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After E&P Sale Fails, MCN Tries New Strategy

After E&P Sale Fails, MCN Tries New Strategy

MCN Energy Group surprised observers and angered some investors yesterday by announcing the cancellation of its Michigan E&P sale and a sharp change in strategic direction to a more regional focus from a national one.

MCN said a sudden price reduction by the winning bidder for its Michigan producing properties prompted it to remove the assets from the auction block and reincorporate them into a new regional strategy. It still plans on going forward with its other two E&P asset sales, but the retention of its Michigan assets and its E&P operations was a costly move. It triggered a wave of accounting changes on MCN's books, resulting in a $86.2 million ($1.03/share) net loss for the second quarter and negative financial results going forward. This new financial trouble is the latest in a series of disappointing news from the company. Last quarter, MCN discovered serious financial accounting manipulation within gas marketing subsidiary CoEnergy Trading and had to recalculate its earnings going back to 1997.

Last year, MCN announced it was discontinuing exploration and production as part of a corporate restructuring plan and took a massive $221 million second quarter charge. The Michigan assets, which contain 500 Bcf of reserves and produce 30 Bcf/year of Antrim Shale gas, were to be sold along with the three other E&P packages that made up MCN's entire exploration and production business (1.2 Tcf of reserves). The western E&P properties sold earlier this year for $165 million (see Daily GPI April 16). The entire divestiture was expected to bring in about $800 million, but now MCN expects proceeds to be about half that.

In addition, it said financial results for 1999 and 2000 will be adversely affected. Earnings are expected to be between $1.10 and $1.15 per diluted share, excluding unusual items, this year compared to $1.47/share analysts had estimated. With E&P operations included, earnings could reach $1.30/share, MCN said, but that still would be 17 cents below Wall Street expectations.

Had the E&P business remained a discontinued operation, MCN would have reported income from continuing operations, excluding unusual charges, of $4.8 million or $0.06 per share, essentially flat with comparable 1998 second-quarter results, the company said. Unusual charges totaled $83.4 million or $1 per share in 2Q99 and $220.5 million or $2.80 per share in 2Q98.

To get the company back on course, MCN launched a new strategic direction focused on regional rather than continental operations, with an emphasis on achieving operational efficiencies and growth through integration of existing businesses rather than through a portfolio of diverse, non-operated energy investments. MCN intends to leverage its core asset base, including its Michigan E&P properties, its Michigan Consolidated Gas utility, its large gas storage holdings and its pipeline investments in Vector, Millennium and Portland Natural Gas Transmission.

"We have adopted an integrated approach that we believe will result in significant operational efficiencies and synergies across our businesses," said CEO Al Glancy. "Our target market region spans the Midwest-to-Northeast corridor, an area in which we have a strong existing and developing infrastructure, where energy needs are growing at rates far above the national average, and where regulatory reform of the natural gas and electricity sectors is advancing relatively quickly. Our decision to retain the Michigan gas production properties was based on two factors: first, their obvious fit within our new strategy; and second, a very recent lowering of the bid for the properties, which changed what would have been a good deal for shareholders into an unacceptable price."

The changes, however, didn't satisfy one angry investor. "I don't think a new integrated strategy makes any sense whatsoever given that you don't operate or control any of the assets outside of the regulated utility that you are talking about getting the synergies from," he said during a conference call. "I don't see how we're not going from replacing unknown but expected transactional investment gains with unknown but expected operational gains when you haven't had an operational focus."

"First of all we're not going to change overnight. I think you are right in that instance," Glancy responded. "But what we want to do and plan to do is to put on future assets a much stronger operational focus than we've had historically."

Still exasperated, the investor asked why MCN's board hasn't just sold the company. "What weight or focus did the board give when they were going through this strategic review on the only option that appears clear to us will maximize shareholder value and that is a sale of the company?" he asked. "In the current environment with gas properties going for three times book, which would be a significant increase in the share price for MichCon -- forgetting about anything else that you have -- what weight [did the board place on that possibility]?"

"Speculating about M&A activity is something that we do not do so I'm going to pass on that question," said Glancy.

"The stock's down from $40 to $20/share over the past year, and we've gone through call after call after call of disappointments both in results, accounting irregularities, irregularities at CoEnergy [Trading]. Why should we as shareholders feel confident that this isn't going to continue to happen?"

"I think this management is committed to making sure this does not continue to happen. We've all got substantial stock and our interests are aligned with shareholders," Glancy said.

He said the company will continue pursuing new pipeline, electric power and energy marketing ventures, with an emphasis on operating projects that enhance other MCN businesses within the Midwest-to-Northeast corridor. Execution of the new strategic direction is expected to improve MCN's earnings and reduce its need for external capital, Glancy said. He said capital expenditures, previously expected to range from $600 million to $750 million per year, now are expected to be $500 million in 1999 and about $300 million in each 2000 and 2001.

The new strategy also includes a new organizational structure and the appointment of Stephen Ewing as president and COO. Ewing continues as president and CEO of Michigan Consolidated Gas, where he has served in positions of increasing responsibility since 1971. In addition, CFO and Treasurer Lee Dow becomes an executive vice president.

"This is the right strategy to carry MCN through the industry's evolution," said Glancy. "We have the organizational flexibility to respond to the changing marketplace and capture emerging opportunities, while remaining highly focused geographically and operationally. I look forward to reporting the results of these efforts."

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