Years in the Making: Kinder Morgan Opportunistically Buys El Paso

Essay

Years in the Making: Kinder Morgan Opportunistically Buys El Paso Corp. for $20.7 Billion


Companies often hold informal merger talks for protracted periods until conditions emerge that are satisfactory to both parties.
Capital requirements and regulatory hurdles often make buying another firm more attractive than attempting to build the other firm’s capabilities independently.
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Using a combination of advanced horizontal drilling techniques and hydraulic fracturing, or “fracking” (i.e., shooting water and chemicals deep underground to blast open gas-bearing rocks), U.S. natural gas production has surged in recent years. As a result, proven gas reserves have soared such that the Federal Energy Information Administration estimates that the overall supplies of natural gas would last more than 100 years at current consumption rates. But surging supplies have pushed natural gas prices to $4 per million BTUs down from a peak of $13 in July 2008. Despite the depressed prices, energy companies around the globe have rushed to enter the business of producing shale gas. With energy prices depressed, independent players are struggling to find financing for their projects, prompting larger competitors to engage in buyouts. Exxon acquired XTO Energy in 2009, and Chesapeake Energy sold a partial stake in its shale gas reserves to Chinese companies for billions of dollars. In 2011 alone, oil and gas firms announced $172 billion worth of acquisitions in the continental United States, accounting for about two-thirds of the $261 billion spent on oil and gas acquisitions worldwide.

The increase in energy supplies has strained current pipeline capacity in the United States. Today more than 50 pipeline companies transport oil and gas through networks that do not necessarily transport the fuel where it is needed from where it is being produced. For example, pipeline construction in the Marcellus shale field in Pennsylvania has not kept pace with drilling activity there, limiting the amount of gas that can be sent to the northeast. In the Bakken field in North Dakota, producers are shipping much of their new oil production by train to west coast refineries, and excess gas is being burned off. In the meantime, new oil and gas fields are being developed in Ohio, Kansas, Oklahoma, Texas, and Colorado. According to the Interstate Natural Gas Association of America Foundation, a trade group, pipeline companies are expected to have to build 36,000 miles of large-diameter, high-pressure natural gas pipelines by 2035 to meet market demands, at a cost of $178 billion.

Responding to these developments, on October 17, 2011, Kinder Morgan (Kinder) agreed to buy the El Paso Corporation (El Paso) for $21.1 billion in cash and stock. Including the assumption of debt owed by El Paso and an affiliated business, El Paso Pipeline Partners, the takeover is valued at about $38 billion. This represents the largest energy deal since Exxon Mobil bought XTO Energy in late 2009.

Kinder Morgan’s stock had been declining throughout 2011, and the firm was looking for a way to jumpstart earnings growth. The acquisition offers Kinder both the scale and the geographic disposition of pipelines necessary to support the burgeoning supply of shale gas and oil supplies. The acquisition makes Kinder the largest independent transporter of gasoline, diesel, and other petroleum products in the United States. It will also be the largest independent owner and operator of petroleum storage terminals and the largest transporter of carbon dioxide in the United States. The combined firms will operate the only oil sands pipeline to the west coast. To attempt to replicate the El Paso pipeline network would have been time consuming, required large amounts of capital, and faced huge regulatory hurdles.

Kinder will own or operate about 67,000 miles of the more than 500,000 miles of oil and gas pipelines stretching across the United States. Kinder’s pipelines in the Rocky Mountains, the Midwest, and Texas will be woven together with El Paso’s expansive network that spreads east from the Gulf Coat to New England and to the west through New Mexico, Arizona, Nevada, and California. In buying El Paso, Kinder creates a unified network of interstate pipelines. By increasing its dependence on utilities, Kinder will reduce its exposure to the more volatile industry end user market. The acquisition also offers significant cost-cutting opportunities resulting from reconfiguring existing pipeline networks.

Kinder paid 14 times El Paso’s last 12 months’ earnings before interest, taxes, depreciation, and amortization of $2.67 billion. Investors applauded the deal by boosting Kinder’s stock by 4.8% to $28.19 on the announcement date. El Paso shares climbed 25% to $24.81. For each share of El Paso, Kinder paid $14.65 in cash, .4187 of a Kinder share, and .640 of a warrant entitling the bearer to buy more Kinder shares at a predetermined price. The purchase price at closing valued the deal at $26.87 per El Paso share and constituted a 47% premium to El Paso 20-day average price prior to the announcement. Kinder’s debt will increase to $14.5 billion from $3.2 billion after the acquisition. To help pay for the deal, Kinder is seeking a buyer for El Paso’s exploration business. The combined firms will be called Kinder Morgan. Richard D. Kinder, the founder of Kinder Morgan, will be the chairman and CEO.

The proposed takeover was not approved by regulators until May 2, 2012, on the condition that Kinder Morgan agree to sell three U.S. natural gas pipelines. The deal represents the culmination of years of discussion between Kinder Morgan and El Paso. Kinder, which went private in 2006 in a transaction valued at $22 billion, reemerged in an IPO in February 2011, raising nearly $2.9 billion. The IPO made the deal possible. While Kinder had for years held talks with El Paso’s management about a merger, it needed the “currency” of a publicly traded stock to complete such a deal. El Paso shareholders wanted to be able to participate in any future appreciation of the Kinder Morgan shares. Whether the combination of these two firms makes sense depends on the magnitude and timing of the expected resurgence in natural gas prices and the acceptability of shale gas and “fracking” to the regulators.
-How would the combined firms be able to better satisfy these needs than the competition?