In a move that will create the largest pure-play natural gas distribution business in the United States, Dallas-based Atmos Energy Corp. announced it will buy substantially all of the operations of TXU Gas Co., a subsidiary of TXU Corp., in an all-cash transaction valued at $1.925 billion.

The transaction brings together two Dallas-based companies with a total of 3.1 million customers in 12 states. TXU Gas, which was founded as Lone Star Gas in 1909, has approximately 26,400 miles of intrastate distribution pipelines and sells approximately 140 Bcf of natural gas to nearly 1.4 million residential and business customers in approximately 550 cities and towns, including the Dallas-Fort Worth Metroplex.

TXU Gas is one of the largest gas pipeline operators in Texas, with a system consisting of 6,800 miles of transmission pipeline within Texas, delivering 400 Bcf annually. TXU Gas also owns five natural gas storage reservoirs connected to the pipeline system with a working capacity of 38 Bcf.

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 the 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. “This creates a huge core market for us … and gives us a huge foundation as we go forward.” The transaction “clearly fits within our stated strategy of growth through acquisitions in our core business. The opportunity to deliver stable, long-term growth by acquiring a large, regulated customer base in metropolitan areas is exciting.”

Best noted that Atmos’ “seasoned management has successfully completed nine major acquisitions during the past 18 years. With a nearly 100-year history of operations in Texas, I am confident that we will make this acquisition successful for our shareholders, customers, employees and communities.” Nearly all of TXU Gas’ employees will be hired by Atmos.

The TXU Gas operations are expected to be immediately accretive to Atmos earnings in fiscal year 2005 by 5-10 cents/share, “even without any incremental revenue or operating synergies,” said J. Patrick Reddy, Atmos’ CFO. “As a result of adding the TXU Gas operations, we will increase the percentage of operating income from our regulated business segment to more than 90%. In addition, the TXU Gas intrastate pipeline system will bring more diversity to our revenue mix and offer attractive incremental investment opportunities.”

TXU has been selling off several of its assets as part of a long-term plan to restructure, and it had been planning to sell its gas unit for several months. CEO John Wilder, who joined the company in February, announced a major restructuring of the debt-ridden company in April, and said that TXU Gas would be sold by the end of the year (see Daily GPI, April 27). Since the beginning of the year, TXU also has shed TXU Communications for $527 million, TXU Australia to Singapore Power for $3.72 billion, and sold TXU Fuel Co. to Energy Transfer Partners LP for $502 million. All of the sales have reduced TXU Corp.’s earnings by 30 cents/share, but they are not expected to impact its earnings forecasts for this year.

According to a report in the Dallas Morning News, TXU Corp. made plans to sell TXU Gas partly because the subsidiary consistently failed to meet its profit expectations. When it announced it would sell the gas utility in April, it apparently received a $2 billion offer. However, management decided to see if other offers would come. Since then, TXU Gas suffered a “major defeat” when it received only a 1% hike in rates from the Public Utility Commission of Texas, after requesting a 7% revenue increase. The News said the rate hearing had been “one of the most heated cases” ever before the commission over how to pay for an expensive gas pipeline replacement program.

Under the terms of the agreement, which has been unanimously approved by Atmos’ board of directors, permanent funding for the acquisition will consist of approximately $500 million to $600 million of equity, with the remainder of the purchase price funded with long-term debt. Merrill Lynch & Co., which acted as exclusive financial adviser, will provide an interim senior credit facility to effect the transaction.

Atmos expects to maintain its investment-grade ratings and will continue to pay shareholders an annual cash dividend, which is currently $1.22 per share. The transaction, to be accounted for as an asset purchase, is expected to close in the first quarter of Atmos’ 2005 fiscal year following regulatory approvals. The transaction does not require the approval of Atmos shareholders.

In response to the acquisition, Moody’s Investors Service on Thursday placed Atmos’ ratings under review for a possible downgrade and maintained its current developing outlook. Standard & Poor’s Ratings Services (S&P) placed the company on CreditWatch with negative implications. Both ratings agencies said they were concerned about the business risks and amount of debt Atmos was taking on, and both said they would be meeting with Atmos management in the near future to clarify details of the acquisition.

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