Recent basement-dweller KN Energy electrified the energyindustry Friday, announcing what one analyst called the deal of thedecade – a marriage with the brains and bucks of Houston’s KinderMorgan Inc. KN’s Chairman Larry Hall immediately resigned, KinderMorgan Chairman Richard D. Kinder, credited with helping buildEnron’s underpinnings, was named heir apparent, and KN’s stockprice soared nearly 55% in one day.

Kinder told a teleconference he plans to “get the car out of theditch and get it going down the highway.” One industry veteran wasexcited to hear “Kinder’s rejoining the industry,” after leavingEnron in 1996 when Chairman Ken Lay announced he would lead thecompany for another five years.

It was less than three weeks since KN’s proposed $6 billionmerger with Sempra Energy fell apart. The new alliance will createa massive midstream energy company with 30,000 miles of gas,petroleum products and liquids pipelines, and an enterprise valueof $8.5 billion.

According to the agreement, KN Energy would issue 41.5 millionshares of KNE stock in return for all of the outstanding shares ofKinder Morgan, Inc. (ENP). Considering share prices at the time ofthe announcement Thursday, the deal would be valued at $654million, including $140 million in debt.

Kinder had been a board member of KN until just a few weeks ago.Upon closing he will be named chairman and CEO of the combinedentity, which will be known as Kinder Morgan Inc. Stewart Bliss, anindependent member of the KN Energy board, has assumed the chairmanand CEO positions on an interim basis. A KN spokesman said thetransaction and subsequent executive changes were KN “boarddecisions.”

“Larry was instrumental in growing the company’s assets from$300 million to $8 billion in the ’90s,” said Bliss. “He built astrong asset base, and we are confident that Rich Kinder has theindustry expertise, vision and leadership to take the combinedentity to the next level and position the company among the leadersin the energy industry.” Kinder has 20 years experience in theindustry, 16 of which were spent at Enron and six of which werespent as Enron’s president and COO.

Something drastic was needed at KN after two warm winters,continued struggling with integration of the MidCon’s assetspurchased in December 1997, significant underutilization of NaturalGas Pipeline Co.’s capacity and the failure of the Sempra merger.

Bliss said the deal will be immediately accretive to earnings.”[It] deleverages our balance sheet by reducing our debt to totalcapitalization ratio from 72% to approximately 65%, enhances thequality and stability of future earnings, improves cash flow tofund future growth, strengthens our already strong midstream assetbase, and provides outstanding leadership from Rich Kinder, anindustry veteran with a proven track record.” KN and Kinder Morganexpect to close the transaction early in the fourth quarter. Theclosing is subject to regulatory and shareholder approvals.

The marriage stunned analysts. “I’ll be honest with you. Ireally didn’t anticipate this one,” said Dain Rauscher Wessels’analyst Mark Easterbrook. “I thought it would be a long recoveryfor KN, at least 12 months. This is a win-win situation for bothKinder Morgan unit holders and KN shareholders. It will bring KNshareholders back from the doldrums. These guys have beenslaughtered in the last 12-18 months and now things are starting tolook up. They are bringing in one of the premiere pipelineoperators in Rich Kinder to run these pipelines that have not donewell.”

Merrill Lynch’s Donato Eassey was awestruck following theannouncement. “This is an absolute home run. If it’s not thetransaction of the 1990 decade, I don’t know what will be,” hesaid.

“Any time you get a situation where a stock is beat up and soout of favor as this one [KNE] was, smart people are going tofigure out where the value is. Certainly one of the best in theindustry figured it out in a hurry and took full advantage of it.It truly is a transaction that stands out. It’s very unique. It isnot complex. It borders on genius,” said Eassey.

“Richard Kinder and Bill Morgan, these are smart guys and theyknow those assets well. Kinder used to run some of those assetswhen he was at Enron. In my view Kinder had a great deal to do withbuilding an extremely solid foundation at Enron, and he’ll takethat same expertise with these assets and build them very nicely,”he added. “They are getting [KN] at the very bottom potentially.”

