It’s been difficult to keep up with the charges and countercharges by the two groups vying to run El Paso Corp. However, as the march toward a June 17 annual meeting in Houston nears, the proxy battle for the board of directors most likely will rest on which group the shareholders find most credible: the current members, who have attempted to remake the company following a blistering two-year stretch, or the proposed board, composed of a group of energy professionals that claims it can do better.

Following weeks of finger pointing and accusations, the opposition slate unveiled its proposed business plan for El Paso last week. The proposed plan actually differs little from the present course on which the company is now set. However, differences abound in how management and directors would be compensated and how businesses and executives would be evaluated. What shareholders now are deciding is, which group is more credible?

El Paso has been revising its business plan and its management team since Enron Corp. blew up two years ago by selling off assets, reworking its operational strategy and attempting to make itself less top heavy by dismissing some top level managers and employees. However, many of the changes have done little to convince investors that the company is moving in the right direction. That is what moved one of its top shareholders, Selim K. Zilkha, to challenge the board in a proxy fight.

Zilkha, who together with former Coastal Corp. Chairman Oscar Wyatt holds about 2% of the company’s shares, is counting on the perception that El Paso’s current management is out of touch and unfocused. However, El Paso management has been quick to remind shareholders again and again exactly what has happened to the industry in the past two years.

El Paso’s Plan

“I think it is important to put the past year and a half in context because today we are living in a vastly different environment,” Ronald L. Kuehn, El Paso’s interim CEO said in a letter to shareholders early last week. “Up until late 2001, there were premium valuations for energy companies focused on what were widely believed to be high growth areas such as trading, merchant power, international energy projects and telecom. Like a number of our peers, we pursued these opportunities.”

However, Kuehn noted that “the environment changed dramatically with the collapse of Enron in late 2001, the severe downturn in energy trading and merchant power markets, changes in rating agency criteria, and the aftermath of the California energy crisis.” In turn, he said, El Paso reacted beginning in December 2001 and all of last year with the following series of moves:

Zilkha’s Plan

Under a new nine-member board, the Zilkha team proposes to make El Paso a company focused on earnings from core assets, not through mark-to-market accounting or off-balance sheet transactions. To achieve its earnings, the new board proposes to do the following:

What the opposing slate is bringing to the table is “more than 300 years” of combined energy industry experience, according to Zilkha board nominee R. Gerald Bennett, who is also a former Enron executive. He said that “all assets must earn the cost of capital or greater.” Productive assets would be defined by their ability to generate returns on invested capital. Assets that generate returns that equal or exceed the cost of capital would be supported and encouraged to grow and provided with the necessary capital.

If an asset is not productive, the Zilkha-led board would determine with management the strategies to make the asset productive. If the asset cannot be made productive, “we will sell the asset and use the proceeds to fund growth or retire debt. If it cannot be sold, it will be shut down and its working capital reinvested.” Asset review would be headed by a board member with expertise in that asset category.

Non-productive assets would be addressed systematically, taking those with the most value first. The first review would be of all assets with $50 million in net book value or greater and would be done within 30 days of the board being seated.

Severance and Compensation

In the areas of severance and compensation, there are several striking differences between El Paso’s current plan and the opposition. Currently at El Paso, the company provides “golden parachutes” for dismissed executives, insurance policies, substantial retirement benefits and also will make loans. For instance, former Chairman and CEO William Wise, who still has an office in the El Paso building in downtown Houston, received a $9.4 million severance and a retirement benefit of $15.3 million. He also had a $9 million loan from the company.

According to El Paso’s Security and Exchange Commission filings, severance arrangements are payable only if there is a change in control over a two-year period with a change in the majority of the board members “unless the election or nomination for the election by El Paso Corporation’s stockholders of each new director was approved by a vote of at least 2/3 of the directors then still in office who were directors at the beginning of the period.” Under its current plan, El Paso’s board could prevent a payment of at least $75 million and an obligation to set aside at least $123 million by allowing shareholders to select a board — without the threat of a financial payout to current management.

Under the Zilkha plan, “there would be no stock repricing, no golden parachute, no contract,” said board nominee Ted Davis, former president of Conoco Inc.’s international exploration and production. Also, Zilkha would waive any compensation as a director. Other compensation would consist of the following:

He Said, He Said

In response to Zilkha’s proposed business plan, El Paso fired back, stating that the “Zilkha/Wyatt implicit threat to derail the company’s California settlement (see related story) is a cause of special concern to all El Paso shareholders.”

During the Wednesday teleconference, there was no mention during the public session that Zilkha and the proposed incoming team would derail deals made between El Paso and California regarding market manipulation. There were, however, statements during the conference call that appeared to deride the length that it was taking El Paso to complete its settlement negotiations as well as the costs involved.

