El Paso, Sonat to Claim Top Spot Among U.S. Pipelines
Western-based El Paso Energy, which lassoed Tennessee Gas Pipeline and
a route to New England three years ago, rode into the Southeast last week,
announcing it will acquire Sonat and its Southern Natural Gas Pipeline
in a $6 billion deal.
With the purchase, El Paso also will lay claim to an additional 14,000
miles of pipe, which includes a half interest in Florida Gas Transmission,
not to mention a hefty 228 Bcfe of annual natural gas and oil production.
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 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.
The $6 billion 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
closing price on the Friday preceding the deal's announcement. Sonat shareholders
would own 48% of the new company.
El Paso-Sonat's interstate pipeline systems, includingTennessee Gas
Pipeline and Sonat's 50% share in Florida Gas Transmission through its
interest in Citrus Corp., would stretch from Bakersfield to Birmingham
and Brownsville to Boston, leaving out only the Midwest. "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
The transaction also would create a top-10 gas marketer Based on 1998
physical sales volumes, the combined company would market about 7.2 Bcf/d
of gas sales, putting it at No.7 in NGI's ranking of North American gas
marketers. The companies claim they would be ranked No. 4 in power marketing,
behind Enron, Duke, and Coastal. However, El Paso was No. 16 last year
with 44.68 million MWh, and with only 11 million MWh sold last year, Sonat
didn't even make the top 20. Combined annual power sales would have put
the company at No. 14 in NGI's power marketer ranking.
Meanwhile, the pipeline company significantly heavied up its E&P activities
with about 228 Bcfe of annual Sonat production. While Wise said the production
would fuel new gas-fired power generation to be developed by the company,
some analysts wondered whether the company would be comfortable with such
an increased E&P exposure.
In a conference call, Wise pledged to maintain E&P operations as
a "strategic asset," not a "growth engine." 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
A year ago, El Paso acquired DeepTech International's interests in Leviathan
Gas Pipeline through a series of transactions worth about $450 million
(see NGI March 9, 1998). "[W]e would
not rule out the company transferring some of (Sonat's) Gulf of Mexico
gathering assets into the Leviathan MLP (master limited partnership) vehicle
and we would not rule out the company transferring some of Leviathan's
non-core assets (such as its E&P plays) up to the parent level,"
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 Commission regulations affecting the amount
of combined company assets it could sell during the first two years.
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.
"Worth noting is that we see no elements in the Sonat deal which
could prevent another company (such as an electric) from acquiring (El
Paso) down the road," Barone wrote in a PaineWebber research note.
"A likely takeout price on El Paso is the upper $40s to $50 per share."
Heavy trading in El Paso and Sonat shares preceded the deal's announcement.
On Friday, March 12, trading in El Paso shares was nearly triple normal
activity. Sonat shares traded at more than five times their usual volume.
The combined company will be headquartered in Houston. Sonat is currently
headquartered in Birmingham, AL, and the headquarters of Southern Natural
Gas, 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
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.
Joe Fisher, Houston