Given the lofty prices paid for midstream assets recently, SanAntonio, TX-based Aquila Gas Pipeline believes the time is right totest the waters for a possible sale or merger. The Texas andOklahoma gas processing and pipeline company has hired MerrillLynch & Co. to assist in the effort.

“Clearly we are in a good M&A (mergers and acquisitions)market right now if you have assets to sell,” said AQP CEO JoeBecraft, referring to recent high-priced purchases of USX Delhi byKoch Industries, TPC Corp. by PacifiCorp and Valero by PG&ECorp. “And we have an excellent strategic position with our assets.We have the Oasis Pipeline and the Southeast Texas Pipeline Systemin the Austin Chalk as well as our pipeline and plant in westernOklahoma.” Aquila owns and operates 13 gathering pipeline systemswith 3,400 miles of pipe, four gas processing plants, two gasstorage facilities, and a 35% ownership interest in the 600-mileOasis Pipeline, which transports about 1 Bcf/d of gas between twokey spot market locations: the Waha Hub in West Texas to the KatyHub in East Texas. “Our total assets list at around $650 million atthe present time,” said Becraft.

AQP’s net income was $25.2 million ($0.86/share) in 1997compared to $32.5 million ($1.10/share) in 1996. Despite the toughyear, which was a result of low natural gas liquids prices andtight marketing and gathering margins, AQP has maintained steadygrowth. But given the current consolidation trend, Becraft saidshareholders would “realize greater value if AQP assets werestrategically linked to create a larger, more competitive growthvehicle.”

The company’s main problem has been that its stock has sold at a”substantial discount” to its peer group, according to Becraft. “Wemight sell on an operating basis 6.5 or 7 times operating income,where our peer group might sell for nine to 15 times operatingincome,” he said. The company’s stock rose $3.56/share yesterday to$15.88/share but has been as low as $9/share over the past year.”Part of that is our capital structure. We have very limited floatout there with 82% of our shares held by UtiliCorp United. So ourstock hasn’t been a good currency for expansion. We’re not in avery good position to grow with our present capital structure.”UtiliCorp is more interested in growing its gas and electric powermarketing business than sinking dollars into midstream assets. Inaddition, UtiliCorp stock trades on a price-earnings basis. “Theyare dedicated to increase their earnings each year by 8%. Thatconflicts fundamentally with being able to make major acquisitionsin the midstream market, which takes several years to realize goodreturns. So it’s just hard to grow with that particular structure,”said Becraft. “It’s like being between a rock and a hard place.”

Becraft believes a “wide range” of companies might be interestedin buying AQP: an electric utility, for example, that believes inconvergence but doesn’t have significant gas assets, a gas pipelinethat doesn’t have a presence in the midstream business, a producerthat has an interest in midstream gas assets, a fully integratedpipeline that might not be well represented in Texas, or perhaps aCanadian energy company that doesn’t have significant U.S. assets.”There’s quite an array of possibilities.”

But one analyst believes otherwise. “It’s a great asset but itsreally a single purpose, fairly geographically circumscribed asset,where your main output is liquid not gas. It doesn’t give anoutsider a chance to build a strategic base, unlike some of theother midstream companies that have been purchased. Delhi, TPC andValero had a wider array of assets and more trading points. This ismore of what I call a ‘plug and play asset,’ where basically youplug it into your system, cut all the overhead, divert a little ofyour gas stream and run the plant higher.

“The most logical buyer would be Union Pacific because they fill[AQP’s South Texas Austin Chalk processing] plant,” the analystsaid. They also have a big physical position in Carthage, TX,marketing in East Texas, a little exposure in the [Pinnacle Reef].But they just bought Norcen and the scuttlebutt is that they wouldlike to sell their midstream business as opposed to add to it.” Heexpects other regional liquids players to be interested, but notessome of most likely candidates currently are digesting otherrecently purchased assets. Tejas Gas bought Transok (a company ofsimilar size to AQP) for $690 million in 1996 and then Shell boughtTejas Gas for $2.4 billion ($61.50/share, a 23% premium). Kochrecently purchased Delhi for $762 million. And NGC entered into a$1 billion merger with Chevron’s Warren Petroleum and its naturalgas business unit.

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