Collecting Tolls On The Energy Super-Highway:

The Largest Corporate Payouts Available to Ordinary Investors

Failure never paid so well. Up until 2008, few jobs matched the benefits of being CEO at a financial firm. Most industries punish abject failure. However, Wall Street had a special solution to dealing with the clowns who run their businesses into the ground: Pay them tons of money. Just ask Stan ONeal, former CEO of Merrill Lynch. Under ONeals watch Merrill Lynch jumped headfirst into the deep end of the subprime mortgage pool. When the firm announced an $8 billion loss in late 2007, ONeal was fired walking away with $161 million in severance pay. Chuck Prince, former CEO of Citigroup, is another rich failure. He steered Citigroup into increased derivative exposure, including subprime mortgage backed securities. Prince resigned in the fall of 2007, right before Citigroup posted a $9.8 billion loss in the fourth quarter. Prince walked out with a $38 million in severance. And hes STILL a consultant at Citigroup. There are plenty of other examples to choose from. Collectively, top executives at seven financial firms (including the now defunct Country Wide Financial, Bear Stearns, Lehman Brothers, Washington Mutual, Morgan Stanley, AIG, and Merrill Lynch) earned $445 million between 1995 and 2007. To make this kind of money, youve got to be implementing some incredibly profitable strategies for your companies, right? Wrong. Collectively, these executives firms lost $100 BILLION in 2007 alone largely from following these very executives business practices and strategies. Like I said before, failure never paid so well. However, as the financial crisis intensified in 2008, the general public became increasingly irate over executive pay. Congressional hearings were held laws were promised and sure enough, in early 2009 Congress passed legislation requiring greater transparency of CEO compensation and salary caps for any financial institution receiving public funding.

And Dan Duncan couldnt care less. With a net worth of $5.9 billion, Dan is the richest man in Houston Texas: the capital of oil billionaires. On average Dan makes more than $150 million PER YEAR. In 2007 alone, he pocketed nearly $360 million. To put that number into perspective, its: Nearly four times as much as Merrill Lynchs CEO More than 20 times as much as the CEO of Exxon Mobil More than 17 times as much as the CEO of General Electric

In fact, if you added up the payouts from all three CEOs, you wouldnt even hit half of Dans paycheck. However, Dan doesnt make this money from some enormous salary or greedy stock options deal. In fact, Dan doesnt even have a salary. Instead, he collects this enormous payouts strictly from distributions based on his ownership of the company. So unlike the crooks on Wall Street, Dans interests are entirely 100% aligned with his shareholders. And he actually pays them twice as much as he makes himself. This isnt a recent development either. Dans followed this arrangement every year since his company started making payouts: 2005 Duncan Payout $236 million Payout to Shareholders $472 million 2006 $278 million $556 million 2007 $315 million $631 million 2008 $360 million $726 million

Since 2001, Dans company has paid out a total of $4.7 billion, two thirds ($3.1 billion) of which went to shareholders. Hes also pocketed a cool $1.6 billion for himself. Youre probably asking yourself, what kind of business pays more than Wall Street, Big Oil, or General Electric? Tollbooths. Dan operates a super-highway, stretching over 36,000 miles and 13 states from the Gulf of Mexico to the Colorado Rockies to the suburbs of Illinois. However, his customers arent individual citizensthough many individual clients pay Dan indirectly. Instead, most of Dans clients are major corporations like Exxon, Apache, and Dow Chemicals. Dan has tollbooths stationed all along his super-highway. And just as individual Americans cant get out from paying a toll on the New Jersey turnpike, these big companies cant avoid paying Dans tolls. In fact, they have to pay Dan if they want to continue doing business in the areas where Dans highway operates.

