After a series of pipeline company acquisitions, El Paso Energy Corp. is now the largest natural gas pipeline company in North America. But its days of continued consolidation in that regulated industry are drawing to a close. El Paso has now embarked on what executive vice-president Ralph Eads calls a period of "organic growth." The businesses created internally include telecommunications and merchant energy. As head of El Paso's merchant energy business, Eads has guided that business towards dramatic growth. Merchant energy is key to El Paso's future growth, especially when coupled with the natural gas assets they will acquire in the Coastal Corp. merger.
OGJ Online Senior Power Writer Ann de Rouffignac interviewed Ralph Eads, executive vice-president for gas and power merchant energy, El Paso Energy Corp., at the company's Houston headquarters.
Ralph Eads jumps from his chair to check El Paso Energy Corp.'s stock price. He returns grinning. The stock is at an all time high of 53 11/16ths.
"You are here on a good day," says Eads, El Paso's executive vice-president for production and merchant energy. The present stock price notwithstanding, analysts' projections suggest El Paso appears poised for an earnings growth spurt that could even surpass industry leader Enron Corp.
But will the stock price keep up? That's the question puzzling Wall Street and shareholders.
First Call Corp. projects El Paso's earnings per share (EPS) will increase to $3.11 in 2001 from $2.57 this year. Enron's EPS are projected to be $1.64 in 2001, up from $1.40 in 2000, according to First Call.
Yet even with a market capitalization of $12 billion that is set to double to about $23 billion after its merger with Coastal Corp. is complete, El Paso's market cap is still much smaller than Enron's $53 billion. But Enron's price-to-earnings multiple is 52 compared to El Paso's 21 times earnings per share.
Wall Street's perception of El Paso, namesake of a dusty West Texas city, could be changing. Analysts have begun to recognize El Paso as a significant industry player that could be harboring some pleasant upside surprises.
After the merger with Coastal is completed, El Paso will be No. 1 or 2 in all segments but one of the natural gas value chain, with 56,600 miles of interstate pipeline transporting 20.7 bcfd, nearly double that of its nearest competitor. The combined company will be No. 2 in the industry in gas processing, No. 3 in gas production after BP and Exxon Mobil Corp., and No. 2 in wholesale gas and power marketing.
PaineWebber energy analyst Ronald Barone reported El Paso's second quarter earnings per share showed a "staggering" increase of 73% to 69� from 40� for the comparable 1999 period�much higher than the street's consensus estimate of 59� or his own estimate of 58�.
"No company of any size [within the industry] is growing as fast as we are," Eads notes.
But yet the company hasn't learned to 'sell the street,' industry sources say.
Even Eads notes that El Paso is almost "self-effacing" and not a big self-promoter.
To stimulate more financial and public interest in the company, El Paso is planning a "branding" campaign, but Eads is holding the details close. Meanwhile, El Paso has been digesting a series of large acquisitions on its climb to the top of the natural gas pipeline world.
Organic growth
After pursuing consolidation of the natural gas pipeline industry for the past several years, El Paso is emerging from its consolidation phase to a new period of "organic growth," Eads says. The company will emphasize its home-grown businesses such as merchant energy and a newly announced foray into telecommunications.
Under the tutelage of Eads, El Paso's merchant energy marketing and trading organization has shown dramatic growth. In the most recent second quarter, merchant energy earned operating income of $152 million vs. $6 million for the 1999 equivalent quarter.
Eads views the merchant business a little differently from most of his competitors.
"We buy and sell energy assets like storage or power plants and trade everything else," he says. "All things we own in the merchant business including power plants can be viewed as options."
Unlike many merchant power companies, El Paso is not amassing a huge portfolio of physical electric generating capacity, he says. He says the company has difficulty today finding power projects that meet its risk criteria.
El Paso is not long on power because Eads believes prices will fall over the next few years, and he warns against an "asset-centric" strategy.
"It's easy for a big company to spend a lot of capital and buy or build a bunch of assets," he says. "We think it's too risky. If you are just going long on assets, that is not a winning strategy.
"We are fast getting to oversupply on the power side," Eads says. "Prices will collapse in certain regions. Texas is a candidate for it."
Besides managing its own risk in the gas and electricity markets, the company generates fee income managing assets for other companies, and it manages gas and electricity risk for third parties such as large industrial gas customers and utilities.
El Paso's market-focus means it will keep or shed assets to improve results. The results will vary with volatility, he says.
El Paso acquired a lot of cheap options on gas and when gas prices became volatile this year, El Paso cashed in. The company bet on prices going up and down. It doesn't care whether prices rise or fall just as long as prices move enough in one direction to cover any bets on the other side and still make money.
"We don't care about prices going up or down. But about prices just going," he says.
With 15 years as an investment banker, Eads is well suited to his position of managing risk and assets at El Paso. Prior to joining the Houston company, he was managing director of the energy group for Donaldson, Lufkin & Jenrette Inc., New York.
Digesting acquisitions
El Paso's acquisition of Coastal Corp. was a bold move for the energy merchant. It will be the only large energy merchant and pipeline company with an independent exploration and production unit. Enron completely spun off and no longer owns any stock of Enron Oil & Gas. But the purchase of Coastal was not a part of a plan to expand into E&P.
"We had an opportunity to acquire Coastal," says Eads. "It was simply a good buy."
He concedes exploration and production was a bad business the last decade, but Eads is sure it will be a good business the next decade. Stepping back into the role of investment banker, Eads is confidant the company will "double" its money on the Coastal purchase.
While approval of the merger winds through the regulatory agencies, El Paso is concentrating on integrating Coastal into El Paso, he says. The US Federal Energy Regulatory Agency approved the $16 billion deal July 26. Still pending is approval from the Federal Trade Commission.
Decisions about some Coastal businesses that don't appear to fit, such as refining, are simply not on the table right now. Eads says it's too soon to discuss divestitures.
Instead, keeping the best people and attracting talent from the outside will be essential to melding the companies together, he says. But El Paso is accustomed to the integration process.
El Paso bought Tenneco Energy in 1996, Sonat in 1999, and hopes to complete the Coastal merger in the fourth quarter of 2000�as well as the acquisition of PG&E's pipeline system. El Paso agreed to buy 8,500 miles of intrastate gas transmission pipelines and related facilities for $840 million, including $561 million in debt.
Are there more acquisitions in the offing?
Eads downplays the possibility of more big moves�especially into retail marketing, the only piece of the value chain in which it does not operate. This means that El Paso won't be buying any electric utilities soon.
"The retail business is off the table for now," Eads says.
Biography
Now group executive vice-president of production and merchant energy, Eads joined El Paso Energy Corp. in 1999 from Donaldson, Lufkin & Jenrette, where he was managing director and co-head of the energy group. He was head of the energy practice at SBC Warburg before joining DLJ and previously worked at Lehman Brothers and Merrill Lynch. Eads serves on the board of visitors at Duke University and the board of trustees of the Nature Conservancy of Texas.