During a conference call, Kinder said he resigned as a KN boardmember after the Sempra deal collapsed “because I thought there wassome possibility of putting together a transaction. We startedmeeting and with the help of the leadership of KN we were able toput together this arrangement. I think one of the real positivethings that I have believed all along is that people ought to puttheir money where their mouth[s are], and when this combination iscompleted Bill Morgan and I will own about 30% of the stock of thecombined company. I personally will own a little over 22% of thecompany so you better believe I am going to be focused like a laseron shareholder value.”

KN has a long way to go however. Back-to-back warmer than normalwinters took a big bite out of KN earnings and coupled with thecancellation of the Sempra merger have crippled KN share prices.Hall announced last month the company expected to experience a lossof $0.20-$0.25 per share in the second quarter of 1999 and likelywould break even or post a modest gain of $0.10 per share for theyear. That compared with analyst’s forecasts of $1.07/share. KNEshares have plummeted from a 52-week high of near $40/share to$12.19/share July 5. On Friday they rocketed to nearly $19/share.

“Kinder won’t take [warm winters] as an excuse for no earnings,”said Eassey. He has had a very successful track record since takingover Enron Liquids Pipeline (renamed Kinder Morgan Energy PartnersLP) in February 1997. The company has provided a 209% total returnto shareholders since that time. It had $17.7 million in net incomein 1997 and expects $170 million in net income this year.

Kinder Morgan Energy Partners LP is the nation’s largestpipeline master limited partnership. The MLP is considered by manyinvestment bankers and major pipeline companies to be a smartmethod of growing a pipeline business because it avoids asignificant tax burden and more of the cash generated falls to thepublic unit holders. Several other major energy companies aretaking advantage of those benefits, including Enron with NorthernBorder, Duke Energy with Teppco and El Paso with Leviathan. Kinderwas ecstatic about the prospect of putting an MLP pipeline and atraditional pipeline corporation under one roof.

“This is a unique combination. You are putting a major MLPtogether with a major midstream regular corporation because you areable to take assets [some of KN’s assets] and put them down taxfree at fair market value into that MLP. That MLP is a veryadvantageous owner of the assets because it does not pay tax,” saidKinder. “We think there are going to be significant assets in theKN family that will qualify for and fit the MLP. We can’t identifythose yet. But when we do that, we’ll get the same price as if itwere sold to a third party but because we own the general partner,we’ll get the general partner’s share of that MLP revenue, which inthe case of Kinder Morgan is about 30%.. And you are stillcontrolling the asset. It’s a wonderful combination that I think isgoing to work very well for the combined company.”

The companies announced that management intends to focus onexpanding KN’s asset base, selling non-strategic assets to reduceKN’s level of outstanding debt and making strategic acquisitions,both on its own and in conjunction with Kinder Morgan EnergyPartners. In addition, the combined company will contribute assetsto Kinder Morgan Energy Partners in exchange for cash and/orpublicly traded limited partnership units. Any transfers of assetswill be made for fair value and only on an accretive basis, thecompanies said. The combined company will continue to share in theearnings of these assets through its limited and general partnerinterest in Kinder Morgan Energy Partners.

Kinder Morgan Energy Partners LP has an enterprise value of $2.5billion. It owns and operates one of the largest product pipelinesystems in the U.S., serving customers in 16 states with more than5,000 miles of pipeline and over 20 associated terminals. It alsooperates 24 bulk terminal facilities which transload over 40million tons of coal, petroleum coke and other products annually.In addition, Kinder Morgan owns 51% of Plantation Pipe Line, 20% ofShell CO2 Co. Ltd. and a 25% interest in an NGL fractionator.

KN, based in Lakewood, CO, is the nation’s sixth largestintegrated gas company with more than $8 billion in total assetsand is one of the largest pipeline operators with more than 25,000miles of pipe. It has operations in 16 states.

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