Fresh off its purchase of Sonat Inc., El Paso Energy Corp.re-entered the consolidation game by announcing plans to merge withCoastal Corp. in a $16 billion deal. The potential union wouldcreate a pipeline empire capable of serving almost all of the majormarkets in the country. The companies expect the transaction,accounted for as a pooling of interests, to be completed by thefourth quarter of this year.

The total value of the transaction includes $6 billion ofassumed debt and preferred equity. Each share of Coastal commonstock and Class A common stock will be converted on a tax-freebasis into 1.23 shares of El Paso Energy common stock.Under thisratio, the deal values Coastal’s stock at $45.66/share based on theclosing price on Jan. 14, representing a premium of 27%.

The move will vault the company into the top five of everywholesale gas and power standard, according to El Paso CEO WilliamWise.

“The merger is expected to be accretive to El Paso’s earningsper share (EPS) immediately and add more than 5% to EPS in both2001 and 2002,” said Wise. “With this merger, El Paso Energy willbecome the only company that is one of the top five companies inevery sector of the wholesale natural gas and power arena,including natural gas transmission, production, gathering andprocessing, marketing, and power generation. As power generationbecomes the largest consumer of natural gas, we believe integrationalong the full value chain will enhance profitability in eachsegment of our business.”

Wise said the combined interstate transmission system of the newcompany will consist of over 58,000 miles of pipeline reaching allthe major growth areas in the country. The combined company will bethe second largest gatherer of natural gas in the United States andthe third largest U.S. producer of natural gas — after BP Amocoand ExxonMobil — with over 5 Tcf of proved gas equivalentreserves and approximately 20.7 Bcf/d of transportation. The newcompany will control over 12,000 net MW of power generationworldwide.

The El Paso/Coastal combination will have 625 Bcf/year in equityproduction to market, said Ralph Eads, El Paso’s group executivevice president of production and merchant energy. That bodes wellfor power marketing operations, he added, because one of the thingsgoing up most in value is secure gas supply for merchant powerplants. The two companies currently have gross U.S. generationcapacity of 7,460 MW at 30 plants, and more than 80% of their poweris sold under fixed-price contracts.

The addition of Coastal would elongate El Paso’s reach as thetop company in terms of mileage of pipeline. The El Paso-Sonatmerger created a company with 38,000 miles of pipe and 12.7 Bcf/dof transportation. Coastal would add 18,000 miles and 8 Bcf/d.Enron would lose ground, but maintain second place with 32,000miles and 9 Bcf/d of transport. Williams would be third, with27,000 miles and 10.1 Bcf/d and Kinder Morgan would be fourth with25,000 miles and 6.5 Bcf/d. (see table)

“Our two companies complement each other in strategicallycompelling ways. El Paso Energy’s coast-to-coast pipeline systemreaches from the West Coast to the southeastern United States andthen moves upward along the eastern seaboard to key markets in theNortheast; Coastal’s ANR pipeline system covers strategic areasacross the Midwest and Great Lakes regions, and its ColoradoInterstate Gas system traverses the Rockies,” Wise added.

The original El Paso Pipeline stretches from Texas toCalifornia, while Southern Natural Gas – acquired when the Sonatdeal was finalized last October (See NGI, Oct. 25) – serves much ofthe Southeast and includes an interest in the main pipeline intoFlorida. El Paso’s Tennessee Gas Pipeline, acquired four years agofrom Tenneco Inc., travels from Texas and Louisiana into NewEngland.

In total, the new El Paso would own or have interest in thefollowing major pipelines: El Paso Natural Gas, Midwestern GasPipelines, Southern Natural Gas Pipeline, Mojave Pipeline,Tennessee Gas Pipeline, Florida Gas Transmission, ANR Pipeline,Colorado Interstate Gas, Great Lakes Gas Transmission and WyomingInterstate.

For Coastal, joining with El Paso represented the best chance toaccelerate growth. “Both companies had very achievable andrealistic growth strategies in place, but from Coastal’sperspective we could see this had the benefit of accelerating ourgrowth,” David Arledge, CEO of Coastal, said. “It will also providea better balance of earnings by lessening the commodity risk andrefining margin risk we have.”

John Olson, a consultant with Sanders, Morris & Mundy saidit was no dark secret that Coastal was looking for a way to lessenthe impact of its oil refining and marketing business. “[Coastal]has said for a long time that its focus was moving toward naturalgas. By implication, that meant moving away from the refiningbusiness.” He estimated the value of the refining business at $4billion.

