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It's True; El Paso, Sonat Plan Combination

It's True; El Paso, Sonat Plan Combination

Like dreams, rumors sometimes come true-and more frequently these days when the gossip foretells of yet another energy industry consolidation. Last week's buzz became this week's ballyhoo Monday when El Paso Energy and Sonat Inc. said they will merge in a $6 billion deal.

The transaction includes $2 billion in Sonat debt and is expected to be completed in the second half of the year. Each Sonat share is to be converted into one share of El Paso in a pooling of interests to create a combined company worth more than $14 billion based on El Paso's Friday closing price. Sonat shareholders would own 48% of the new company.

According to the companies, the joining of El Paso and Sonat would unseat top players as measured by two industry yardsticks. El Paso-Sonat's 40,600 miles of interstate pipe would surpass Enron's 32,000 miles, and El Paso-Sonat's 12.4 Bcf/d of interstate transport volumes would better Williams and the stand-alone El Paso, both of which transport 9.2 Bcf/d. The combined company would rank No. 3 in gas marketing, behind Enron and Duke Energy, and No. 4 in power marketing, behind Enron, Duke, and Coastal.

"The merger between El Paso and Sonat will create the preeminent natural gas company in North America," said El Paso CEO William A. Wise. "The combined company will rank among the leaders in all key sectors of our industry including interstate transmission, intrastate transmission, gas gathering and processing, energy marketing and power development."

Wise will head the combined company, which will retain the El Paso name. One industry observer said he thinks it was Wise's desire to remain top dog that quashed a rumored El Paso pairing with Southern Co. Still, the observer did not rule out the potential for El Paso to pair with an electric company down the road.

El Paso-Sonat's interstate pipeline systems would stretch from Bakersfield to Birmingham and Brownsville to Boston. "They will tap the most prolific supply basins in North America and access the largest and fastest growing natural gas markets in the United States, including Florida and other key southeastern states," Wise said. "New gas-fueled power generation development is particularly active in these areas. Our ability to access these new markets will further diversify our market base and allow us to employ our combined expertise in energy marketing and power generation."

Wise also highlighted the Sonat E&P assets his company would acquire and the opportunities they would provide for El Paso Field Services. In a conference call, Wise pledged to maintain E&P operations as a "strategic asset," not a "growth engine." Sonat's production is seen by El Paso as ripe for powering gas-fired electric generation. The combined company would control about 4,000 MW of generation, and there are plans in the next two to three years to develop 7,000 to 8,000 MW more. Some analysts scoffed at the idea of merely maintaining an E&P business, saying it's either a growth or depletion business. One noted Sonat produces far more gas than a combined El Paso-Sonat would need to fire its power plants.

"Sonat Exploration has a substantial oil and gas exploration and production base that spans the southern United States from Texas to Alabama, including an important presence in the Gulf of Mexico," Wise said. "Our onshore gathering and processing facilities and Leviathan Gas Pipeline's offshore gathering operations will provide Sonat Exploration's existing 1.6 Tcf of natural gas equivalent reserves access to burgeoning power generation markets and the best interstate pipeline network in the U.S."

El Paso-Sonat would hedge a large portion of its production. "[El Paso] is acquiring the E&P program at near $1.00 per Mcf after it has been fully restructured over the past year. Nevertheless, we would not rule out a divestment at some point," PaineWebber said in a research note. As the merger would be a pooling of interests, El Paso would be constrained by Securities and Exchange regulations affecting the amount of combined company assets it could sell initially.

Analysts considering an El Paso-Sonat pairing generally didn't see a deal as being non-dilutive to earnings, one of El Paso's stated criteria for acquisitions. That thinking has changed. PaineWebber analyst Ron Barone, in a research note, said three factors cause him to believe the deal will be accretive in 2000. They are cost savings and synergies, a lower depreciation, depletion and amortization rate per unit of production at Sonat after a ceiling test write-down, and lower benefits plan expenses at El Paso. PaineWebber raised its 2000 earnings per share estimate for El Paso to $2.40 from $2.35 and retained its 1999 estimate of $2.10/share. El Paso said it expects earnings accretion of about 3% in 2000.

The combined company will be headquartered in Houston. Sonat is currently headquartered in Birmingham, AL, and the headquarters of Sonat's interstate pipeline, Southern Natural Gas Co., will remain in Birmingham. Sonat CEO Ronald L. Kuehn Jr. will become the non-executive chairman of the board for the combined company until Dec. 31, 2000. The board will consist of 15 directors-nine designated by El Paso and six by Sonat. The merger is subject to customary conditions, including approval by the stockholders of Sonat and receipt of certain required governmental approvals.

To assure Sonat stockholders the deal will be completed, El Paso agreed that if El Paso stockholder approval for the common issuance were not obtained, El Paso would issue 19.9% of its outstanding common stock as merger consideration, with the balance of the consideration paid in non-convertible, long-term preferred stock. This arrangement, which is not expected to come to pass, is similar to a provision in El Paso's acquisition of Tenneco Energy three years ago.

The merger agreement includes customary non-solicitation, termination fee and expense reimbursement provisions. In addition, each of the companies granted the other an option to buy up to 19.9% of its outstanding common stock, exercisable if the merger is terminated under certain circumstances. Members of the Zilkha family, who own about 21% of the outstanding Sonat shares, agreed to vote for the merger. Donaldson, Lufkin and Jenrette Securities is El Paso's financial advisor, and Merrill Lynch is advising Sonat.

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