Kinder Morgan, Inc. Business Information, Profile, and History

Company Perspectives:

Kinder Morgan, Inc. is one of the largest midstream energy companies in America, operating more than 30,000 miles of natural gas and product pipelines across the United States. It also has significant retail distribution, electric generation and terminal assets.

History of Kinder Morgan, Inc.

Based in Houston, Texas, Kinder Morgan, Inc. (KMI) is one of the largest midstream energy companies in the United States. Rather than drill for oil and natural gas, or market the commodities, KMI focuses on delivery through its network of more than 30,000 miles of pipelines in the United States. KMI is the corporate component of a unique business structure. Most of the company's $18 billion in assets are held by Kinder Morgan Energy Partners, L.P. (KMP), a Master Limited Partnership (MLP) comprised of units that can be traded like shares of stock. Unlike a corporation, however, an MLP does not pay taxes, rather all of its "available cash" is distributed to its partners each quarter. KMI and its principal executives, Richard Kinder and William Morgan, control most of the MLP's units. A third entity, Kinder Morgan Management, LLC, was created specifically to allow institutional investors to hold partnership equity in Kinder Morgan Energy Partners. In addition to delivery systems, KMI is involved in the retail sale of gas, storage facilities, and the development of small power plants that are connected directly to natural gas through its pipelines.

Formation of Kinder Morgan: 1997

Partners Kinder and Morgan created Kinder Morgan Energy Partners in February 1997 after purchasing the general partnership that ran the liquids pipeline operations of energy giant Enron Corporation. Both men had worked at Enron and were friends from their law school days in the early 1960s at the University of Missouri, where they both knew the CEO and chairman of Enron, Kenneth Lay. Years later, Lay was working for Florida Gas Transmission and hired Morgan, who in turn hired Kinder. Florida Gas was then sold to Houston Natural Gas in 1984, and the following year Houston Natural Gas merged with InterNorth to create Enron, which was headed by Lay. Morgan ran several pipeline operations for Enron, then in 1987 left to manage private energy investments. Kinder, in the meantime, advanced through the ranks of Florida Gas and Enron, serving in a variety of legal and executive positions until he was named president and chief operating officer for Enron in 1990. He was a key player in the development of Enron Capital & Trade, the corporation's merchant arm. Because of his demonstrated ability it was widely assumed that Kinder was Lay's heir apparent at Enron. However, when Lay agreed in 1996 to a new five-year-term as the chairman of Enron (a term, ironically, that would coincide with Enron's tumultuous downfall in late 2001), Kinder, now 52 years old, concluded that it was unlikely that he would ever assume the top management position and therefore opted to resign.

Although Kinder was rich enough to support an early retirement, he retained a desire to head a company. Morgan then convinced his old friend and colleague to go into business together. Along with minority partner First Union Capital Markets, based in Charlotte, North Carolina, they negotiated a $40 million deal to acquire Enron Liquids Pipeline, L.P., a general partnership that had been formed in 1992 and, although profitable, had enjoyed little growth. In addition to natural gas liquids pipelines, company assets included a CO2 pipeline (used in the further recovery of oil in old wells) and a rail-to-barge coal terminal. Kinder quickly demonstrated his aptitude as a CEO by taking the partnership public as Kinder Morgan Energy Partners, putting the little-employed MLP structure to effective use. MLPs are similar to Real Estate Investment Trusts (REITs), which were created by Congress in 1960 as a way for small investors to become involved in real estate in much the same way a mutual fund allows small investors to pool resources in buying stock. Because REITs were required to pay out at least 95 percent of their taxable income to unit holders each year, thus severely limiting their ability to raise funds internally, the structure was rarely used. The Tax Reform Act of 1987 not only initiated changes that invigorated the use of REITs, it extended the exemption from corporate taxes to MLPs. This provision allowed Kinder Morgan to buy assets that were unattractive to "C" corporations that were taxed both at the corporate and investor level. Kinder explained the MLP advantage in a 1998 Forbes profile: "When I was president of Enron, I would throw people out of the room if they came in with a proposal that had anything less than a 15% aftertax return. We can make acquisitions all day as long as we're over 8.5% pretax."

The goal was to focus on midstream fee-based pipeline businesses, serving as a conduit for commodities rather than the drilling or marketing sectors. Before embarking on external growth, however, Kinder cut $5 million in expenses, eliminating staff as well as instituting such cost savings measures as a companywide policy of flying coach. Both he and Morgan received only $1 a year in salary, which simply allowed them to be eligible for healthcare benefits, a decision made to counteract what they had experienced in the corporate world, where some executives had placed their interests ahead of shareholders. Dependent on dividends under this arrangement, Kinder and Morgan would only prosper to the extent that MLP's unit holders were rewarded. Although Kinder owned a 22 percent stake in the partnership to Morgan's 8 percent and operated as the lead executive, they viewed themselves as equals in the running of the business.

