Despite finally convincing Columbia Energy Group to completelyreverse its position and sell-out for about $72/share, $2/shareless than the previous tender offer, NiSource Inc. still faces asteep uphill battle to get the transaction approved by shareholdersand regulators, and to finance the deal, according to investmentbankers.

“It’s not going to be a walk in the park,” said PaineWebber’sRonald J. Barone. “Their stock is killed; they can’t sell stock [tofinance it]. They’re just going to have to do it through assetsales and debt initially.” In its prior offer for Columbia,NiSource planned to issue $2.6 billion in equity, the largest everby a U.S. utility, to retire part of the $6 billion loan it plansto get from Credit Suisse First Boston and Barclays Bank. That’s nolonger a viable option, however.

Barone said he was surprised during the first part of theconference call on the transaction last week to hear NiSourceofficials saying they had not planned any asset sales to cover thecash portion of the deal or to pay off the debt. “Then a little bitlater in the call it came out that there were going to be assetsales,” potentially as much as $1.5 billion in assets sales.

The company also sent out mixed signals regarding the amount ofearnings dilution expected from the transaction, whether Columbiaexecutives were going to be offered positions in the new company oron its board, if there were going to be any layoffs and if so wherethey would take place.

One observer said, “Stuff like that makes you wonder aboutcredibility. I just felt there wasn’t a true, open, fulldiscussion. I think stuff just tripped out. Are they just glancingover things or what? They are very vague on the assets sales.”

The immediate cause for concern, however, is the collapse ofNiSource’s stock price. Following the merger announcement lastMonday, in which NiSource said it will take on about $2.5 billionin Columbia debt in addition to paying out $6 billion in cash andstock, NiSource shares crashed to a six-year low of less than$13/share, a 16.5% drop from the day prior. Its shares remainednear $13/share throughout the rest of the week. It’s stock hadtraded above $30/share in fall of 1998.

“This will be a very close one to watch given that NiSource’sstock price has done so poorly,” said Edward Jones analyst RobinDiedrich. “I think they have tightened up the terms enough so thatit looks like it will get done one way or another. Even ifNiSource’s shareholders do not approve the deal, they can take awaystock options and then go forward. If you look at the fact that60-70% of Columbia’s shares already were tendered to NiSource, Idon’t think you have to worry about Columbia shareholders [buyingthis].”

The agreement calls for Columbia shareholders to receive$70/share in cash plus a $2.60 face value SAILS(SM) (a unitconsisting of a zero coupon debt security with a four-year forwardequity contract). Columbia shareholders also have the option toreceive new holding company stock in a tax-free exchange, for up to30% of the outstanding Columbia shares. Under the common stockoption, each Columbia share will be exchanged for $74 in newholding company stock subject to a collar. If the average NiSourceshare price during the 30 days prior to closing of the transactionis $16.50 or below, Columbia shareholders will receive 4.4848shares of new holding company stock for each Columbia share.

If NiSource shareholder approval is not obtained, thetransaction will automatically be restructured so that Columbiashareholders will receive $70 in cash plus a $3.02 face-value SAILSunit of NiSource with no option for Columbia shareholders to electnew holding company stock.

Responding to a question from a reporter during the conferencecall regarding the contingency set up in case NiSource shareholdersreject the deal, NiSource CEO Gary Neale said the company didn’tput that option in place expecting shareholder rejection. “We thinkwe have good support from our shareholders. That was the Columbiaboard just wanting to be conservative to make sure that they didn’thave a deal that could unwrap.”

The transaction requires approval by shareholders, as well asregulators in five states and the federal government beforeNiSource can even begin attempting to cross the significantfinancial hurdles ahead.

If NiSource’s shareholders did reject the transaction, Nealesaid, it wouldn’t mean they were against it entirely. “If theyvoted against it, our shareholders [would be saying] really thatthey don’t want any equity issued at this time — ‘do it withdebt.’ I don’t think they would be saying they don’t want the dealdone.”

Neale also said he expected no regulatory trouble because theassets of the two companies do not overlap. He noted the FederalTrade Commission raised no objection to a previously proposedNiSource transaction with Columbia.

NiSource has obtained a commitment from Credit Suisse FirstBoston and Barclays Bank Plc for a bank facility in an amountsufficient to finance the cash portion of the purchase price.

In addition, Neale said NiSource has identified about $150million in costs savings from eliminating duplicative corporate,administrative and purchasing functions.

But Neale waffled on the earnings impact. At first he said thetransaction would dilute earnings by 10 cents/share in 2001. Thenon Thursday PaineWebber’s Barone said NiSource had revised that to13 cents/share dilution.

The long-term picture apparently is somewhat brighter. NiSourceexpects a 10-cents/share increase in earnings in 2002 and doubledigit earnings growth annually thereafter.

“I think it will probably be successfully completed,” saidBarone. “I would think probably late this year. It will be aformidable competitor. But near-term the stock is going to sufferbecause, number one and probably foremost, its’ dilutive in thefirst year.. “[Investors] aren’t going to look ahead and say ‘ohit’s good for 2002, and therefore I’m going to buy it today.’ Themarket is too myopic for that.”

Merrill Lynch energy analyst Donato Eassey attributed some ofNiSource’s current stock problems to the quirkiness of investors.”While I like it, the market clearly doesn’t in NiSource’s case,but I think that will change over time,” he said. “First of all,[the market] likes anything with a dot com associated with it.That’s what the market is infatuated with. These kinds oftransactions also are usually good for the acquiree, but not theacquirer near term. The combination of those things is hurtingthem, but over time I think rational investors will prevail. If youlook at the multiple that it is currently trading at, it’sridiculous, ridiculously cheap.