In some of its strongest criticism to date, El Paso also warned shareholders about the possibility that Chesebro could become the new CEO under the proposed board. El Paso said its candidates for CEO (although not revealed publicly in any statements) were “clearly superior to Zilkha/Wyatt hand-picked CEO choice, Stephen Chesebro, based on current employment experience as senior executives of major energy companies.” Chesebro is former CEO of PennzEnergy as well as former CEO of Tenneco Inc., which was taken over by El Paso.

Although it has not been substantiated, El Paso also implied that Wyatt had selected the “entire slate” of proposed directors. Ousting the current board “poses a clear threat” to the progress El Paso claimed to have made so fair and said there was a “risk of significant management disruption.”

Referring to the business plan unveiled by Zilkha, El Paso stated, “many elements remain unclear, but a cornerstone of that ‘plan’ is their idea to reduce annual capital expenditures to less than $1 billion while generating sufficient cash to pay down debt substantially. Zilkha/Wyatt call this ‘math’; we call it alchemy.”

El Paso chided the “Zilkha/Wyatt slate” with “particular examples of projects they believe could perform better under Zilkha/Wyatt and Chesebro’s management. The examples they choose happen to be former pet projects of Mr. Chesebro and Mr. Wyatt.” El Paso claimed that it was Chesebro’ “who got Tenneco Energy into an investment in an Australian pipeline that generates unacceptable returns.” And it claimed that El Paso’s Aruba refinery “inherited from Mr. Wyatt’s Coastal Corp., has only generated in excess of $100 million of annual operating income once over the past 13 years despite a cumulative investment of approximately $1.3 billion.”

Zilkha wasted no time in his retort to what he called El Paso’s “mudslinging.” In a letter to shareholders on Friday, Zilkha noted “that as the limitations of the incumbent slate have become more evident, the tone of their attacks on our slate has become increasingly personal in a desperate attempt to deflect your attention from the real issues.”

The incumbent board members, said Zilkha, are “lacking a clear vision for El Paso’s future, are resorting to mud-slinging — by challenging the impeccable record of Stephen D. Chesebro, our choice to be El Paso’s next CEO, and by attacking Oscar S. Wyatt Jr., a major shareholder who is not seeking to hold office or serve on the El Paso board,” Zilkha wrote.

He cited Chesebro’s “39 years of experience in the energy industry, including serving as Chairman and CEO of Tenneco Energy; President and COO of Pennzoil Co.; and President and CEO of PennzEnergy,” adding, “These cheap shots are based on blatant misrepresentations and have been dismissed by [Institutional Shareholder Services] and others, who have chosen instead to focus on what really matters — which group is better equipped to lead El Paso out of its current difficulties — and have concluded that the right group is the Zilkha group.”

The Board Nominees

El Paso has 12 candidates up for re-election to its board, including several former directors of Coastal Corp., which ironically, is the former company of opponent Wyatt. The El Paso slate includes current Chairman John M. Bissell, 72, a director of the board since 2001 and a former director of Coastal. Also up for re-election are Juan Carlos Braniff, 45, director since 1997; James L. Dunlap, 65, former vice chair of Ocean Energy elected this year; Robert W. Goldman, 60, a business consultant elected this year; Anthony W. Hall Jr., director since 2001 and former Coastal board member; current CEO Ronald L. Kuehn Jr., director since 1999; J. Carleton MacNeil Jr., director since 2001 and former Coastal director; Thomas R. McDade, director since 2001, also former Coastal director; J. Michael Talbert, 56, elected this year and former chair of Transocean Inc.; Malcolm Wallop, 70, director since 1995 and chair of Western Strategy Group; John Whitmire, 62, chair of CONSOL Energy Inc. elected this year; and Joe B. Wyatt, 67, director since 1999 and chancellor emeritus of Vanderbilt University.

The Zilkha-led team includes two with former Enron ties as well as several with indirect El Paso experience. The nine standing in opposition to the El Paso board include R. Gerald Bennett, 60, chair of Total Safety Inc. and a former Enron executive; C. Robert Black, 67, retired from Texaco Inc. after 41 years; Charles H. Bowman, 67, professor emeritus at Texas A&M University; Ronald J. Burns, 50, chair of Burns Capital Partners LP and a former Enron executive; Stephen D. Chesebro, 61, proposed CEO and former CEO of PennzEnergy and Tenneco Inc.; Ted Earl Davis, 63, consultant and former Conoco Inc. executive; John J. Murphy, 71, retired, former managing director of SMG Management LLC; John V. Singleton, 84, retired U.S. federal district judge; and Zilkha, 76, 50% owner of Zilkha Renewable Energy LLC and former director of El Paso from November 1999 to February 2001. Zilkha also was an El Paso advisory director until June 2002.

