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Outlook Remains Cloudy for NiSource, Columbia

Outlook Remains Cloudy for NiSource, Columbia

Despite finally convincing Columbia Energy Group to completely reverse its position and sell-out for about $72/share, $2/share less than the previous tender offer, NiSource Inc. still faces a steep uphill battle to get the transaction approved by shareholders and regulators, and to finance the deal, according to investment bankers.

"It's not going to be a walk in the park," said PaineWebber's Ronald J. Barone. "Their stock is killed; they can't sell stock [to finance it]. They're just going to have to do it through asset sales and debt initially." In its prior offer for Columbia, NiSource planned to issue $2.6 billion in equity, the largest ever by a U.S. utility, to retire part of the $6 billion loan it plans to get from Credit Suisse First Boston and Barclays Bank. That's no longer a viable option, however.

Barone said he was surprised during the first part of the conference call on the transaction last week to hear NiSource officials saying they had not planned any asset sales to cover the cash portion of the deal or to pay off the debt. "Then a little bit later in the call it came out that there were going to be asset sales," potentially as much as $1.5 billion in assets sales.

The company also sent out mixed signals regarding the amount of earnings dilution expected from the transaction, whether Columbia executives were going to be offered positions in the new company or on its board, if there were going to be any layoffs and if so where they would take place.

One observer said, "Stuff like that makes you wonder about credibility. I just felt there wasn't a true, open, full discussion. I think stuff just tripped out. Are they just glancing over things or what? They are very vague on the assets sales."

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

"This will be a very close one to watch given that NiSource's stock price has done so poorly," said Edward Jones analyst Robin Diedrich. "I think they have tightened up the terms enough so that it looks like it will get done one way or another. Even if NiSource's shareholders do not approve the deal, they can take away stock options and then go forward. If you look at the fact that 60-70% of Columbia's shares already were tendered to NiSource, I don't think you have to worry about Columbia shareholders [buying this]."

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

If NiSource shareholder approval is not obtained, the transaction will automatically be restructured so that Columbia shareholders will receive $70 in cash plus a $3.02 face-value SAILS unit of NiSource with no option for Columbia shareholders to elect new holding company stock.

Responding to a question from a reporter during the conference call regarding the contingency set up in case NiSource shareholders reject the deal, NiSource CEO Gary Neale said the company didn't put that option in place expecting shareholder rejection. "We think we have good support from our shareholders. That was the Columbia board just wanting to be conservative to make sure that they didn't have a deal that could unwrap."

The transaction requires approval by shareholders, as well as regulators in five states and the federal government before NiSource can even begin attempting to cross the significant financial hurdles ahead.

If NiSource's shareholders did reject the transaction, Neale said, it wouldn't mean they were against it entirely. "If they voted against it, our shareholders [would be saying] really that they don't want any equity issued at this time --- 'do it with debt.' I don't think they would be saying they don't want the deal done."

Neale also said he expected no regulatory trouble because the assets of the two companies do not overlap. He noted the Federal Trade Commission raised no objection to a previously proposed NiSource transaction with Columbia.

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

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

But Neale waffled on the earnings impact. At first he said the transaction would dilute earnings by 10 cents/share in 2001. Then on Thursday PaineWebber's Barone said NiSource had revised that to 13 cents/share dilution.

The long-term picture apparently is somewhat brighter. NiSource expects a 10-cents/share increase in earnings in 2002 and double digit earnings growth annually thereafter.

"I think it will probably be successfully completed," said Barone. "I would think probably late this year. It will be a formidable competitor. But near-term the stock is going to suffer because, number one and probably foremost, its' dilutive in the first year.. "[Investors] aren't going to look ahead and say 'oh it's good for 2002, and therefore I'm going to buy it today.' The market is too myopic for that."

Merrill Lynch energy analyst Donato Eassey attributed some of NiSource'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 of transactions also are usually good for the acquiree, but not the acquirer near term. The combination of those things is hurting them, but over time I think rational investors will prevail. If you look at the multiple that it is currently trading at, it's ridiculous, ridiculously cheap.

"Every acquirer's stock takes it on the chin initially. Look at Dominion Resources [which bought Consolidated Natural Gas for $6.4 billion at the beginning of the year]. See how well it performed over 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 surprising reversal to the more upbeat tune of "right price, right time, right company." Columbia gave in to NiSource's demands and somehow ended up accepting an even lower price than the one it rejected only a few months earlier.

