In what one observer described as one of the first “blunders”among energy mergers, Sempra Energy and KN Energy said yesterdaythey have mutually agreed to call off their $6 billion marriage,which was first announced in February. The two companies said thatas they were studying the integration process they discovered thecombined company “would not be able to realize the businessobjectives they originally anticipated.”

Sempra has agreed to reimburse KN $5.95 million for expensesincurred in connection with the proposed deal and the two companieshave entered into a confidential termination and release agreementthat requires each to refrain from soliciting the employees of theother for a two-year period and to refrain from acquiring any stockor making any proposals to acquire the other party for a three-yearperiod.

“When it became clear that the transaction with KN Energy couldnot be completed to both companies’ mutual satisfaction, wedetermined that it was time to close this chapter and focus on ourown business strategy,” said Sempra Energy CEO Richard D. Farman.Sempra had intended to pay $1.8 billion in cash and stock for KNand to assume $4.2 billion of KN’s debt.

Most observers speculated Sempra just couldn’t stomach KN’s poorfinancial performance and large debt given its own financial woes.KN CEO Larry Hall revealed that the company’s earnings will besignificantly below analysts expectations. KN is expected toexperience a loss of $0.20-$0.25 per share in the second quarter of1999 and likely will break even or post a modest gain of $0.10 pershare for the year. That compares with analyst’s forecasts of$1.07/share. KN estimates earnings for the year 2000 are expectedto be in the range of $0.70 to $0.90 per share but officials saidit could be six months to 12 months before performance begins toreflect improving market conditions.

Hall blamed KN’s woes a variety of accidental factors, includingthe warm winter, poor basis differentials between producing andmarket areas on KN’s pipelines, greater competition for markets inthe Midwest, and lower production from the Rocky Mountain and Gulfregions to serve its pipeline assets. KN officials said about 14%of Natural Gas Pipeline Co.’s firm capacity was not under contractin the first quarter and 12% was not under contract in the secondquarter. KN expects a $20 million income decline during the secondquarter from the uncontracted capacity and noted a significantnumber of contracts are terminating in 2000. High storage levelsalso have not helped.

Some observers see KN’s problems dating back to its acquisitionof MidCon in December 1997, which was followed by deep staffreductions and large financial and operational hurdles. During aconference call with analysts yesterday, KN CEO Larry Hall said thecompany has cut about $95 million in costs related to the KN-MidConintegration, but “..we’ve got some challenges to replace” thepersonnel that left following the KN-MidCon merger. He indicatedthe KN-MidCon integration was a small part of KN’s difficulties.

KN intends to heal its wounds by selling off up to $300 millionnon-strategic and unprofitable assets, but it has not disclosedwhich assets have been targeted. KN officials said pipeline assetsother than NGPL will be included in the sales.

Merrill Lynch analyst Rebecca Followill said KN’s earningsprojections came as a shock to everyone and were probably to blamefor the merger’s failure. “Even the people who study the companyand have studied the company for a long time weren’t looking forthis.”

Followill, however, said KN shouldn’t entirely take the blame.”Not every marriage works, you know. It’s like blaming a divorce onone party. You know markets change during due diligence, and thesepeople just walked away. It was mutually agreeable. I don’t want tocall it a spat.”

Analysts called the Sempra-KNE deal a steal when it was firstannounced because Sempra was paying $25/share when KNE’s 52-weekhigh was $40. Some were expecting a bidding war for KNE with otherenergy companies jumping in. But since then KN’s stock price hascascaded downward. Before the announcement yesterday, its stockprice had been hovering slightly less than $20/share. Afterward itfell nearly 30% to close the day down $5.13 at $13/share. SRE wasdown $1.13, or 5%, to $22.81/share.

“Ultimately this industry is about scale and scope and themerger gave Sempra scale and scope, just what they were lookingfor,” said Followill. “It gave them a more diversified asset base,pushed them out of California where they were so heavily dependent,gave them more pipeline assets to play off from a power generationstandpoint. We liked it for those reasons,” she said. “I think anymerger Sempra gets in after this may be more conservative. KN had alot of nonregulated assets which provide a lot of advantages butalso are a much higher risk as you can see with what KN announcedon earnings.”

KN’s Hall stressed the positive in saying the company is”engag[ing] in some capital reallocation planning, which will serveus well moving forward as we focus on improving operationsefficiencies, managing capital expenses and investing in projectsthat will position KN for long-term earnings growth.”

Farman said Sempra intends to expand its “geographic footprint,”work on retail energy services, build wholesale trading, and growan asset base that supports those operations.

Sempra, based in San Diego, has two regulated utilititysubsidiaries– Southern California Gas and San Diego Gas &Electric. KN Energy is the sixth-largest integrated gas company inthe U.S.

©Copyright 1999 Intelligence Press Inc. All rights reserved. Thepreceding news report may not be republished or redistributed, inwhole or in part, in any form, without prior written consent ofIntelligence Press, Inc.