With the sale of Terasen Inc., Kinder Morgan Inc. (KMI) is exiting the retail utility business and buyer Fortis Inc. is bolting gas distribution onto its existing electric business, nearly doubling its customer base to 1.9 million.

Last Monday Fortis said it would acquire Terasen from a Kinder Morgan subsidiary for C$3.7 billion (US$3.2 billion), including the assumption of approximately C$2.3 billion (US$2 billion) of debt. Fortis CEO Stan Marshall told financial analysts last week that the company had been looking to acquire gas distribution assets for some time.

Terasen (formerly BC Gas Inc.) is a holding company headquartered in Vancouver, BC, involved in gas distribution and petroleum transportation. The purchase does not include the petroleum transportation assets of Kinder Morgan Canada (formerly Terasen Pipelines), which are composed primarily of refined product and crude oil pipelines. KMI acquired Terasen in November 2005 for US$5.6 billion (see NGI, Nov. 21, 2005; Aug. 8, 2005). The sale continues the transformation of KMI, which is on its way to privatization (see NGI, Jan. 29; June 5, 2006).

Following the acquisition, Fortis will be the largest investor-owned utility in gas and electric distribution in Canada with regulated electricity distribution utilities in five Canadian provinces and three Caribbean countries and regulated gas distribution utilities in British Columbia.

The gas distribution business, Terasen Gas, is one of the largest gas utilities in Canada. Terasen Gas is the principal gas utility in British Columbia, serving approximately 900,000, or 95% of the gas customers in the province. Terasen Gas owns and operates 44,100 kilometers (27,400 miles) of distribution pipelines and 4,300 kilometers (2,670 miles) of transmission pipelines. Its service territory includes the populous lower mainland, Vancouver Island and the southern interior of the province. As of Sept. 30, Terasen Gas had an aggregate of C$3.6 billion (US$3.06 billion) of assets, an aggregate rate base approaching C$3 billion (US$2.6 billion) and 1,200 employees. The company is regulated by the British Columbia Utilities Commission.

“These are high-quality utility assets located in a region with strong economic growth,” said Marshall. “Through our FortisBC electric utility operations, we are very familiar with the regulatory environment and energy markets in British Columbia. Our expansion into the natural gas distribution business adds a third business segment and doubles the regulated rate base of Fortis to C$6 billion. The acquisition is expected to be immediately accretive to earnings per common share.”

Fortis Inc.’s total assets will increase by 94% to C$8.9 billion (US$8 billion) and regulated utility assets will comprise 92% of total assets. Approximately 93% of these regulated assets will be located in Canada. Terasen Gas accounts for 83% of the assets being purchased. The remaining utilities are Terasen Gas (Vancouver Island) Inc. and Terasen Gas (Whistler) Inc. The unsecured long-term debt of Terasen Gas Inc. is rated ‘A’ by DBRS and ‘A3’ by Moody’s Investors Services.

“Terasen Gas is a well run utility, which will give Fortis a platform for further growth in the natural gas distribution business,” said Marshall. “It will complement our electric utilities, providing value for our customers and shareholders. Terasen Gas will remain autonomous in the Fortis model.”

Terasen Gas will significantly increase the earnings of Fortis from regulated utilities. The service territory of Terasen Gas is experiencing strong economic growth and includes substantially all of the service territory of FortisBC Inc.

The purchase price represents approximately 1.2 times the approved rate base of Terasen Gas for 2007. Similar to the electric distribution utilities of Fortis, Terasen Gas operates under principally cost-of-service rates. Terasen Gas has a gas distribution franchise with a diversified, mature, principally residential customer base. The acquisition is expected to improve the risk profile of Fortis by providing it with a more economically diverse portfolio of assets.

In August the British Columbia Utilities Commission agreed to open a portion of the province’s residential natural gas market to competition, allowing homeowners to sign long-term fixed price contracts for natural gas with companies other than Terasen Gas (see NGI, Aug. 21, 2006). The company filed its unbundling proposal with regulators in April (see NGI, April 24, 2006).