"Our board of directors and senior management fully support this transaction, which we have determined is in the best interest of Columbia and its shareholders," said Richard. "The board reached this conclusion after a comprehensive evaluation of strategic alternatives to generate value greater than that which Columbia's business plan could create. We believe this merger with NiSource not only meets our objective of delivering superior value to Columbia's shareholders, but provides an opportunity for our shareholders and employees to participate in the growth of the combined entity."

Energy analyst Curt Launer of Donaldson Lufkin and Jenrette said, "The good news is that there is a transaction being done after this long wait. The bad news is to some degree that the overall decline in the market over the past six to eight weeks, including the dramatic decline in most utility stocks, which are trading at 52-week lows, really is what took away Columbia's opportunity to get the kind of value we once thought that they were worth." He values the transaction at $71.75/share based on the present value of the SAILS.

"There wasn't anything to go on at the end of the day for Columbia to achieve the higher valuation, and they were left to do the right thing by selling out to NiSource." Launer said the other companies who were "in the mix" included FirstEnergy, Southern Company and Constellation Energy among others.

Columbia spokesman Al Rankin said negotiations involved "more than a dozen" U.S. and foreign companies. "The board's decision in October that NiSource's $74/share offer was inadequate was based on information available at that time including written opinions from two investment banks...," Rankin noted. "Since that time the Standard & Poors electric index has declined 12-14% while interest rates have climbed significantly. Also as a result of the company's evaluation of its alternatives we got a lot of new information about the competitive landscape in this rapidly consolidating energy industry and therefore the board reached the conclusion that the revised offer was in the best interests of the company'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," said Rankin. "Both Rick Richard and Gary Neale have expressed a desire to work together in a collegial, professional manner to make sure the integration of the two companies is as rapid and seamless as possible."

It doesn't appear, however, that Neale and Richard will be working together for very long. In its prior offer, NiSource was planning to give Columbia's five top managers, including Richard, seats on an expanded NiSource board. Richard was even offered a vice chairmanship.

"According to the information we got today, there's not going to be any Columbia representation on the board or in a major management position after the close," said analyst Robin Diedrich.

Although Neale assured observers that Columbia management would be given opportunities in the new company, he said it has not been determined which positions will be available. "There are no formal offers of positions for either [Columbia's] directors or for [Rick Richard], but we are taking all of that under advisement. We have the freedom to do anything we want."

"There was just too much bad blood between Richard and NiSource's management," said Deutsche Bank Alex. Brown analyst Ed Tirello.

Tirello also said Columbia "got a tad too greedy" in turning down NiSource's sweetened $74/share bid with its special management incentives.

NiSource apparently does intend to keep lower management personnel onboard from Columbia's operating units. "Our success at building our business at NiSource has always been predicated upon fully utilizing the skills and experience of the management team and employees present within the company with which we have merged," Neale said. "We're very encouraged by the similarity of our corporate cultures. We've been impressed by the quality of Columbia's management team. We anticipate retaining key management personnel for each of the critical operating units and maintaining headquarters in their current locations."

Largest Gas Company East of the Rockies

With assets stretching from the Gulf of Mexico, through the Midwest to the Northeast, the combined company will have a powerful platform, 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 nine states. It will be the largest gas company east of the Rockies based on customers. It will have the nation's second largest volume of gas sales with 911 MMcf/d, and it will have the most gas storage with 700 Bcf of capacity. Based upon the closing market price for NiSource on Feb. 25, the combined company would have an enterprise value of $13.7 billion.

"This combination creates the leading gas competitor within the key energy corridor between the Gulf Coast and the Northeast," said Neale. "It will be a super-regional energy company with complementary market areas and no asset overlap. Scale and geography are critical to success in the evolving competitive energy industry, and we will have the size and scope necessary to compete and win."

Merrill Lynch's Donato Eassey said the new energy companies have to be of "size, scope and scale to compete in this ever-increasing utility world going forward. While there are some challenges near term, I think the long-term prospects of such a combination are very formidable in terms of the number of customers that they will have, their storage position and their ability to arbitrage off geographic diversification."

Rocco Canonica

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