Given the lofty prices paid for midstream assets recently, SanAntonio, TX-based Aquila Gas Pipeline (AQP) started testing thewaters last week for a possible sale or merger. The Texas andOklahoma gas processing and pipeline company hired Merrill Lynch&amp Co. to assist in the effort.

“Clearly we are in a good M&ampA (mergers and acquisitions)market right now if you have assets to sell,” said AQP CEO JoeBecraft, noting the recent purchases of USX Delhi by KochIndustries, TPC Corp. by PacifiCorp and Valero by PG&ampE Corp.”And we have an excellent strategic position with our assets. Wehave the Oasis Pipeline and the Southeast Texas Pipeline System inthe Austin Chalk as well as our pipeline and plant in westernOklahoma.”

AQP owns and operates 13 gathering pipeline systems with 3,400miles of pipe, four gas processing plants, two gas storagefacilities, and a 35% ownership interest in the 600-mile OasisPipeline, which transports about 1 Bcf/d of gas between two keyspot market locations: the Waha Hub in West Texas to the Katy Hubin East Texas. (Oasis’ other owners include El Paso, with 35%, andDow Chemical, with 30%). Becraft said AQP’s total assets currentlylist at about $650 million.

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 stock has sold at a “substantial discount”to its peer group, he said. “We might sell on an operating basis6.5 or 7 times operating income, where our peer group might sellfor nine to 15 times operating income.” AQP’s stock rose$3.56/share to $15.88/share following the announcement last Tuesdaybut has been as low as $9/share over the past year. “Part of thatis our capital structure. We have very limited float out there with82% of our shares held by UtiliCorp United. So our stock hasn’tbeen a good currency for expansion. We’re not in a very goodposition to grow with our present capital structure.”

Majority owner UtiliCorp is more interested in growing its gasand electric power marketing business than sinking dollars intomidstream assets, said Becraft. In addition, UtiliCorp stock tradeson a price-earnings basis. “They are dedicated to increase theirearnings each year by 8%. That conflicts fundamentally with beingable to make major acquisitions in the midstream market, whichtakes several years to realize good returns. So it’s just hard togrow with that particular structure,” he said. “It’s like beingbetween 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 some analysts believe otherwise. “It’s a great asset but itsreally a single purpose, fairly geographically circumscribed asset,where your main output is liquid not gas,” said one analyst, whoasked to remain anonymous. “It doesn’t give an outsider a chance tobuild a strategic base, unlike some of the other midstreamcompanies that have been purchased. Delhi, TPC and Valero had awider array of assets and more trading points. This is more of whatI call a ‘plug and play asset,’ where basically you plug it intoyour system, cut all the overhead, divert a little of your gasstream and run the plant a little higher.

“If I was in the advising business, and we are to some degree,and some electric company said ‘boy isn’t this great, lets go bid Iwant to be in the gas business’ we’d throw up 47 red flags,” hesaid. “That doesn’t mean that XYZ bank, or ourselves running forsome fee, wouldn’t eventually do it for them if they said ‘I reallywant this.'”

Carl Kirst of Jeffries &amp Co. agreed AQP probably would not bethat attractive to an electric company. “I don’t know if anelectric is really going to be able to strip out enough costs toreally make it economical and make [worth while] whatever multiplethey have to pay.” AQP is more likely to attract another liquidsplayer, both analysts agreed. “For the gathering and processingbusiness, it’s really a critical mass and size and scale game. Justlook back five years ago and [you’ll see] we had 12 independentG&ampP companies in our universe. Now we have only four: Aquila,Western Gas, NGC and Mitchell Energy,” Kirst noted.

The other analyst said the “most logical buyer” would be UnionPacific resources because they provide the largest amount ofnatural gas to AQP’s South Texas Austin Chalk processing plant.”They also have a big physical position in Carthage, TX, marketingin East Texas, a little exposure in the [Pinnacle Reef]. But theyjust bought Norcen and the scuttlebutt is that they would like tosell their midstream business as opposed to add to it.” Otherregional liquids players might be interested, but some of the mostlikely candidates currently are digesting other recently purchasedassets. Koch recently purchased Delhi (which is similar in size toAQP) for $762 million. PacifiCorp bought Tejas Power for $13.41 pershare or about $288 million. Tejas Gas bought Transok (also ofsimilar size to AQP) for $690 million in 1996 and then Shell boughtTejas Gas for $2.4 billion ($61.50/share, a 23% premium). And NGCentered into a $1 billion merger with Chevron’s Warren Petroleumand its natural gas business unit.

Kirst estimates AQP’s projected EBITDA (earnings beforeinterest, taxes, depreciation and amortization) at $75 million thisyear and expects the company to bring in about 10 times that,”north of $750 million” in a sale.

The other analyst sees a lower value in AQP. “Delhi went out at14 times EBITDA. Valero went out in the low teens. You can see alot of strange things happen, but I’d be surprised if these guysget double digits,” he said. “This looks more to me like a TPC kindof deal without the marketing company. If they get eight timesEBITDA that would be about $14/share, 10 times would be $20/share.Their stock has been trading about seven or eight times EBITDA.” Hesaid one possibility, however, is a company could come in and buyAquila for $20/share with the expectation that oil prices soon willreturn to $20/bbl, gas prices are due for a downturn and NGL priceswill soon experience an up-surge. “But that’s a stretch.” AQP mightbring in about $750 million in that scenario.

AQP may be one of the last publicly traded, free standingmidstream companies in the market, but buyers shouldn’t see it as alast opportunity to grab a piece of the midstream business, bothanalysts said. Most of the majors still hold significant midstreamassets which could be divested. Some of the interstate pipelinesalso hold midstream assets they may want to part with in thefuture.

“Operating under the philosophy that ‘gees there’s only a few ofthese guys left; I’ve got to own one’ is asking for it,” said theunnamed analyst. “That’s me kind of ranting and raving and wavingmy hands looking out the window here, as opposed to somebody who’sgot an idea of how they’re going to collect a fee or build anempire.. Stranger things have been done.”

Rocco Canonica

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