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Setting the Record Straight on Kinder Morgan

Most, if not all, MLPs report distributable cash flow (DCF), which does not in the calculation consider growth capex, an important driver behind the generation of increased cash flow from operations in the future. When MLPs report distribution coverage ratios, this particular calculation also backs out growth capex from the equation, instead using only ‘sustaining capital expenditures.’

There are a number of contractual reasons why the data is presented in such a way, but from a valuation standpoint, we’ve always taken an issue with the MLP universe being implicitly valued on a future distributable cash flow stream that “covers” the distribution than on future free operating cash flow, which is a better measure of the free operating cash flow that a business generates.

The reason why free operating cash flow is more informative is quite straightforward. Distributable cash flow does not deduct the investment associated with driving future growth in an MLP’s cash flow from operations. Said differently, it’s like getting a free pass on all of the future growth spending that is required to drive incremental cash flow from operations, a severe imbalance in the valuation equation.

In valuing MLPs, we’ve circumvented the valuation imbalance by making the universal assumption that MLPs will continue to have access to the capital markets and that they will be able to issue equity and/or debt in such a way that is not value-destructive. Said differently, in our valuation models, we give MLPs credit for the future growth in cash flow from operations without deducting the growth capex that is required to drive it. We disclose this dynamic in every one of our 16-page reports within the MLP space.

5 Reasons Why We Expect Kinder Morgan to Collapse, June 11, 2015

A performance track record is always evolving, and some of the best calls today may turn into some of the worst calls tomorrow. It happens all the time even with some of the best investors, and whether an idea is good or bad all depends on one’s time horizon, to a degree and in almost all cases.

First, we remain incredibly humble, understand that we could still be wrong, are grateful for a broad audience that appreciates our work, and we hope this article is not misconstrued as one in which “we’re patting ourselves on the back,” but instead, we hope it is viewed as one in where we’re setting the record straight. For those that may not be...