Kinder Morgan says preferred shares help in long run

Houston pipeline powerhouse Kinder Morgan has proved it can raise a billion dollars in new capital without selling common stock or borrowing, even if it means taking a bruising from investors.

Last week Kinder Morgan executives announced that they would stop raising money through sales of common stock until next spring and instead opt for other sources of capital they consider cheaper.

This week, the company hit the market with $1.6 billion in preferred shares — a kind of security that combines components of equity and debt.

Those preferred shares pay a 9.75 base coupon — the yield on a fixed-income security, which is set at the time of issue. That’s more than two percentage points higher than the dividend yield on the common stock that the company didn’t want to sell because it was too expensive.

The comparison isn’t direct, though. Kinder Morgan’s preferred shares are structured to turn into common stock after three years. And the number of common shares investors will get for each share of preferred falls if the price of Kinder Morgan’s common stock rises.

Essentially, the exchange means that Kinder Morgan can raise money at a lower cost over the long term if the price of its common shares rises in the next three years.

Kinder Morgan common shares slid 13 percent from the Oct. 21 announcement until the close of trading on Tuesday, the day the preferred shares were offered — although common shares gained 46 cents Wednesday to $27.74. Sees benefits

David Michels, vice president of investor relations at Kinder Morgan, said the company expected that its common stock would take a temporary hit after the offering.

“While we’re paying a little bit more for this security over the next three years than common equity, the benefit of ultimately issuing fewer shares will mean a cheaper form of financing over the long term,” he said in an interview.

It’s likely other midstream companies will follow Kinder Morgan’s lead, said Brandon Blossman of Houston energy investment bank Tudor, Pickering, Holt & Co.

“The market may not like this particular deal, but it still proves there’s capital available,” Blossman said.

Part of the reason companies are expected to continue issuing preferred shares is that the other options are worse.

Midstream companies typically earmark their income to pay dividends to investors.

They fund new growth through a combination of issuing equity — or shares of ownership in the company — and borrowing.

That model has faltered recently as the value of midstream equity has fallen sharply and companies have had to issue more equity — and ultimately pay more dividends — to raise the same amount of money. Large debt loads

Simply issuing more debt isn’t a great option either. Kinder Morgan and many other midstream ventures already carry large debt loads and are trying to cut back to appease ratings agencies.

Preferred shares can be issued in a way that won’t affect debt ratings and can sell for more than the currently cheap common stock, depending on how the security is structured.

But as Kinder Morgan’s steep coupon showed, preferred stock isn’t a free lunch.

“High level, from an economic perspective, it’s not that much different than if they’d issued common shares,” Blossman said.