Dan first began building his empire 40 years ago with $10,000 in cash and a couple of trucks. Back then, his primary clients were small oil and natural gas wildcatters based around Texas. Dan approached these guys and told them that if they used his superhighway instead of shipping their oil or gas over the normal US highway system, not only would their fuel get to consumers faster, but hed let them use his trucks too, thus saving them the costs of hiring a trucking outfit. The only catch was that theyd have to pay Dans tolls. Business exploded. Within five years, Dan was generating more than $3 million in sales$30 million in todays money. Rather than cashing out or buying a mansion, Dan plowed this money into buying up more highway. Pretty soon his highway stretched over 1,000 miles. By the time he decided to take his company public in 1998, Dans routes had grown to over 13,000 miles crossing 10 states. By then, Dan was in his mid-sixties and already worth hundreds of millions of dollars. He wanted to step back from the day-to-day operations of his business and enjoy his later years. But he also wanted to make sure that his company was set up in such a way that he would retain control and receive regular payouts. So Dan set his company up as an MLP. He gave investors like you and me a chance to put our money to work right along his, collecting 7%, 8%, even 9% a year at the lowest tax rate of any corporate payout. Speaking of which, the payouts keep growing. In 2002, Dans company paid out over $213 million. The next year it was $309 million. The year after that it was $438 million. And last year it was a whopping $1.1 BILLION. Today, shares in Dans company yield nearly 9%, making it one of the largest income plays in the world. Looking at these results, its easy to think youre too late to get in on the action. But Dan certainly doesnt think so. Hes been buying shares in his MLP hand over first every year for the last four years. In 2004, Dan bought over $49 million worth of stock. In 2005, he was back for another $10 million. And in the last three years hes increased his holdings by an incredible $79 million (including $15 million worth of purchases in 2008 alone). Clearly, Dans not betting on a slowdown in the payouts. If anything, he expects them to be even larger this year. Dans MLP is Enterprise Products Partners LP (NYSE: EPD).

The Richest Man In Houston Doesnt Own A Drop of Oil

Dans super-highway doesnt involve asphalt or pavement. Its actually made up of pipelines thousands and thousands of miles of them stretching from the Gulf of Mexico to the Colorado Rockies to the suburbs of Illinois. Pipelines are the cheapest means of transporting fuel. And oil and natural gas companies are only too happy to pay Dan to ship their wares.

Dans Super-Highway

But they pay him for a lot more, too. You see, oil and natural gas are not usable when first extracted from the ground. Instead, these fuels have to be processed, fractionated, stored and then eventually transported to consumers. You can see a diagram of the whole process below. Dan controls everything in that diagram the pipelines, processing, fractionation, and storage facilities everything except the actual natural gas. Aside from his massive pipeline network, Dan controls 24 processing plants, 13 fractionation plants, 6 offshore hub platforms, and storage containers capable of holding 27 billion cubic feet of natural gas. You can think of these various units as massive tollbooths that energy companies have to pay as they ship their oil and gas through Dans pipelines. Since exploring for oil and natural gas is already a capitally intensive business, big oil and gas explorers rarely want to spend the money to maintain their own processing, fractionation and storage plants. Instead, they outsource these responsibilities to companies like Dans.

Natural Gas Production Chain

The irony here is that Dan never actually owns the oil or gas. Thus, the richest man in Houston and 81st richest man in the world doesnt actually own a drop of oil. Instead, he controls every step of energy production between extraction and actual consumption by consumers. Hes the ultimate middleman. And best of all, he cant be cut out of the equation. Energy companies HAVE to use his services to bring their products to consumers.

A 600% Increase in Sales Even During Gas Corrections

EPDs business is attractive for many reasons. Because it doesnt actually own any oil or natural gas, the company is somewhat shielded from commodity price fluctuations. As you probably know, oil and natural gas have both staged three major corrections of 50% or more since the commodity bull market began in 1999. However, you wouldnt know this looking at EPDs revenues which have risen 600% since 2000.
Millions Sales 2000 $3,073 2001 $3,179 2002 $3,584 2003 $5,346 2004 $8,321 2005 $12,257 2006 $13,991 2007 $16,950 2008 $21,905

However, EPD is indirectly affected by energy prices. The companys revenues predominantly stem from the volume of gas and oil pumped through its pipelines and midstream assets. If energy prices get so high that demand wanes (like it did last summer) or if the economy contracts sharply to the point of reducing energy consumption, then EPD will take a hit. However, this hasnt been an issue at any time in the last ten years. For a more detailed example of EPDs revenue stability see the table below, chronicling oil and natural gass quarterly fluctuations against EPDs revenues in 2006: a year in which oil and gas fluctuated as much as 20% and 18% respectively.

