All eyes on Kinder Morgan IPO

Quality of demand seen as key factor

On Tuesday the market will, for the first t i me, get to pass judgment on the recently priced initial public offering of Kinder Morgan Canada.

So far the underwriters have rounded up enough investors for 102.9 million shares. Those shares were priced at $ 17 — or a tad below the previous marketing range of $ 19-$ 21 a share. At $ 1.75 billion, the IPO could be classified as the country’s largest initial public offering outside of insurance demutualizations and government privatizations.

But the issuer, a unit of Kinder Morgan Inc., opted to receive the same amount of gross proceeds by selling more shares than originally anticipated. After the transaction — and assuming the over-allotment option is not exercised — the parent will own about 70 per cent of the Trans Mountain pipeline system.

On Tuesday, those newly issued shares will start trading on the TSX. And there will be some nervous anticipation given three main factors: the very recent election of a minority government in B.C. (with the Greens and the NDP, who are opposed to the pipeline, holding the balance of power); the reality that Kinder Morgan faced to get the deal over the line; and the quality of the demand.

Of the three, the latter is expected to have the greatest near-term impact on trading — and hence on prices. The ideal situation is the extent that the shares end up with investors who want to own the company. The less than ideal situation is where the shares have not been allocated properly and are in the hands of the flippers — those looking for a quick turn.

One complication is the seeming lack of a relationship between the extent to which the deal is over subscribed and the initial trading price. Consider Real Matters, which recently went public: the talk was that the deal was multiple times oversubscribed (which suggests unfilled demand), yet in subsequent trading the shares have not closed above the $13 issue price.

On Friday, Wells Fargo Securities issued two reports on t he parent company, Kinder Morgan Inc., both of which gave some attention to the IPO. Wells Fargo was not part of the syndicate formed to sell the shares.

Wells Fargo, which has an outperform rating on the parent and a US$ 25 a share target, noted that the “IPO is not without controversy and there is no shortage of opinions.”

For Wells, which made a quick trip to Canada “to take the pulse,” the crux of the issue is the risk associated with the expansion of the Trans Mountain pipeline. “Investors who believe TMX gets built largely on time and on budget, find Kinder Morgan attractive. Investors who believe execution risk is high, don’t,” noted the report. In other words it comes down to “how you risk-weight the value of TMX and what you are willing to pay for it today.”

The Wells Fargo report was notable for another observation: A general disparity in views between U.S. and Canadian investors with “a majority of U.S. investors… more optimistic on the prospects for TMX.”

On the other hand, Canadian investors view the B.C. government election outcome “as negative for TMX” and believe “activist, environmental, and certain First Nations opposition will be strong and they see significant headline risk over the next 2-3 years, which will impact the trading of the stock,” noted the report.

The analysts behind the report commented that even if the pipeline is ultimately built, “Do I want to deal with the volatility along the way?”

Overall, Wells Fargo views the IPO as “a net positive” for the parent with the lower offering price causing a marginal drop in discounted cash flow per share.

U.S. INVESTORS … MORE OPTIMISTIC ON THE PROSPECTS.