MDU Resources Group Inc. has agreed to acquire Cascade Natural Gas Corp. for $26.50/share cash, about $475 million. The combination will double the number of MDU’s gas utility customers with the addition of Cascade’s Washington and Oregon ratepayers.

Bismarck, ND-based MDU Resources will pay a 23% premium over Cascade’s July 7 closing price. MDU has been flying high lately, partly on results in its exploration and production operations driven by high commodity prices.

The boards of both companies approved the deal. Cascade will join Montana-Dakota Utilities Co. and Great Plains Natural Gas Co. as MDU Resources utility business units. Montana-Dakota and Great Plains serve about 250,000 gas customers and 120,000 electric customers in five Upper Midwest states.

“The merger with Cascade is a great strategic fit with our existing regulated operations and is consistent with our long-term objective of growing our regulated utility as part of our overall business portfolio,” said MDU CEO Martin A. White. “Cascade is in a high-growth area and is a well-managed operation. It will be effectively integrated into MDU Resources’ existing operations.”

Cascade serves 235,000 customers in 93 communities — 65 of which are in Washington and 28 in Oregon. Cascade’s service areas are concentrated in western and south-central Washington and south-central and eastern Oregon. Cascade’s recent customer growth has been more than 4% on a compound annual basis. Cascade was founded in 1953 and employs 378 people.

“We are very pleased and excited by the opportunity to join the MDU Resources family of companies,” said Cascade CEO David W. Stevens. “Earlier this year we announced plans to evaluate strategic alternatives to enhance our stockholder value and this merger is the result of our evaluation.”

Analysts at Janney Montgomery Scott LLC said in a note that they view the deal as positive for MDU Resources, rating its shares a “buy” with fair value of $40/share.

“Our positive view on MDU’s potential acquisition of Cascade Natural Gas is based on the success the company has had on growing from primarily a regulated utility to a well-diversified energy resources company through both acquisitions and organic growth and the company’s earnings and dividend growth record,” wrote Janney analysts Joanne Fairechio and Heike Doerr.

They wrote that the addition of Cascade could add 5 to 10 cents/share to MDU’s annual earnings. After a planned three-for-two stock split the effect off the MDU addition would be 3 to 6 cents/share.

Questioned by analysts on a conference call as to the reasons for the acquisition, MDU executives during a conference call said Cascade was “right-sized and a good clean utility in a high growth market, and a well-run operation….The growth potential is primary.” They did not claim extensive gains from synergies in operations, but said the main savings will come in the administrative costs, such as Securities and Exchange Commission filings and call center operations.

One analyst noted the company was paying more than twice book value, but MDU executives responded that Cascades’ returns were typical of a regulated utility, and “we have an opportunity to grow those returns….Based on their rate base and cash flow multiple, it met our criteria.”

In their note, the Janney analysts pointed out that Cascade’s recent performance has been erratic. “Although the LDC has had one of the highest customer growth rates (about 4% per year) in the natural gas industry, it has not been profitable growth. Cascade’s earnings trends have been erratic; it has not been able to earn its allowed returns; its capital structure approximates 61% debt and 39% common equity, and the dividend (currently 96 cents/share) has not been increased since 1994.”

One analyst noted that taking on another regulated utility would lower MDU’s overall risk by helping to balance its E&P operations; company officials agreed.

Standard & Poor’s Ratings Services affirmed its ratings on both companies. MDU is “BBB+/AA-2” and Cascade is “BBB+,” both stable.

MDU expects to finance the transaction through traditional means, including the issuance of a combination of long-term debt and equity. The completion of the acquisition is subject to the approval of Cascade’s shareholders and various regulatory authorities. These include the Washington Utilities and Transportation Commission, the Oregon Public Utility Commission and the various jurisdictions under which MDU Resources’ utility divisions operate, as well as clearance under the Hart-Scott-Rodino Act, and the satisfaction of other customary closing conditions. Regulatory approvals are anticipated to be obtained by mid-year 2007.

In April MDU reported record first quarter earnings, mainly from its natural gas and oil production operations, which turned a first quarter profit of $41.3 million, compared to $38.8 million for the first quarter of 2005 (see Daily GPI, April 27). The earnings increase resulted primarily from what the company called the average realized natural gas price being 37% higher and average realized oil prices that were 18% higher than they were in the first quarter the previous year. MDU also had record annual earnings in 2005 (see Daily GPI, Feb. 2).

Cascade also has enjoyed strong results lately. The company reported earnings of $9 million, or 78 cents/share, for the fiscal second quarter ended March 31, 2006, compared to $7.4 million, 65 cents/share, for the second quarter ended March 31, 2005. Earnings for the six-month period were $17 million, or $1.49/share, compared to $14 million, or $1.24/share, for the six months ended March 31, 2005. These represent 22% improvements for both the quarter and the six-month periods.

Cascade will become a wholly owned subsidiary of MDU Resources, continuing to operate as Cascade Natural Gas Corp.

MDU includes natural gas and oil production, construction materials and mining, domestic and international independent power production, natural gas pipelines and energy services, electric and natural gas utilities, and construction services. Cascade is incorporated in the state of Washington as a natural gas distribution company serving parts of Washington outside the Seattle-Tacoma area as well as central and eastern Oregon. The area served has a population of one million. The company has a mix of residential, commercial and large industrial customers totaling 235,000.

UBS Investment Bank acted as financial advisor to MDU Resources, and J.P. Morgan Securities Inc. acted as financial advisor to Cascade. Thelen Reid & Priest LLP acted as legal counsel to MDU Resources, while Preston Gates & Ellis LLP served as legal advisor to Cascade.

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