Plans for a new publicly-traded energy giant were revealed last week, as Duke Energy and Phillips Petroleum announced their intentions to form a midstream company called Duke Energy Field Services (DEFS). Expected to have an enterprise value of between $5 and $6 billion, DEFS will result from a merger of Duke’s gathering and processing businesses (also called Duke Energy Field Services) with Phillips’ Gas Processing and Marketing (GPM) unit. Subject to approval by the FTC under the Hart-Scott-Rodino act, the deal is expected to close by the first quarter 2000.

The new company, touted by its two creators as the largest midstream gas liquids business in the country, will have a strong position in most of the significant hydrocarbon basins in the continental United States. Richard Priory, Duke CEO, said the deal is a merger of the two largest gas liquids players in the country, and that the next four largest players would have to combine in order to produce more liquids than the new DEFS. The combined revenues and EBITDA for the two businesses in the third quarter of 1999 were $1.6 billion and $183 million, respectively.

The details of the new company’s workforce were left undefined by Duke and Phillips. “Most employees” from the two merging companies will get an opportunity to work for DEFS, Duke said. GPM, located in Houston, employs 1,100 people and the Denver-based Duke subsidiary employs 1,600 currently.

The new company will be based in Denver, CO, operate 67 plants, 57,000 miles of pipelines and have an estimated 17 Tcf of contracted supply. It will process 5 Bcf/d of raw gas, and produce 400,000 b/d of gas liquids. Duke Energy and Phillips said they believe the new company will realize synergies, primarily from operating efficiencies. Duke said the combination will most positively affect Midcontinent and Permian basin assets.

“This combination represents the latest and most dramatic example of the restructuring and consolidation in the midstream gas business. It immediately creates shareholder value for both Duke Energy and Phillips Petroleum. By combining DEFS and GPM’s businesses, we will have the best collection of people and assets in the gathering and processing industry. This transaction brings together the fastest growing midstream business, DEFS, with one of the most experienced, GPM. Additionally, Phillips Petroleum’s assets and gas contracts provide additional balance to our existing business,” said James Mogg, current president of the old Duke Energy Field Services and future president of the new company.

Both Duke and Phillips stand to gain immediate and significant cash flow once the new company meets its FTC approval. Under the terms of the agreement, DEFS will seek to arrange $2.4 billion of debt financing and will make one-time cash distributions of $1.2 billion to both Duke and Phillips. Duke said the money will help reduce its need to issue equity to cover its capital expenditures. Phillips said it plans to retain $1.15 billion after taxes, which it will put toward debt and “other corporate purposes.” As a result, Phillips expects its net debt-to-capital ratio to decline from 47% to near 40%. During the first half of 2000, following completion of the deal and if market conditions permit, the new DEFS is expected to offer 20% of its equity in an initial public offering (IPO) to reduce debt.

Analysts applauded the move. “These are two well-run companies,” said Donato Eassey, an analyst for Merrill Lynch. “Michael Panatier, CEO of GPM especially, has done an excellent job with his company under tight capital restraints. The new company will be a formidable competitor in its industry. The parent companies as well, will be able to reap the benefits from its formation.”

Ed Tirello, an analyst with Deutsche Banc Alex. Brown, said he wished he had thought of the idea himself. “It’s such a smart idea. Clearly the new company will be ahead of all the other players. It’s accretive to all the companies involved. The move allows Duke to hit the high end of its growth goal.

“For Phillips, it’s the best possible situation. Everyone knew GPM was on the block, but with so many other midstream assets on the block as well, it would have been hard to get full value out of an outright sale. Through this transaction, they not only get full value, they also get to keep some interest in the business as well.”

Initially, Duke will own 70% of DEFS and Phillips will own 30%. After the IPO, it is expected that Duke’s interest will be between 57% and 55%, while Phillip’s will drop to the 25% to 23% range.

“Obviously there is still some diligence work to be done concerning the IPO,” Eassey said. “Certainly if this management team stays in place, I’ll advise my clients to get in on it.”

Given the company’s size and access to the capital markets, it will immediately have the flexibility to pursue its growth opportunities. In a conference call after the announcement, Mogg said the company has a list of four transactions it hopes to trigger. Although none of them were disclosed, he did reveal all of the deals on the list are big enough to require FTC approval under the Hart-Scott-Rodino Act. One company mentioned was Dynegy Midstream Services, but neither Duke nor Phillips would comment.

The new company will be governed by a board of directors which will initially consist of three directors to be chosen by Duke Energy and two directors to be selected by Phillips Petroleum. Following the IPO, the board will be expanded from five to 11; Duke Energy will choose seven members (two of whom will be independent) and Phillips Petroleum will choose four (one of whom will be independent).

Last quarter, DEFS reported EBIT of $49 million, up from $9 million in 3Q98. By itself, it is one of the largest U.S. producers of NGL, one of the largest gas gatherers and marketers and one of the largest NGL marketers. In 1999, DEFS became the industry’s top NGL producer by acquiring UPR’s natural gas gathering, processing, fractionation and NGL pipelines for $1.35 billion (see NGI, April 5). The company operates 52 plants today in Wyoming, Colorado, Kansas, Oklahoma, New Mexico, Texas, along the Gulf Coast and in northwestern Alberta, Canada.

GPM reported net income of $39 million last quarter, up from $11 million in 3Q98. The Phillips subsidiary, however, has been on the auction block for the past few months (see NGI, Sept. 27). GPM operates 15 plants in Texas, New Mexico and Oklahoma.

James J. Mulva, CEO of Phillips Petroleum, said the transaction “monetizes a substantial portion of the value of one of Phillips Petroleum’s key non-E&P assets, thereby increasing Phillips Petroleum’s financial flexibility to pursue attractive exploration and production growth opportunities. It also enhances and makes more transparent the value of our GPM asset.”

John Norris

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