Yesterday Bloomberg posted an article called “Kinder Morgan Sued by Investor Over Pipeline Distributions,” noting that Jon Slotoroff, a unit holder of Kinder Morgan Energy Partners (KMP), has sued Kinder Morgan Inc. (KMI) seeking damages for alleged improper distribution of affiliates’ profits. The crux of the Slotoroff suit is that KMI has been over distributing cash flow from KMP thus benefiting KMI as the GP and Incentive Distribution Rights (“IDR”) owner to the detriment of KMP unit holders because some of those distributions should have been kept to pay for maintenance of KMP’s pipeline systems. The Slotoroff suit alleges that KMI has taken $3.2 billion from KMP improperly since 2010 by classifying certain capital expenditures as Expansion when in Slotoroff’s opinion they should have been Maintenance (thus lowering the calculation of Distributable Cash Flow).

This argument also means that Slotoroff has been receiving distributions on his KMP investment that he considers to be too high. In the Complaint Slotoroff wants KMI to disgorge any amounts that would have been distributed in accordance with a “good faith allocation of Maintenance Capex.” So using his logic, Slotoroff must also want owners of KMP units (like himself) to disgorge an additional $3.2 billion of excessive distributions that they received over that same time frame as well (since KMP and KMI have essentially split incremental Distributable Cash Flow 50%/50% under the IDR structure).

I can’t recall seeing any lawsuit with this premise before so it made me wonder: how has Slotoroff’s investment in KMP performed since the start of 2010? I am making the simplifying assumption that he is an individual investor and that the KMP units were purchased on December 31, 2009 (since the lawsuit appears to cover the period since the start of 2010). For comparison purposes I also looked at the performance of the S&P 500 ETF (SPY) over the same period.

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Since the beginning of 2010 KMP has slightly outperformed the SPY ETF on a Pre-Tax Total Return basis. Using the December 31, 2009 closing price for the return calculation seems conservative to me because here is how KMP performed during 2009:

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Due to the general uptrend in KMP’s unit price during 2009 (up ~35% for the year) if Slotoroff purchased units earlier in the year that probably means that his total return would improve further.

I am used to seeing investor and class action lawsuits against companies when the stock/unit price has gone down substantially and investors have experienced substantial losses so this Slotoroff suit seems rather different. If Slotoroff’s total return from his investment in KMP has actually outperformed the S&P 500 what are his specific damages?

Part of Slotoroff’s complaint is that KMP’s units are “overvalued” since the “bad faith allocation of Maintenance Capex  has artificially inflated KMP’s growth rate and profitability.” Allocating Maintenance capital expenditures as Expansion and then financing those capital expenditures with a combination of additional debt and equity actually lowers profitability / Net Income instead of inflating it. The increased carrying cost of the new debt lowers overall Net Income (and if the capex in question was really Maintenance then it clearly didn’t grow the company’s total cash flow).

In addition, making the case that Slotoroff is better at determining Maintenance Capex than the management team that has grown the company since late 1996 may be very difficult. While the ultimate outcome of any legal action is always difficult to handicap in advance, if I were Kinder Morgan’s General Counsel I would be working up a motion to dismiss.

UPDATE: Hedgeye’s Kevin Kaiser discusses the lawsuit in his blog post here: LP/GP Tension: KMP Investor Sues KMI He has also read the full Complaint (I have not since I couldn’t find a full copy of it out on the web) so you should definitely read his post as well. He also has various additional quotes from the Complaint in his post and was gracious enough to allow me to link to it.

UPDATE2: MLP Data posted a copy of the full Slotoroff complaint on its website.