“Every acquirer’s stock takes it on the chin initially. Look atDominion Resources [which bought Consolidated Natural Gas for $6.4billion at the beginning of the year]. See how well it performedover time after the deal?”

Columbia Reverses Course

Meanwhile, observers also were surprised to see Columbia doing what it spent that last eight months saying it would never do. After NiSource raised its tender offer last October to $74/share from $68/share, Columbia initiated a review process during which it brought in other potential suitors to in effect test the market for its assets and see if it could get a better price (see NGI, Oct. 25).

Following the review, its long-standing and frequent refrain of”wrong price wrong time, wrong company” underwent a surprisingreversal to the more upbeat tune of “right price, right time, rightcompany.” Columbia gave in to NiSource’s demands and somehow endedup accepting an even lower price than the one it rejected only afew months earlier.

“Our board of directors and senior management fully support thistransaction, which we have determined is in the best interest ofColumbia and its shareholders,” said Richard. “The board reachedthis conclusion after a comprehensive evaluation of strategicalternatives to generate value greater than that which Columbia’sbusiness plan could create. We believe this merger with NiSourcenot only meets our objective of delivering superior value toColumbia’s shareholders, but provides an opportunity for ourshareholders and employees to participate in the growth of thecombined entity.”

Energy analyst Curt Launer of Donaldson Lufkin and Jenrettesaid, “The good news is that there is a transaction being doneafter this long wait. The bad news is to some degree that theoverall decline in the market over the past six to eight weeks,including the dramatic decline in most utility stocks, which aretrading at 52-week lows, really is what took away Columbia’sopportunity to get the kind of value we once thought that they wereworth.” He values the transaction at $71.75/share based on thepresent value of the SAILS.

“There wasn’t anything to go on at the end of the day forColumbia to achieve the higher valuation, and they were left to dothe right thing by selling out to NiSource.” Launer said the othercompanies who were “in the mix” included FirstEnergy, SouthernCompany and Constellation Energy among others.

Columbia spokesman Al Rankin said negotiations involved “morethan a dozen” U.S. and foreign companies. “The board’s decision inOctober that NiSource’s $74/share offer was inadequate was based oninformation available at that time including written opinions fromtwo investment banks…,” Rankin noted. “Since that time theStandard & Poors electric index has declined 12-14% whileinterest rates have climbed significantly. Also as a result of thecompany’s evaluation of its alternatives we got a lot of newinformation about the competitive landscape in this rapidlyconsolidating energy industry and therefore the board reached theconclusion that the revised offer was in the best interests of thecompany’s shareholders.”

Too Much Bad Blood

For many observers, it still seems amazing that two companies who waged such dirty public relations campaigns against each other could bury the hatchet and come to terms. There were multiple lawsuits on both sides. Columbia took out full-page ads criticizing NiSource’s environmental and rate records, and then warned its own ratepayers of the potential for price increases and restrictions on customer choice if NiSource was successful (see NGI, July 26).

“What was said in the heat of battle is now behind us,” saidRankin. “Both Rick Richard and Gary Neale have expressed a desireto work together in a collegial, professional manner to make surethe integration of the two companies is as rapid and seamless aspossible.”

It doesn’t appear, however, that Neale and Richard will beworking together for very long. In its prior offer, NiSource wasplanning to give Columbia’s five top managers, including Richard,seats on an expanded NiSource board. Richard was even offered avice chairmanship.

“According to the information we got today, there’s not going tobe any Columbia representation on the board or in a majormanagement position after the close,” said analyst Robin Diedrich.

Although Neale assured observers that Columbia management wouldbe given opportunities in the new company, he said it has not beendetermined which positions will be available. “There are no formaloffers of positions for either [Columbia’s] directors or for [RickRichard], but we are taking all of that under advisement. We havethe freedom to do anything we want.”

“There was just too much bad blood between Richard andNiSource’s management,” said Deutsche Bank Alex. Brown analyst EdTirello.

Tirello also said Columbia “got a tad too greedy” in turningdown NiSource’s sweetened $74/share bid with its special managementincentives.

NiSource apparently does intend to keep lower managementpersonnel onboard from Columbia’s operating units. “Our success atbuilding our business at NiSource has always been predicated uponfully utilizing the skills and experience of the management teamand employees present within the company with which we havemerged,” Neale said. “We’re very encouraged by the similarity ofour corporate cultures. We’ve been impressed by the quality ofColumbia’s management team. We anticipate retaining key managementpersonnel for each of the critical operating units and maintainingheadquarters in their current locations.”

Largest Gas Company East of the Rockies

With assets stretching from the Gulf of Mexico, through theMidwest to the Northeast, the combined company will have a powerfulplatform, with access to 30% of the U.S. population and 40% of U.S.energy consumption. The company will have over 4.1 million gas,electric, water and propane customers located primarily in ninestates. It will be the largest gas company east of the Rockiesbased on customers. It will have the nation’s second largest volumeof gas sales with 911 MMcf/d, and it will have the most gas storagewith 700 Bcf of capacity. Based upon the closing market price forNiSource on Feb. 25, the combined company would have an enterprisevalue of $13.7 billion.

“This combination creates the leading gas competitor within thekey energy corridor between the Gulf Coast and the Northeast,” saidNeale. “It will be a super-regional energy company withcomplementary market areas and no asset overlap. Scale andgeography are critical to success in the evolving competitiveenergy industry, and we will have the size and scope necessary tocompete and win.”

Merrill Lynch’s Donato Eassey said the new energy companies haveto be of “size, scope and scale to compete in this ever-increasingutility world going forward. While there are some challenges nearterm, I think the long-term prospects of such a combination arevery formidable in terms of the number of customers that they willhave, their storage position and their ability to arbitrage offgeographic diversification.”

Rocco Canonica

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