First Major Acquisition: 1997

Within six months Kinder was able to increase the dividend paid to unit holders by 50 percent. By October 1997 KMP made its first major acquisition, buying Santa Fe Pacific Pipeline Partners, L.P. from Burlington Northern Santa Fe Railroad for approximately $1 billion in units and cash, plus the assumption of $350 million in debt. The assets, renamed Kinder Morgan Pacific, included 3,300 miles of pipeline, providing an important West Coast presence, as well as 14 truck-loading terminals. In short order, $20 million in costs was eliminated and the acquisition began to produce strong revenue growth. In June 1998 KMP acquired a 24 percent interest in Plantation Pipe Line, paying $110 million to Equilon. A year later the partnership would acquire a controlling interest in Plantation by paying Chevron $124 million for its 27 percent interest. Plantation's 3,144 mile system distributed refined products throughout the Southeast and as far north as Washington, D.C.

While there were many advantages to the MLP structure, it was limited in its ability to grow. It could use cash and units to buy assets from corporations but was unable to buy companies outright. Moreover, institutional investors such as mutual funds were limited in their ability to hold MLP units. The next step for Kinder and Morgan, therefore, was to create what they called "the second barrel of the shotgun," a publicly traded corporation that would control the MLP. The corporation could use stock to acquire assets, which would then be sold to the MLP, in effect coupling the tax advantages of the partnership with the flexibility of a corporation. In 1998 Kinder and Morgan were about to make an initial public offering for Kinder Morgan, Inc. when they recognized an opportunity to gain corporation status while acquiring an array of valuable assets by engineering a reverse merger with KN Energy.

The roots of KN Energy reach back to the formation of Kansas Pipe line & Gas Co. in 1927. Unlike most gas pipeline businesses of the time, which believed only urban areas were economically viable, the company looked to serve small communities. In 1941 it acquired Nebraska Natural Gas Co. for $1.7 million and changed its name to Kansas Nebraska Natural Gas Co. Over the next 30 years, operating out of Hastings, Nebraska, the company would acquire a number of nearby pipeline companies and other assets, and by 1970 was listed on the New York Stock Exchange. In 1982 the company relocated its headquarters to Lakewood, Colorado, and a year later became known as KN Energy Inc., drawing on the first letters of Kansas and Nebraska to create its name. By this time the company ran a 16,000 mile, natural gas pipeline network throughout Kansas, Nebraska, Colorado, and Wyoming.

In the 1980s KN Energy, with $300 million in assets, would attract the attention of legendary corporate pirate T. Boone Pickens, whose Mesa Petroleum Co. failed on three different occasions to gain control of the business. In 1994 KN Energy merged with American Oil & Gas of Houston in a $282.5 million exchange of stock, structured as a tax-free pooling of interests. As a result of the transaction, KN Energy's CEO, Charles W. Battey, became the chairman of the combined company and Larry D. Hall took over as president and chief executive officer. Less than two years later Battey retired, and Hall assumed the chairmanship and was granted even greater latitude in changing the company from a natural gas business to a total energy provider. Hall looked to exploit deregulation and the assets of KN Energy to provide an array of services that could be bundled together. For instance, the company offered an appliance protection program for residential customers. To which he hoped to add other services such as home security and even television entertainment in partnership with telecommunications companies. The goal was to be in a position through strategic alliance to offer customers a package of services from a single vendor. Underpinning this plan was Hall's belief that a gas utility with decades of community involvement had an edge over cable TV companies and electric utilities, which were either local and perceived as notorious for poor service or run from afar and indifferent. In essence, he wanted to join economies of scale inherent in a large company with the consumer friendliness of a small gas company.

However appealing Hall's vision may have appeared in theory, the reality proved to be far different. In January 1998 KN Energy acquired MidCon Corp. from Occidental Petroleum for $4 billion. While the deal quadrupled its assets and transformed KN Energy from a regional to a national energy services company, it also saddled it with an enormous debt load that cut into earnings. Two consecutive warm winters combined with greater competition to severely cripple the company and undercut the price of its stock. In February 1999 Sempra Energy of San Diego, California, made a tentative deal to purchase KN Energy for $1.9 billion, but by June the deal was off, scuttled by KN Energy's $3.3 billion in long-term debt.

