratings for all firms remain intact.

The deal creates the largest energy midstream firm, period. The new Kinder Morgan will have an enterprise value of roughly $140 billion and generate EBITDA of $8 billion a year. We concur with company estimates of 10% annual dividend growth through 2020, and a straight dividend discount model valuation of KMI implies the firm would be worth $41 per share.

There is significant upside for Kinder MLP investors. Holders of KMP will receive 2.1931 shares of KMI plus $10.77 for each unit owned, or $90 per unit, a 12% premium over Friday's close. KMR holders will receive 2.4849 shares of KMI, a 16.5% premium, and EPB holders will receive 0.9451 KMI share plus $4.65 cash, or $39, a 15% premium. Moreover, we expect KMI dividends to grow near 10% annually, significantly faster than KMP/KMR's 5% rate and the current 0% growth at EPB.

The consolidated entity is poised for growth. A streamlined structure without incentive distributions will allow new growth investments to generate nearly twice the cash flow accretion as KMP's economics supported, putting more cash in investors' pockets and helping KMI establish high dividend growth and likely a competitive cash cost of equity (measured by yield), implying a more favorable currency for future acquisitions. We certainly see KMI as an industry consolidator going forward.

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