EX-99 2 p08-1160exhibith.txt EXHIBIT H EXHIBIT H SANDELL ASSET MANAGEMENT ------------------------- CASTLERIGG INVESTMENTS July 16, 2008 Southern Union Company 5444 Westheimer Road Houston, TX 77056 Attn: George Lindemann, Chairman and Chief Executive Officer Dear George: As you are well aware by now, Sandell Asset Management ("Sandell") has been a shareholder of Southern Union Company ("Southern Union", "SUG" or the "Company") for over three years and we remain your largest single shareholder. We purchased the shares because we believed the value of the Company's assets were well in excess of its stock price, and subsequently were even convinced that management was dedicated to realizing that value. We also believed that you, Mr. Lindemann, would be willing to sell the Company if you could not deliver that value in a reasonable timeframe. The record now clearly shows that our patience was misplaced. During the past few years shareholders have witnessed the following: 1. Continued and consistent underperformance in SUG's share price relative to its peers. In fact, we have recently seen this performance gap widen even further 2. A consistent exodus of management talent replaced with less qualified internal candidates 3. Generous compensation for the most senior executives not tied to operating performance or share price 4. Broken promises to investors and analysts that have dramatically eroded management's credibility 5. An inability to communicate and execute a concrete plan for value enhancement We believe the poor and declining share price performance is a clear sign that the market has utterly lost confidence in the Company's leadership. In 2006, we initiated a proxy contest to elect director candidates in an effort to improve the Board's qualifications, add new perspectives, and foster a new urgency to drive shareholder value. We agreed to withdraw those nominees in view of the stated intentions in your February 2007 Strategic Plan to engage in several value enhancement initiatives including the creation of an MLP and the opportunistic return of capital to shareholders. Thus far, none of those goals have been met in substance, and we strongly question your level of actual commitment to them in the first place. July 16, 2008 Page 2
------------------------------------------------------------------------------------------------- Total Shareholders Return 2005 2006 2007 2008 YTD 2005-Current ------------------------------------------------------------------- Spectra Energy Corp NA NA (3.6%) 7.7% NA El Paso Corp 18.6% 27.1% 14.0% 14.0% 153.6% ONEOK Inc. (2.8%) 67.8% 6.9% 8.0% 151.9% Williams Cos Inc. 44.0% 14.4% 38.7% 2.2% 289.7% Equitable Resources Inc 24.1% 16.5% 29.9% 20.9% 230.4% Sempra Energy 25.6% 28.1% 12.7% (8.5%) 108.2% National Fuel Gas Co 14.3% 27.7% 24.5% 24.5% 173.6% ------------------------------------------------------------------- Average 20.6% 30.3% 17.6% 9.8% 184.6% Southern Union Co 3.5% 20.1% 6.6% (12.5%) 58.6% Note: As of 7/11/08 -------------------------------------------------------------------------------------------------
With regards to the MLP, you indicated that you intended to complete an IPO by the end of the third quarter of 2007. It has been 498 days since the withdrawal of our nominees and we have yet to even see an S-1 filing. Notwithstanding the disruptions in the capital markets recently, there were ample opportunities for SUG to complete an offering prior to the current market slowdown had the Company moved with real urgency and commitment. In fact, even as recently as this past May when the tightening of the capital markets was already well underway, Anadarko Petroleum successfully priced a midstream MLP IPO at a yield of 7.3% - the very same transaction that SUG's new Chief Operating Officer, Eric Herschmann, cited on the last earnings call. In the table below, you will note that several companies were able to announce, file and successfully price MLPs since you announced your Strategic Plan. History shows that companies dedicated to creating shareholder value find ways to do so regardless of market conditions.
DAYS FROM INITIAL ANNOUNCEMENT INITIAL ----------------------------------------------------------------------------------------------------------------- ANN. 0 30 60 90 120 180 210 240 270 300 330 360 390 420 450 480 510 540 570 600 APC 10/15/2007 Filed S-1 Pricing PXD 4/23/2007 Filed S-1 Delay Pricing EAC 1/17/2007 Filed S-1 Pricing WMZ 7/20/2007 Filed S-1 Pricing EPB 2/21/2007 Filed S-1 Pricing SUG 2/28/2007 Postponed Storage Ann. Midstream Postpones Midstream
The Company's track record of capital return is only slightly better. Since you announced your Strategic Plan, SUG has not repurchased a single share of stock, despite the trading price recently hitting a low not seen since January 2005. We acknowledge that SUG did raise the quarterly dividend by close to 50% - however, this exaggerated increase was off a miniscule base of 10 cents per share. Further testament to the market's lack of confidence in SUG, is the stock's discounted multiple and gap to its NAV. The price discount to a pro forma MLP valuation is particularly striking and a strong sign that both investors and sell-side analysts do not believe that the Company's board and/or management will follow through on an MLP. It raises significant concerns about July 16, 2008 Page 3 complacency around value creation when such compelling opportunities are available. We dispute your frequently offered excuse that an MLP does not create value due to tax leakage, as it is well known that there are numerous structures available that mitigate tax leakage and defer tax payments. We do not subscribe to any theory that SUG is in such a unique position to justify holding MLP-eligible assets in a fully taxable form while virtually every other midstream and/or pipeline company has moved aggressively to sell or convert these assets into MLPs to the benefit of shareholders.
