Atmos Energy (ATO) last week became the country’s largest gas-only utility company by completing its $1.9 billion purchase of the natural gas distribution and pipeline operations of TXU Gas Co.

“Atmos Energy now serves 3.1 million natural gas customers — more than any other pure natural gas utility in the United States,” said Chairman Robert W. Best. “Atmos Energy also now operates one of the largest intrastate natural gas pipelines, which should create added value in the future.”

Atmos has made steady acquisitions since 1986, when it expanded its gas distribution to Louisiana with the acquisition of Trans Louisiana Gas Co. In 1987, it picked up Western Kentucky Gas Co. and acquired Greeley Gas Co. of Denver in December 1993. In July 1997, the company bought United Cities Gas Co., adding customers in Georgia, Tennessee, Virginia, Illinois, Kansas, Missouri, Iowa and South Carolina. The South Carolina assets were sold in 2000.

In 2000, Atmos added the Missouri assets of Associated Natural Gas Co. and acquired an indirect equity interest in Heritage Propane Partners. In 2001, Atmos obtained 100% interest in Woodward Marketing LLC, and it bought Louisiana Gas Service Co. and LGS Natural Gas Co. And in December 2002, Atmos acquired Mississippi Valley Gas Co.

Atmos CEO Robert Best said this latest acquisition makes sense, giving his company a “strategically important business” at a cost of about $1.284 per customer. “Our roots are in Texas, and if we’re going to make a bold move, this one is extremely logical,” Best said when the company first announced the TXU purchase in June.

Funding of the transaction includes $500-600 million in equity, including the issuance of about $235 million in equity in July 2004 and the remainder in long-term debt of $1.3-1.4 billion.

According to Merrill Lynch Analyst Sam Brothwell, Atmos paid about 10 times TXU Gas earnings before interest, taxes, depreciation and amortization. The TXU Gas operations are expected to be immediately accretive to fiscal 2005 earnings, contributing from 5 cents to 10 cents to Atmos’ diluted earnings per share, the company said.

“We’ve previously noted that ATO has a good acquisition and integration track record over the past 18 years, although this is by far the biggest and will pose challenges, both operational and financial. While management indicated that cost cutting is not the main objective, we believe that opportunities to consolidate back-office operations should improve earnings in F2005 and beyond.” About 1,350 TXU Gas employees will be transferring to Atmos as part of the merger, Atmos said when it announced the deal.

Last Thursday, the credit rating agencies lowered Atmos’ ratings because of the deal. S&P cut ATO to BBB from A- and revised the outlook to stable from negative. Moody’s dropped ATO three notches to Baa3 from A3 and revised its outlook to stable from developing. Fitch lowered ATO by one notch to BBB+ with a negative outlook.

“The credit downgrades will eat into cost savings, although this was not unexpected,” Brothwell said. “We estimate the incremental interest associated with a two-notch downgrade at around 25-30 basis points for long-term utility debt. Given our projected debt issuance of $1.3-1.4 billion, we believe the incremental interest costs would dilute ATO’s F2005 [earnings per share] EPS by approximately $0.03-$0.04 per share. That said, we believe TXU Gas can still be accretive in F2005 by approximately $0.05.”

The acquired operations serve 1.5 million customers located in the Dallas-Fort Worth Metroplex and more than 500 other communities across the northern half of Texas. The operations will become a separate division of Atmos and will be renamed Atmos Energy in coming months.

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