Merrill Lynch analyst Sam Brothwell believes the last four major pipeline company sales indicate that the market for pipeline assets is “likely peaking here” at nine or 10 times earnings before interest taxes depreciation and amortization (9X or 10X EBITDA) and should drift back to more normal levels of about 8X EBITDA over time.

But valuations have risen substantially since collapsing in 2002 to about 7X EBITDA. Pipeline valuations rose sharply this year with four major asset sales going for values in the 9X EBITDA area, including the planned purchase announced last week of Enron’s pipelines by Southern Union (9.8X EBITDA), TransCanada’s purchase of Gas Transmission Northwest (9.3X), Magellan’s purchase of Shell’s product pipelines (10.9X) and Atmos Energy’s purchase of TXU Gas (10.1X).

Historically, regulated pipeline assets have been valued at about 8X EBITDA. But after Enron’s demise and the financial collapse of many industry companies, pipeline assets were going for fire sale prices of 7X EBITDA. Kern River Gas Transmission, Northern Natural and Williams Central went out the door for bargains. Low valuations persisted last year with CMS selling Panhandle to Southern Union and Williams selling Texas Gas to Loews Corp. Enbridge also picked up Alliance for roughly 7X EBITDA, said Brothwell.

“In our view, the low multiples were not only driven by the dire financial condition of many pipeline companies, but also reflected the low gas prices and perceived oversupply that characterized the markets after Enron’s blowout,” he said, recalling that gas prices fell to less than $2.00 in early 2002, “dragged down by the weak economy and a winter that basically didn’t happen.”

“The attendant tripling of natural gas prices since the 2002 nadir has, in our view, heightened the market’s awareness of the importance of gas infrastructure,” said Brothwell. “All that said, there is a practical limit to how high things can go.

“Keep in mind that these remain regulated assets…[that] in most cases probably can’t earn much more than a mid-teens return on equity,” he said, also noting that pipeline companies are facing shorter contract durations, pipe-on-pipe competition and tougher expansion battles with states and landowners.

Many of buyers in the most recent transactions have been in the industry rather than private equity companies, indicating that the premiums likely have peaked and valuations should begin to come down, he added.

There also are only four major pipelines left out of 20 that previously were publicly traded. And the major pipeline companies have made significant financial progress and are in better shape than they were a year ago. “That said, the potential for another asset sale or two does remain as these companies seek to optimize their asset mix,” said Brothwell.

He also predicted further consolidation or asset sales at the local distribution company level. There remains at least one financially distressed LDC on the market currently — NUI Corp.

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