January 7, 2002; Enron Legacy - Energy Infrastructure Partnerships

Summary and Recommendation

During the course of investigating the factors causing the fall of Enron, our political leaders may recognize similarities in an Enron legacy, energy infrastructure partnerships.  Some of our representatives may conclude that those entities give the appearance of disguising losses, overcompensating general partners, operating under conflicts of interest, taking on too much debt and preying on retirement investors.  The largest partnership, Kinder Morgan, was founded by Enron and is run by Enron's former second in command who has become a billionaire with the Enron brainchild.  We strongly recommend the sale of the securities of Kinder Morgan, Inc. (KMI), Kinder Morgan Energy Partners, L.P. (KMP) and Kinder Morgan Management, LLC (KMR).   

Eight Enron Investigations Keep Consciousness Awake

The Wall Street Journal reports, “Sen. Joseph Lieberman says the Senate Governmental Affairs Committee, which he heads, will hold hearings into Enron's collapse when Congress returns to work later this month. Internal Enron documents show top management and directors viewed controversial partnerships, which played a role in the company's demise, as integral to maintaining its rapid growth in recent years.”

Senate Governmental Affairs is one of eight committees and agencies the Journal lists as launching investigations.  The others are House Financial Services Committee, House Commerce Committee, House Education and Workforce Committee, Senate Commerce Committee, Securities and Exchange Commission, Justice Department and Labor Department.

Energy infrastructure limited partnerships are a closely related area where promises to retirement investors are questionable.  We noted last week that one of those, Genesis Energy, L.P. suspended its distribution only a few years after raising money on the promise of high income.  We have been expanding on our grave reservations about the largest energy infrastructure limited partnership, Kinder Morgan, for the past several weeks.  

Energy Infrastructure Partnerships A Risky Choice for Retirement

Energy infrastructure partnerships may have a combined market capitalization half that of Enron at its peak of some $77 billion.  The Kinder Morgan entities have a combined market cap of $13 billion.  Eight more similar stocks in our coverage are worth another $13 billion not counting the general partners.  Inspired by Kinder's example, there may be more than twenty additional similar entities. The limited partners of energy infrastructure partnerships appear to be predominantly investors looking for high current income, in many cases to live on in retirement.  Our conclusions stem primarily from our analysis of Kinder Morgan though most of the other partnerships share similar features to varying degrees.

Accounting Statements Disguise Losses 

We have pointed out that the limited partners take an immediate hit to value when the general partner gets a disproportionate share of cash from a new acquisition.  The accounting statements may show that the deal is supposedly positive because the distribution to limited partners may be increased modestly.  The actual loss may be evident only when the partnership ultimately collapses from too many deals as we feel is likely eventually.  We suspect that in the process, most investors do not understand all the implications of the complicated structure.  As a result, the accounting statements, even though they may conform to arcane rules, effectively disguise losses, in our opinion.

The Fastow partnerships at Enron were apparently approved by top executives and the board of directors and disclosed in the company’s public government filings.  Yet when the chairman of Enron made an offhand comment about a billion-dollar loss that did not flow through the income statement, the collapse of public confidence was triggered.

High Compensation to General Partner

Investors may have grimaced upon learning that Enron’s chief financial officer earned $30 million from partnerships that lost a billion.  On a much larger scale, the latest acquisition by Kinder Morgan apparently can put hundreds of millions into the general partner’s pocket at the expense of the limited partners.  The general partner of Kinder Morgan gets 50% of the cash generated by new deals as long as he can keep distributions above a threshold that has been easily reached.  Depending on financing costs and the pattern of cash generation, 50% of the cash can be 50% of the value.  It might even be more than 50% of value in some cases considering that the general partner has minimal obligation to repay the principal of the financing.

Conflict of Interest Encourages Destructive Action

As general partner, the chief financial officer of Enron earned high compensation from partnerships he formed to shield losses.  He made money by doing something destructive to Enron.  No person can be expected to act impartially in a conflict of interest situation.  That is what the phrase means.  At Kinder Morgan, the general partner’s deal appears highly rewarding on the upside and only lightly penalizing on the downside.  That could encourage a general partner to take greater risks than are suitable for limited partners even to the point of near collapse.

With the general partner benefit accruing to the shareholders of KMI and the limited partner obligation accruing to the unitholders of KMP and shareholders of KMR the conflict of interest pits one class of public owner against the other.  High compensation and obscure presentation magnifies the conflict beyond normal bounds.

Arthur Andersen Opines for Enron and Kinder Morgan

We note the commonality of auditor, but wish to cast no aspersions.  Arthur Andersen is also auditor for stocks we are recommending positively.  We do believe that the negative implications of the general partner’s high compensation and conflict of interest are inadequately portrayed in current accounting statements. 

High Valuation and High Debt Set the Stage for Rapid Collapse

Overvalued stocks can become more overvalued.  High debt stocks can move up rapidly in price as well as down.  When high valuation and high debt are combined with a hint of something that is not right, the combination can lead quickly to a reversal of investor perceptions.  Perhaps the public scrutiny of Enron and Enron's legacy may bring attention to any one or more of the issues of disguised losses, general partner compensation, conflict of interest, risks of high debt, risks of high valuation and perceived exploitation of retirement investors.

January 7, 2002; Meter Reader: Enron Legacy - Energy Infrastructure Partnerships