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Enron Considers Selling E&P Unit

December 21, 1998
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Enron Considers Selling E&P Unit

Enron Corp. notified the Securities and Exchange Commission last week it is considering an unsolicited offer from an unidentified company for its 53.5% share of Enron Oil and Gas, one of the largest independent gas producers in the U.S. According to the solicitation, the third party would acquire Enron's shares in EOG and make an offer for all the outstanding shares. It also would require that Enron dispose of certain other assets.

While trying not to minimize the offer, an Enron spokesman did say it was among many such offers the company receives for its interests in assets. Most offers go unreported. But because Enron owns a majority share in EOG, it had to report the offer.

"Seems like they wouldn't have filed that 13 D [with the SEC] if this wasn't a good enough offer," noted Mike Cha of J. P. Morgan. "If they can get a good price for the stock, it's a good opportunity to get out of a business they may have been trying to get out of for a while," he said.

"They've always been looking for some way to make it a more liquid investment, but I think also they are considering whether they should even be in the E&ampP business," said another observer who requested anonymity. "When you look at it over time, the E&ampP business basically destroys value. It's not a value creation industry. EOG hasn't really made them money in the last 10 years. They had problems four years ago, then three years ago and then again two years ago, and every year they have said the problems were over and they would show up again the next year. It was always a good subsidiary to dump their hedging losses. They took a lot of onetime losses."

Enron formed Enron Oil &amp Gas in 1987 from its existing InterNorth and Houston Natural Gas units. It maintained full ownership until 1989, when it spun off a portion to the public to raise $200 million.

EOG has had great success building reserves and replacing production. In 1997, it replaced 220% of production, including 194% through drilling additions. It also has an attractive set of assets, including more than 4.5 Tcfe of gas and oil reserves. It focuses on the U.S., Canada, Trinidad and India. About 69% of its reserves are in North America while the rest are overseas, and about 85% of its reserves are natural gas while 15% are oil. In the third quarter, Enron Oil &amp Gas produced 1.02 Bcf/d of gas and 31,600 b/d of oil. However, the company reported third quarter 1998 net income of $5.9 million, or $.04 per share, compared to net income of $31.2 million, or $.20 per share, for the comparable period a year prior. The decrease in earnings was attributable to lower prices for both natural gas and crude oil, the company said. Earnings of $122 million, or $0.78 per share, in 1997 compared with $140 million, or $0.88 per share, in 1996, were below original expectations primarily because of natural gas hedging losses. Net income would have been a record $158 million had it not been for the hedging transactions which primarily affected earnings for the first quarter of 1997.

Donato Eassey of Merrill Lynch said Enron's decision to sell EOG will "boil down to price and value and what it would take them to replace that cash flow and earnings power. EOG is a cash-flow business. It would be kind of odd if they sold it. They just increased their own ownership in that company not long ago.

"I would think they would consider it [if the offer was in the low $20s/share]." EOG has a market value of $2.52 billion. EOG shares rose $2.63 on the news late Tuesday last week following the announcement, to close the day at $15.50 a share. On Wednesday its shares inched up another 6% to close at $16.38. By Friday, share prices were more than $17.

Cha agreed Enron probably would consider an offer in the low $20s, particularly if it included a combination of cash and stock in an attractive company. "Earlier this year their stock had hit the low-$20s and they said it was way under-valued, which probably meant they wanted high-$20s or low-$30s. Now it's a different world so maybe the low-$20s is what they could price it at."

Eassey said proceeds would be "additive in terms of the company's financial flexibility" because Enron already has a financing plan in place for the international water company it formed during the summer. In July, Enron announced the formation of a global water business, called Azurix, to own and operate strategic water and wastewater assets, develop related infrastructure, and extend critical risk management and finance skills into the international water market. As a key step in establishing the business, Enron announced an offer for Wessex Water Plc, a water and wastewater company in the south west of England. That transaction is scheduled to close this month.

Enron also plans to invest more than $100 million in Brazil in 1999 to expand its local business and announced last week it plans to invest $300 million in a gas distribution joint venture in South Korea.

Rocco Canonica

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