Avg. price oil Avg. Price Nat Gas EPDs Revenues

1Q06 $63.27 $8.17 $3.2 billion

2Q06 $70.41 $6.96 $3.5 billion

3Q06 $70.41 $6.84 $3.8 billion

4Q06 $59.97 $6.93 $3.3 billion

This revenue stability is due to the fact that EPD is not merely a single service company. Instead it offers a whole portfolio of energy assetsprocessing plants, fractionation plants, offshore platforms, pipelines, etc. each of which contribute to maintaining the companys growth. Thus it can service a wide variety of energy explorers and producers needs depending on the quality of the fuels they extract from the earth. Which brings us to today.

Domestic Reserves + Changing Energy Policy= $$ For EPD

As Im sure youre aware, the US experienced a major energy bubble in 2008. Exxon posted the largest quarterly profit in US history and gasoline prices hit $4+ per gallon resulting in gas consumption falling to a five year low. With energy prices at or near all time highs, energy demand falling, and the dollar staging a temporary bottom, the energy bubble was primed to burst. It did so in July 2008. Between then and January 2009, oil prices plummeted 80% and natural gas fell 76%. However, what you may not know is that oil has since nearly doubled from its bottom of $30. As I write, black gold is trading around $50 a barrel. Natural gas, however, has continued to fall due to major discoveries in Texas, Louisiana, Arkansas, and Pennsylvania. To be blunt, the US is now swimming in natural gas. By conservative estimates, the supplies that have recently been discovered could satisfy the USs oil needs for at least 18 years. More liberal analysis (from industry-backed studies) claims the US may be sitting atop 2,200 trillion cubic feet of natural gas: enough to supply 100 years worth of US natural gas demand. These discoveries occur simultaneously with a noted shift in US energy policy. President Barack Obama has made it no secret that he wants to focus on and fund cleaner, domestic energy for the US. Of the viable choices (solar, biomass, natural gas, coal), natural gas has the distinction of fitting well into pre-existing US energy infrastructure AND releasing less carbon emissions that oil. Now, I am not implying that solar or biomass or wind energy are not viable options. And there is always the potential for technological breakthroughs that could make any or all of these options economically viable. However, natural gas will undoubtedly play a major role in the USs energy future. We have tremendous domestic reserves, which would dramatically reduce our dependency on

foreign supplies (98% of the gas consumed in the US is produced in North America). Natural gas is cleaner than oil. And it can also be rapidly implemented to the USs preexisting infrastructure. In fact, it already has. According to the Energy Tribune, 90% of the US energy capacity that has been added since 1998 has been natural gasified. Electrical generation based on natural gas has increased 34% since 2002. And several of the USs largest states California, Texas, and Florida are now generating between 40 and 50% of their energy from natural gas And remember, EPD doesnt actually OWN any natural gas. It simply processes, fractionates, and ships the stuff. It will profit from ANY increased focus on natural gas in the US, regardless of the commoditys price.

A Business Where Even the Waste is Profitable

EPD has assets in every step of natural gas production from offshore hubs to the pipelines that deliver the gas. Energy companies pay EPD for the use of these facilities, much as US drivers pay tolls for the use of certain roads. And the compensation can come in either cash or natural gas liquids (NGLs). Ill explain As I mentioned before, natural gas is not usable when first extracted from the ground. Its considered too rich due to the presence of various chemicals, most notably NGLs. Consequently, these are separated from the gas during the processing and fractionation processes. If the name NGL doesnt sound familiar, you probably know these chemicals by their individual names: ethane, propane, butane, etc. Theyre used in numerous industries ranging from plastics to fuel to industrial chemicals. Energy producers pay EPD for the right to use its fractionation plants, processing plants, storage facilities, and pipelines. Sometimes they pay in cash. And sometimes they pay by gifting EPD the NGLs produced during processing and fractionation. Energy companies love this option because it costs them next to nothing they only have to pay for transportation. And EPD loves it because it gets billions of cubic feet of NGLs that it can sell at market prices. As a result, EPD actually makes most of its revenues66% from its NGL segment. In addition to charging for fractionation and processing, EPD also charges its clients for storage and transportation services. EPD owns storage facilities in Texas, Louisiana, Mississippi, and elsewhere. All told the company has interests in facilities capable of storing 154 million barrels of fuel. EPD rents out these facilities to energy producers on a monthly basis. The beauty of this arrangement is that EPD actually charges based on the amount of space the producer

reserves, NOT the amount used. Thus if a company reserves room for 20 million barrels of petrochemicals but only stores 10 million barrels, EPD charges for the full 20 million. And then, of course, there are the pipelines: all 36,000 miles of them spread across 13 states. Cheaper than shipping or trucking, pipelines are the mode of transportation of choice for energy producers. And EPDs pipeline volumes have increased each of the last three years. (in Millions Barrels Per Day) Volumes 2006 1.8 2007 1.9 2008 2.0

Simply put, EPD is making money hand over fist from every step in natural gas production. And because its registered as a Master Limited Partnership (MLP) it has to distribute most of its earnings to shareholders. Today, EPD yields nearly 9%.