In 2004 Fortis acquired all of the issued and outstanding shares of FortisBC Inc. [formerly, Aquila Networks Canada (British Columbia) Ltd.] and FortisAlberta Inc. [formerly, Aquila Networks Canada (Alberta) Ltd.] and has integrated these utilities into the Fortis Group.

During a conference call with analysts last week, Marshall compared the Terasen transaction with the Aquila acquisition.

“If you go back to the Aquila transaction, we were really taking over assets which were in some disarray…,” he said. “On the other hand, they were in an area where we had considerable expertise and people available, and we put the proper human resources in there and achieved results.”

Marshall said the Aquila acquisition was expected at the time to be accretive to earnings within two years but turned out to be immediately accretive.

“This one [Terasen] is a more strategic move in the sense that we’re entering a new area, and that is, of course, gas distribution,” Marshall said. “It’s an area that is as close to electrical distribution as you can get. Indeed in many places in North America gas and electric are combined in one entity. It’s a logical next step in terms of our corporate growth, and we were looking for a gas company that was very well managed because it hasn’t been a core area for us until now.”

For KMI, letting go of Terasen is yet another step in the company’s transformation. KMI acquired the Terasen mainly for its crude oil pipelines out of Alberta, which it is retaining. KMI had its eyes set on the tremendous oilsands production growth upstream of Terasen’s petroleum pipeline business, CEO Richard D. Kinder said at the time KMI acquired Terasen, but it also came away with an attractive and stable gas utility operation in British Columbia.

“With the sale of Terasen Gas, KMI will be exiting the retail utility business, as we previously announced an agreement to sell our U.S. retail operations,” said Kinder. “While Terasen Gas is a strong local distribution company that produces stable cash flow, our core business continues to be building and operating pipelines and terminals.”

Friday, KMI said state regulatory utility commissions in Colorado, Nebraska and Wyoming had approved the buyout of KMI by investors including Kinder, other senior members of KMI management, co-founder Bill Morgan, current board members Fayez Sarofim and Mike Morgan and affiliates of Goldman Sachs Capital Partners, American International Group Inc., The Carlyle Group and Riverstone Holdings LLC. Because all of the regulatory approvals have not yet been obtained, the termination date for the going-private transaction has been extended to Aug. 28.

Last week Standard & Poor’s Ratings Services placed ratings of Terasen Inc. and Terasen Gas Inc. (TGI) on watch with positive implications following announcement of the deal. “The ratings on TGI were previously on CreditWatch with negative implications, relating to the lower ratings on Terasen (as consolidated with Kinder Morgan),” S&P said. “The ratings on TGI had previously been differentiated from the ones on Kinder Morgan, reflecting a strong degree of regulatory insulation provided by the British Columbia Utilities Commission.”

KMI’s board and the sponsors of the company’s pending privatization have approved the sale. KMI said it expects to recognize a substantial book loss from the sale. Proceeds will be used to pay down debt. TD Securities Inc. acted as financial advisor to KMI.

Closing is expected in mid-2007 following regulatory and other approvals. Fortis has obtained commitments from Canadian Imperial Bank of Commerce to provide financing. CIBC World Markets Inc. acted as financial advisor to Fortis.

Fortis is principally a diversified, international electric utility holding company with assets exceeding C$5.4 billion and annual revenues of approximately C$1.5 billion. Fortis has holdings in regulated electric distribution utilities in Alberta, British Columbia, Newfoundland, Ontario, Prince Edward Island, Belize, Grand Cayman and the Turks and Caicos Islands. It has nonregulated generation operations in Belize, Ontario, Newfoundland, British Columbia and upper New York State. Fortis also has investments in real estate and hotels through its wholly owned nonutility subsidiary.

©Copyright 2007Intelligence Press Inc. All rights reserved. The preceding news reportmay not be republished or redistributed, in whole or in part, in anyform, without prior written consent of Intelligence Press, Inc.