TEV MLP Sub(s) Name Recent Dropdowns -------- ---------- ------------------------------ --------------------------------------- ONEOK INC OKE $10,138 OKS ONEOK PARTNERS LP Apr. 06 - $3bn WILLIAMS COS INC WMB $27,794 WPZ WILLIAMS PARTNERS LP Aug. 05 - $124mm IPO, $317 mm asset Jun. 06 - $360mm Nov. 06 - $1.2bn Jun. 07 - $78mm Dec. 07 - $750mm WMZ WILLIAMS PIPELINE PARTNERS L Jan. 08 - $358mm IPO for $718mm asset DUKE ENERGY CORP DUK $33,610 DPM DCP MIDSTREAM PARTNERS LP Nov. 06 - $77mm Jul. 07 - $271mm Aug. 07 - $166mm ($635mm total) SPECTRA ENERGY CORP SE $27,090 SEP SPECTRA ENERGY PARTNERS LP Jul. 07 - $230mm IPO for $550mm asset Dec. 07 - $107mm EL PASO CORP EP $27,231 EPB EL PASO PIPELINE PARTNERS LP Nov. 07 - $537mm IPO for $962mm asset
At this point, we do not have any faith that management or the board of directors harbor any real intention of moving forward actively with an MLP or other value enhancing restructuring alternatives. Even if our continued insistence does result in a meager MLP IPO of the former Sid Richardson assets, we have no confidence that you will move aggressively to drop the remaining assets into the MLP over a reasonable timeframe. While virtually all of the Company's assets qualify for the MLP structure, only a real and disciplined commitment to follow through on the conversion process will maximize value. Unfortunately, we have no indication that such commitment exists at SUG. In fact, on the last earnings call, you suggested that SUG might even be interested in PURCHASING more midstream assets. We are shocked that you would even consider acquisitions given SUG's weak stock currency and the existing limitations your current debt load puts on the Company's strategic options. Further, you would likely be bidding against existing MLPs that have stronger currency, virtually assuring that you would be overpaying for the assets. For these reasons, among others, we strongly oppose any acquisitions. July 16, 2008 Page 4
Firm Name Analyst Rating Target Commentary -------------------------------- -------------------------- ---------------- ------- ----------------------------------------------- Wachovia Capital Markets LLC SAMUEL BROTHWELL market perform $27.50 "... we are revising our valuation range down to reflect: 1) the MLP delay, and--more importantly--2) to reflect a lower level of confidence that this management team will act to optimize shareholder value in a timely fashion. Part of the reason to own SUG was that CEO George Lindermann is seen as a value / deal guy. But at his insistence, the MLP was kept at bay until it withered on the vine. SUG is a public company, not a family business, management's lack of urgency is disturbing, and we can't just keep on waiting, waiting for the world to change." BMO Capital Markets-US CARL L KIRST outperform $35.00 "... at some point in the furture ... value will get recognized via either MLP creation, future stock buyback, asset optimization, or even an outright sale for the right price." RBC Capital Markets LASAN JOHONG sector perform $29.00 "While we do not believe this is the optimal strategy [for SUG to form a new MLP], and would have preferred SUG sell to another MLP and focus its strategy on its core LNG, transportation and distribution business, we do believe the formation of an MLP could create shareholder value." Banc of America ELVIRA SCOTTO neutral $30.00 "Management has acknowledged recent incremental market liquidity ... Becoming more constructive on the shares ... However, with the midstream MLP shelved for the time being, we do not see any near-term catalyst to drive the shares meaningfully higher from current levels." Citigroup FAISEL KHAN buy $37.00 "Our NAV analysis results in a value of $36.83 per share ... [but] we also attribute no MLP valuation uplift to SUG" JPMorgan XIN LIU/GLENN MULLIN overweight "Longer term, we continue to believe an MLP makes sense as part of the company's stragegy." Calyon Securities (USA) Inc GORDON HOWALD buy $41.00 "We constantly hear criticism from investors about Southern Union's preceived lack of shareholder focus, particularly management access." Stifel Nicolaus SELMAN AKYOL buy $32.00 "We do not expect that the company will move forward with a G&P MLP at this time" Lehman Brothers RICHARD GROSS overwt/neutral $33.00
