August 5, 2002; Financial Markets Reject the KMR Peso

Strong Sell recommended Kinder Morgan raised about $300 million in new shares of Kinder Morgan Management (KMR).  That is about a half year late and about 70% shy of expectations at the time of the last large acquisition. 

We can now call KMR stock the “KMR Peso” following the elimination of the exchange feature that linked the price of KMR to Kinder Morgan Energy Partners (KMP).  We see a similarity to when Argentina eliminated convertibility of its peso to the U.S. dollar earlier this year. 

The Kinder Morgan entities have high McDep Ratios and high ratios of Debt to Present Value.  In simpler terms, the stocks have high valuation risk and high risk of financial failure.  For example, investment values for energy infrastructure properties may be down by as much as a third in the current distressed market.  At a ratio of Debt to Present Value of 0.87, KMI can withstand a reduction of only 0.13 in value before the stock is worthless. At a ratio of Debt to Present Value of 0.49, KMP and KMR would see the net present value of units and shares fall by some two thirds to low single digits.  In other words, Kinder Morgan stock prices seem to be lagging well behind the decline in value that has taken place in its industry.  Thus, further stock price decline seems likely for Kinder Morgan.

Kinder Morgan was in violation of its debt covenants earlier this year.  Lenders apparently were willing to give the entities more time to raise equity.  We can’t say whether the lenders will allow Kinder to continue its high-risk ways, but there is no doubt that its bargaining position is weak. We see more negative implications than positive implications in the experience of the latest underwriting.

In the context of our discussion of the Walsh book, institutions, the targeted buyers of KMR, may see that Kinder Morgan has reached the top level of the pyramid.  It is quite expensive for new investors in KMR/KMP to give up economic value not only to the GP, but also to the participants who got in the pyramid earlier.