Merging of KN Energy and KMI: 1999

Richard Kinder was well situated to observe the plight of KN Energy, having served on its board of directors since June 1998. Recognizing an opportunity, he promptly resigned from the board, canceled the Kinder Morgan IPO, and within a month engineered a deal to combine the assets of KN Energy with KMI. Technically KN Energy acquired KMI, paying $506 million in stock, but in reality KMI was taking over the corporate structure of KN Energy, effecting what was a reverse merger as well as a reverse IPO, in the process gaining a valuable position on the New York Stock Exchange. In October 1999 KN Energy changed its name to Kinder Morgan, Inc., Hall and other senior executives resigned, and Kinder and Morgan assumed the top positions of the newly combined company, even though they and First Union owned just a 38 percent stake. Unlike Hall's desire to cast a wide net, Kinder made it clear from the outset that he wanted KN Energy to return to its basics, concentrating on the midstream pipeline business and unloading the rest of its assets. He also was quick to institute his usual cost-cutting measures. Staff was reduced, mostly through attrition, interest in three corporate jets was eliminated, the travel budget was slashed from $9 million a year to just $2.5 million, and luxuries such as season tickets and sky boxes to sporting events in Chicago, Denver, and Houston were eliminated. The corporate headquarters was also officially moved to KMI's Houston offices.

KMI again took advantage of the MLP, into which some $700 million of KN Energy assets were transferred in exchange for 9.81 million KMP units and $330 million in cash. The cash would allow KMI to reduce its debt, and the additional units allowed the company to increase its stake in the MLP. Other KN Energy assets were also put on the market in order to eliminate debt. In February 2000 KMI sold its natural gas gathering and processing businesses located in Oklahoma, Kansas, and Texas to Oneok of Tulsa, Oklahoma, in a $400 million deal that included $114 million in cash and the assumption of debt. By October 2000 KMI had completed the digestion of KN Energy assets. After attempts to sell MidCon failed, KMI elected to keep the business, renaming it Kinder Morgan Texas Pipeline and selling it to the MLP for $150 million in cash and $150 million in partnership units. The company also exploited KN Energy's move into the independent power business, establishing Kinder Morgan Power and a proprietary gas-turbine system called Orion. Because these systems would be powered by natural gas and connected to the company's pipeline network, the niche business would remain within the scope of KMI's midstream energy philosophy. In December 2000 KMP began adding external businesses. It bought two pipelines and 12 terminals from GATX Corp. for $1.05 billion. One of the pipelines, CalNev Pipe Line Co., readily connected to a system already owned, and the other, Central Florida Pipeline Co., gave the company a presence in a fast-growing part of the country. A few days later KMP acquired Delta Terminal Services Inc. for approximately $114 million in cash, a deal that included storage terminals in New Orleans and Cincinnati. KMI capped off 2000 by being added to the Standard & Poor's 500 Stock index, after the Philip Morris acquisition of Nabisco Holdings Corp. created an opening.

In 2001 KMI created a third public company, Kinder Morgan Management, to allow institutional investors easier access to participation in KMP. Although nine million shares were intended to be sold in the initial public offering, demand was so strong that in the end 14.9 million shares were sold, raising over $1 billion in gross proceeds, which were then used by KMI to increase its stake in KMP. Kinder's personal net worth ballooned to an estimated $1.5 billion, placing him number 336 among the world's wealthiest people according to Forbes magazine. His wealth as well as the fortunes of KMI appeared to be bright for the foreseeable future. Because the company was concentrated on fee-based businesses it was not as vulnerable as other energy companies on commodity price swings. Moreover, the prospects for the increased use of natural gas over the next 20 years were solid, as would be the need for new pipeline systems. There also appeared to be many pipelines available for purchase in a highly fragmented industry, enough to feed KMI's voracious appetite for a number of years to come.

Principal Subsidiaries: Kinder Morgan Energy Partners, L.P.; Kinder Morgan Management, LLC.

Principal Competitors: TEPPCO Partners; Western Gas; The Williams Companies, Inc.

Chronology

• Key Dates:
• 1927: Kansas Pipe Line & Gas Co. is incorporated.
• 1941: Nebraska Natural Gas Co. is acquired, name changed to Kansas Nebraska Natural Gas Co.
• 1970: Company begins trading on New York Stock Exchange.
• 1983: Name is changed to KN Energy.
• 1997: Kinder Morgan Energy Partners is formed.
• 1999: Following acquisition, name is changed to Kinder Morgan, Inc.
• 2001: Kinder Morgan Management is formed.