Overall, Olson approved of the deal. “It’s a fortunate merger.Clearly, three heads are better than one. The three heads in thiscase are Sonat, El Paso, and Coastal. Combined, they will have amore enhanced business than if they stood alone. Coastal is gettinga good price, but not a great price. And because of that, El Pasowill still have room to grow into some exciting possibilities.”

Besides its existing pipeline infrastructure, Coastal is anattractive pick-up for El Paso because of the pipeline projectsCoastal’s subsidiary, ANR Pipeline, is involved in. ANR has itshands on some of the most talked-about pipeline projects going ontoday including the Alliance Pipeline and the Gulfstream project.Alliance currently is under construction and is designed to carry1.3 Bcf/d of gas from western Canada to the Chicago-area fordistribution throughout North America. The 1,900-mile pipeline isscheduled to be in service Oct. 1, 2000 and ANR owns 14.4% of it.The 744-mile, 1.1 Bcf/d Gulfstream would originate near Mobile, AL,and cross the Gulf of Mexico with more than 400 miles of 36-inchdiameter pipeline to Manatee County, FL.

“The involvement with these projects is definitely a part ofthis deal,” said Ed Tirello, an analyst for Deutsche Banc Alex.Brown. “If you’re not getting bigger somehow, you’re not going tolast long. The deal also adds 5% to earnings per share growth. Sonow you’re looking at 20% growth instead of 15%, which is veryattractive.”

If the merger is approved, El Paso also would be gettinginvolved in one of the most highly debated pipeline projects in theU.S. right now; the Independence and related MarketLink andSupplyLink project. The $678 million proposed pipeline would runabout 400 miles from Defiance, OH, to the hub in Leidy, PA, whereit would intersect with up to six different pipelines capable ofdelivering gas to the entire eastern seaboard. However, the projecthas run into a wall of landowner and political confrontation. (seeseparate story, this issue).

Both Wise and Arledge said it was too early to discuss layoffs.Although they acknowledged that some cutbacks are probable, theysaid many of them will be achieved through early retirement.Overall, the two companies expect $200 million in cost savings. Bycomparison, the El Paso-Sonat merger caused more than $100 millionin savings and more than 600 people to lose their jobs.

Despite the volume of assets involved, management for bothcompanies expressed confidence that the deal will be done on time.”These are very complementary assets,” Wise said in a conferencecall. “We do not expect any significant problems.” He added thatany required asset sell-off would be “proportionately,significantly less than the Sonat deal.” The FTC required El Pasoto sell the Sea Robin and East Tennessee pipelines, as well as itsshare of the Destin Pipeline. The deals were performed earlier thismonth.

“I think the mix of assets is just right,” Tirello said. “Butthen you have the government saying it is going to take a longerlook at these big mergers, so we’ll have to wait and see.”

The merger needs SEC, FERC, shareholder and FTC approval. Nostates are required to ratify the transaction.

To those worried about the challenge of taking on another giantmerger so soon after last year’s deal with Sonat, don’t be, saidBrent Austin, executive vice president and CFO. “We were able toput the Sonat transaction to bed the day after it was closed,” hesaid.

Once approved, Wise said the new El Paso will explore manygrowth opportunities, while keeping the exploration and productionbusiness stable. “The E&P business is not a growth driver forus,” he said. Two areas where Wise said El Paso would focus on forgrowth are telecommunications – thanks to its nearly 60,000 milesof right-of-way – and electricity asset acquisition.

But don’t count on any major purchases or sales in the nearfuture. The management teams stressed the pooling restrictionsinvolved in the merger, which prohibit additions and sales by ElPaso or Coastal for a two year period.

The combined company will be headquartered in Houston. On oraround Dec. 31, 2000, Wise will assume the position of chairman inaddition to continuing as president and CEO of the new El Paso.Arledge, will become the vice chairman and will oversee thenon-regulated operations of the combined company. The board ofdirectors for the combined company will consist of twelve directors- seven designated by El Paso Energy and five designated byCoastal.

No decision has been made yet on what will happen to EngageEnergy, Coastal’s 50-50 joint marketing venture with Vancouver,BC-based Westcoast Energy, said Ralph Eads, El Paso’s groupexecutive vice president of production and merchant energy.However, he added, discussions on the subject will begin “soon.”

John Norris, Roger Tanner

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