Both Sides Get Major Endorsements

The Zilkha-led slate got a huge boost one day before it unveiled its business plan, when influential proxy service Institutional Shareholder Services (ISS) advised investors to elect all of Zilkha’s board nominees except Zilkha to the new board because the group of candidates “appears well balanced and seems to possess the necessary industry experience to minimize disruption in the event of a board change.” The ISS excluded Zilkha because he was on the El Paso board when many of the decisions that he is now criticizing were actually made.

The ISS has a pretty convincing track record. Since the beginning of this year, ISS has made recommendations in 18 proxy contests involving board seats, siding with the dissident slate in six companies. Of the 12 that have come to a vote, ISS has backed the winner eight times. Last year, the ISS recommendation in a proxy fight over Hewlett-Packard’s plan to buy Compaq Computer Corp. was said to play an important role in the outcome when it supported the merger effort. Walter Hewlett, son of co-founder Bill Hewlett, had led a fight to convince shareholders to vote against the merger, losing by the narrowest of margins, just under 50%.

While the Zilkha plan is “substantially similar” to El Paso’s plan, “we believe the biggest difference will be one of credibility,” ISS wrote in its report.

The new board, said ISS, would be “unencumbered by the legacy of past mistakes.”

In its report, ISS recommended shareholders withhold their vote for Zilkha because he was a member of El Paso’s board when many of the decisions were made regarding acquisitions, energy trading and marketing and its entry into telecommunications. Zilkha served as a director of El Paso from November 1999 to February 2001, and as an advisory director from February 2001 to June 2002. From January 1998 to November 1999, Zilkha was a director of Sonat Inc., which eventually merged with El Paso.

“Mr. Zilkha in his role as one of the directors approved these decisions and is therefore equally culpable,” ISS wrote.

ISS noted that while the incumbent El Paso board had been proactive in some matters, other decisions were merely reactive. For instance, when former Chairman and CEO William Wise stepped down earlier this year and four new directors were added to the board, ISS called it “an exercise in damage control.”

ISS, headquartered in Rockville, MD, has provided proxy voting and corporate governance services for more than 15 years. It serves more than 950 institutional and corporate clients worldwide. Its core business is analyzing proxies and issuing research and vote recommendations for more than 10,000 U.S. and 12,000 non-U.S. shareholder meetings each year.

In response to the ISS report, El Paso stated that it believed ISS had “reached the wrong conclusion” regarding the upcoming board election. “Given El Paso’s sizeable retail shareholder base and the fact that most larger institutions make their own decisions, El Paso believes that ISS’ position will sway few votes,” it said.

El Paso’s Kuehn said ISS had “focused on the past and did not consider the future. We believe ISS failed to recognize that with our current board of directors, El Paso is taking all the right actions to restore value and position the company for the future.” El Paso also is continuing its search for a new permanent CEO.

“El Paso believes its high-caliber board is the best team to lead the company into the future,” the statement said. “We believe that shareholders do not want to see our progress derailed by a whole new board that we believe would seriously disrupt the steady improvements that El Paso is making.

“Notwithstanding ISS’ flawed evaluation, we believe our shareholders share our concerns regarding the risks of replacing our entire board with a slate of nominees that has no well defined business plan for El Paso and that has selected one of its own as CEO without undertaking a process to select the best possible candidate for this critical post.”

On Friday, El Paso got a boost from a major shareholder when San Diego-based Brandes Investment Partners LLC, which owns 6% of the common shares of El Paso, said it will vote to keep the current board of directors. On May 31, Brandes owned nearly 36 million shares of the company, however some of its clients retain voting discretion.

“While acknowledging the seriousness of the problems at El Paso and the impact the dissident group has had in creating healthy pressure for positive changes at El Paso, at this time Brandes believes its clients will be best served by maintaining stability in management of El Paso,” Brandes said in a statement.

Brandes said it “considered” the opposition to the re-election of the board by ISS. “Brandes recognizes the value of ISS research and, in many cases, has concurred with its recommendations. In this case, however, Brandes believes support of current management is in the best interests of its clients.”

When asked whether the ISS report would hold sway over El Paso shareholders, analyst John Olson with Sanders Morris Harris in Houston said he simply did not know. “From the media reports, it seems that it holds a significant amount of power. It is a new phenomenon and it alters the chess game to some degree.”

Olson would not wager what would happen to El Paso’s board at the June 17 meeting, believing that “it will all come out in the wash.” However, Olson added that he believes there are “grounds for compromise” by the two sides, which may become apparent before the meeting.

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