Dan Duncans Personal CD

Dan Duncan currently has approximately 50% of his personal fortune tied up in EPD shares. And he adds to his holdings every chance he gets. In 2004 he bought over $49 million worth of EPDs stock. In 2005 he was back for another $10 million. And in the last two years hes bought another $79 million (including $15 million in 2008 alone). Dans reasoning for this is two fold: EPD pays out more money to its limited partners than its general partner. EPDs annual payouts have more than doubled over the last four years.

As I mentioned before, MLP ownership is divided between two groups: the general partner and limited partners. The general partner holds most of the voting rights and oversees operations. The limited partners have little voting rights, but are not responsible for overseeing the business. Dan Duncan is the majority owner of the general partner shares, which gives him voting control over EPD as a whole. However, it is the limited partners, not the general partner who receive the biggest payouts. Between 1999 and 2008, EPDs limited partners received $4.5 billion in payouts. The company retained an addition $899 million to reinvest in the business. And the general partner received $579 million in payouts. Put another way, the general partner is the lowest on the ladder in terms of cash distribution. Limited partners collected nearly 8X as much money as the general partner. So its no surprise that Dan Duncan uses every chance he gets to increase his limited partner shares. EPD is in many ways his personal CD. And he gets a far higher yield by owning EPD common shares.

Today, EPD yields 8%. This income acts as a buffer against any share price volatility. And best of all, because EPD is an MLP, its payouts are not double-taxed once at the corporate level, the second time at the personal level. However, because of this, should you choose to invest in the company, you will have a separate tax form to fill out at year-end. Its called a K-1. Its simply a tax statement on your income as part owner of EPD. EPD will mail it to you. And TurboTax or any other tax preparation software has fields for this form. At most, it will add another 15-30 minutes to your tax preparation.

So Whats It Worth?
Today EPD is trading at 13 times earnings and 8 times cash flow. Based on its earnings and cash flow multiples, EPD has not been this cheap since the Tech Bubble (when energy companies were as popular as lepers). Its also cheaper than the S&P 500 as a whole based on Price to Earnings (P/E), Price to Sales (P/S) and Price to Cash Flow (P/CF). And EPD yields three times as much as the average S&P 500 company! In addition, because of the stability of its earnings and large payouts, EPD shares have shown an unusual degree of resilience during the market volatility of the last year. As you can see, its outperformed the S&P 500 dramatically since the financial crisis began. Its also worth noting that with its 7-9% yield (depending on share price), EPD fell only 15% in 2008 vs. a loss of 37% for the S&P 500.

One item to watch for, however, is EPDs cash flow. In the last couple of years, EPDs debt load has forced the company to actually issue more debt to continue maintaining its payouts. This is an acceptable practice temporarily, especially if the company is

expanding via acquisitions and new projectswhich EPD has been, spending $1.9 billion on new projects scheduled for completion by year-end 09. However, I would like to see this situation turnaround by the end of 2009 when the projects are completed. If EPD continues taking on more and more debt at that point, it will be time to revisit the companys financials to ascertain whether it can continue to fund its payouts via normal operations. EPD is Dan Duncans personal investment vehiclenearly 50% of his wealth is tied up in the company. Dan became Houstons richest man, and the 81st richest man in the world thanks to his holdings. Hes very committed to maintaining EPDs payouts and profitability. With EPD, we get 24 processing plants, 13 fractionation plants, 6 offshore hub platforms, and over 36,000 miles of onshore and offshore pipelines. Its an energy super-highway, with multiple billion-dollar tolls along its routes. And best of all, energy companies HAVE to use these services to bring their fuel to the market. By buying today, you can get in on the action at todays prices EPD yields 8.64%. Good Investing, Graham Summers