Since management has yet to offer, much less enact, a substantive value creation plan, WE BELIEVE THAT THE ONLY VIABLE OPTION FOR VALUE CREATION IS A SALE OF THE COMPANY. Despite the poor performance of the equity markets, we are confident there would be significant interest in a transaction and note that the share prices of virtually all of SUG's competitors (and possible acquirers) are up materially this year on both relative and absolute bases. We were told that SUG had received offers for the Company during the last two years but walked away from a potential deal over 50 cents (or less) on the proposed stock purchase price. July 16, 2008 Page 5 Strongly supportive of the potential sale price is the value that can be realized through a proactive execution of an MLP conversion. On this basis we believe SUG is worth between $32-$42 per share depending on the sequence of particular assets contributed, the prevailing market environment and the level of tax mitigation. This valuation is well supported by sell-side research which often have a wide variance between SUG's target price in the status quo, and the Company's materially higher MLP or sum-of-the-parts valuations. We believe this gap represents a material "credibility discount" for SUG's management as the Company's operating assets have significantly greater strategic value. As such, we believe that an acquirer would be willing to pay between $35-$40 for SUG and still generate attractive returns from cutting costs and dropping assets into its own MLP.
Sum of the Parts Valuation Sum of the Parts Sale -------------------------- ---------------------- 2008E Value 2008E Value EBITDA Multiple per Shr EBITDA Multiple per Shr ------ --------- -------- ------ --------- -------- Transportation & Storage $593 8.7x $41.41 Transportation & Storage $593 9.5x $45.39 Gathering & Processing $189 8.5x $12.91 Gathering & Processing $189 9.0x $13.67 Gas Distribution $111 8.0x $7.16 Gas Distribution $111 8.0x $7.16 Corporate $2 7.0x $0.12 Corporate $2 7.0x $0.12 ------------------------------------------------------- -------------------------------------------------------- Total TEV $895 8.5x $61.60 Total TEV $895 9.2x $66.35 Net Debt $28.93 Net Debt $28.93 ------------------------------------------------------ -------------------------------------------------------- Equity Value $32.68 Equity Value $37.42 ------------------------------------------------------- -------------------------------------------------------- Upside % 28.2% Upside % 46.8%
Summary MLP Valuation --------------------- TEV Per Shr -------- --------- Full Midstream & Pipeline/LNG MLP --------------------------------- NPV of IPO Proceeds & Dropdown Proceeds $2,287 $18.42 Value of GP Distributions $2,143 $17.26 Value of Subordinated LP Distributions $3,468 $27.93 Legacy Assets Value $905 $7.29 ---------------------------------------------------------------- Total TEV $8,803 $70.90 Net Debt ($3,592) ($28.93) ---------------------------------------------------------------- Equity Value $5,211 $41.97 ---------------------------------------------------------------- Upside % 64.7%
July 16, 2008 Page 6 The market has no more patience with management's poor performance, outsized compensation and complacency towards value creation. This belief is clearly supported by the dismal share price performance and the Company's discounted public valuation. We believe the option that creates the most value for shareholders at this point is an immediate sale of the Company. On this basis, we strongly recommend that the Company retain a financial advisor. However, if SUG were to remain independent, there would need to be a significant restructuring of the Company which would include the following at a minimum: 1. Separation of the Chairman and CEO roles, and recruitment of an experienced energy CEO. This candidate would then evaluate and fill out other senior executive roles where appropriate 2. A detailed plan and public commitment to converting all of the Transportation/Storage and Gathering & Processing assets into one or even separate MLPs 3. Commitment to a minimum level of capital return to shareholders 4. Replacement of a majority of the existing board with truly qualified candidates who have relevant experience and no ties to management In conclusion, the market has clearly shown that our decision to not seek representation on the board two years ago in reliance upon your hollow commitment was a mistake. Ample time has elapsed and opportunities squandered by the Company, and we no longer have the appetite for false promises and delaying tactics offered in the hope that we will go away. While there is still some time before the next opportunity to nominate candidates in December, we have begun the process of searching for qualified candidates because we believe that nothing will meaningfully change in the next several months. Yours truly, Thomas Sandell Chief Executive Officer Sandell Asset Management Corp.