Sempra-KNE Merger is Dead
In what one observer described as one of the first "blunders"
among energy mergers, Sempra Energy and KN Energy said yesterday
they have mutually agreed to call off their $6 billion marriage,
which was first announced in February. The two companies said that
as they were studying the integration process they discovered the
combined company "would not be able to realize the business
objectives they originally anticipated."
Sempra has agreed to reimburse KN $5.95 million for expenses
incurred in connection with the proposed deal and the two companies
have entered into a confidential termination and release agreement
that requires each to refrain from soliciting the employees of the
other for a two-year period and to refrain from acquiring any stock
or making any proposals to acquire the other party for a three-year
"When it became clear that the transaction with KN Energy could
not be completed to both companies' mutual satisfaction, we
determined that it was time to close this chapter and focus on our
own business strategy," said Sempra Energy CEO Richard D. Farman.
Sempra had intended to pay $1.8 billion in cash and stock for KN
and to assume $4.2 billion of KN's debt.
Most observers speculated Sempra just couldn't stomach KN's poor
financial performance and large debt given its own financial woes.
KN CEO Larry Hall revealed that the company's earnings will be
significantly below analysts expectations. KN is expected to
experience a loss of $0.20-$0.25 per share in the second quarter of
1999 and likely will break even or post a modest gain of $0.10 per
share for the year. That compares with analyst's forecasts of
$1.07/share. KN estimates earnings for the year 2000 are expected
to be in the range of $0.70 to $0.90 per share but officials said
it could be six months to 12 months before performance begins to
reflect improving market conditions.
Hall blamed KN's woes a variety of accidental factors, including
the warm winter, poor basis differentials between producing and
market areas on KN's pipelines, greater competition for markets in
the Midwest, and lower production from the Rocky Mountain and Gulf
regions to serve its pipeline assets. KN officials said about 14%
of Natural Gas Pipeline Co.'s firm capacity was not under contract
in the first quarter and 12% was not under contract in the second
quarter. KN expects a $20 million income decline during the second
quarter from the uncontracted capacity and noted a significant
number of contracts are terminating in 2000. High storage levels
also have not helped.
Some observers see KN's problems dating back to its acquisition
of MidCon in December 1997, which was followed by deep staff
reductions and large financial and operational hurdles. During a
conference call with analysts yesterday, KN CEO Larry Hall said the
company has cut about $95 million in costs related to the KN-MidCon
integration, but "..we've got some challenges to replace" the
personnel that left following the KN-MidCon merger. He indicated
the KN-MidCon integration was a small part of KN's difficulties.
KN intends to heal its wounds by selling off up to $300 million
non-strategic and unprofitable assets, but it has not disclosed
which assets have been targeted. KN officials said pipeline assets
other than NGPL will be included in the sales.
Merrill Lynch analyst Rebecca Followill said KN's earnings
projections came as a shock to everyone and were probably to blame
for the merger's failure. "Even the people who study the company
and have studied the company for a long time weren't looking for
Followill, however, said KN shouldn't entirely take the blame.
"Not every marriage works, you know. It's like blaming a divorce on
one party. You know markets change during due diligence, and these
people just walked away. It was mutually agreeable. I don't want to
call it a spat."
Analysts called the Sempra-KNE deal a steal when it was first
announced because Sempra was paying $25/share when KNE's 52-week
high was $40. Some were expecting a bidding war for KNE with other
energy companies jumping in. But since then KN's stock price has
cascaded downward. Before the announcement yesterday, its stock
price had been hovering slightly less than $20/share. Afterward it
fell nearly 30% to close the day down $5.13 at $13/share. SRE was
down $1.13, or 5%, to $22.81/share.
"Ultimately this industry is about scale and scope and the
merger gave Sempra scale and scope, just what they were looking
for," said Followill. "It gave them a more diversified asset base,
pushed them out of California where they were so heavily dependent,
gave them more pipeline assets to play off from a power generation
standpoint. We liked it for those reasons," she said. "I think any
merger Sempra gets in after this may be more conservative. KN had a
lot of nonregulated assets which provide a lot of advantages but
also are a much higher risk as you can see with what KN announced
KN's Hall stressed the positive in saying the company is
"engag[ing] in some capital reallocation planning, which will serve
us well moving forward as we focus on improving operations
efficiencies, managing capital expenses and investing in projects
that will position KN for long-term earnings growth."
Farman said Sempra intends to expand its "geographic footprint,"
work on retail energy services, build wholesale trading, and grow
an asset base that supports those operations.
Sempra, based in San Diego, has two regulated utilitity
subsidiaries-- Southern California Gas and San Diego Gas &
Electric. KN Energy is the sixth-largest integrated gas company in