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VALERO NATURAL GAS PARTNERS, L.P.
(Commission File No. 1-9433)
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of
1934
(Amendment No. 3)
Filed by the Registrant [x]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement
[x] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section
240.14a-12
--------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
--------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement)
Payment of Filing Fee (Check the appropriate box):
[ ] $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1) or 14a-6(j)(2).
[ ] $500 per each party to the controversy pursuant to Exchange Act Rule
14a-6(i)(3).
[x] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and
0-11.
1) Title of each class of securities to which transaction applies:
Common Units of Limited Partner Interests ("Common Units")
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2) Aggregate number of securities which transaction applies:
9,711,919 Common Units
3) Per unit price or other underlying value of transaction
computed pursuant to Exchange Act Rule 0-11: $12.10 per
Common Unit(1)
4) Proposed maximum aggregate value of transaction:
$117,514,210(1)
[x] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the Form or Schedule and the date of its filing.
1) Amount Previously Paid:
$23,502.80
2) Form, Schedule or Registration Statement No.:
Schedule 13E-3
3) Filing Party:
Valero Natural Gas Partners, L.P., Valero Natural Gas Company
and Valero Energy Corporation
4) Date Filed:
December 30, 1993
____________________
(1) In the merger transaction described in the enclosed preliminary proxy
statement, the publicly-held Common Units would be converted into a
right to receive $12.10 per Common Unit, or an aggregate of
$117,514,210, based on an aggregate of 9,711,919 publicly-held Common
Units.
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VALERO
[VALERO LOGO] NATURAL GAS PARTNERS, L.P.
VALERO NATURAL GAS COMPANY, GENERAL PARTNER
530 MCCULLOUGH AVENUE
SAN ANTONIO, TEXAS 78215
Dear Unitholder:
You are cordially invited to attend a Special Meeting of holders of common units
of limited partner interests ("Common Units") of Valero Natural Gas Partners,
L.P. ("VNGP, L.P." and, collectively with its consolidated subsidiaries, the
"Partnership") to be held on May 31, 1994. At the Special Meeting, the holders
of the Common Units will vote upon a proposal that will result in the merger
(the "Merger") of VNGP, L.P. with a wholly owned subsidiary of Valero Energy
Corporation ("VEC" and, collectively with its consolidated subsidiaries, the
"Company"). As a result of the Merger, VNGP, L.P. will become a wholly owned
subsidiary of VEC, and the Common Units held by persons other than the Company
(the "Public Unitholders"), will be converted into the right to receive $12.10
in cash per Common Unit.
The Board of Directors (the "Board") of Valero Natural Gas Company, a Delaware
corporation ("VNGC") and general partner of VNGP, L.P. (the "General Partner"),
and a Special Committee of outside directors appointed by the VNGC Board to
consider the proposal each have concluded that the Merger is fair to, and in the
best interest of, the holders of the Common Units, including the Public
Unitholders, and have unanimously approved the Merger. See "The
Partnership -- Conflicts of Interest." In arriving at its conclusion, the
Special Committee gave due consideration and significant weight to the fact that
its financial advisor, Dillon, Read & Co. Inc. had delivered to the Special
Committee its written opinion, dated December 20, 1993 (and confirmed in writing
on April 27, 1994), that, based upon the considerations and subject to the
assumptions and limitations set forth therein, the consideration to be received
by the Public Unitholders in the Merger is fair to the Public Unitholders from a
financial point of view. The VNGC Board unanimously recommends that the holders
of the Common Units vote "FOR" approval of the Merger and the transactions
contemplated thereby.
The Merger must be approved by the holders of a majority of the Common Units,
including Common Units held by the Company, and also by the holders of a
majority of the Common Units held by Public Unitholders and voted at the Special
Meeting. The Company holds approximately 47.5% of the issued and outstanding
Common Units and intends to vote such Common Units "FOR" approval of the Merger.
Including its general partner interests, the Company holds an effective equity
interest of approximately 49% in the Partnership.
The accompanying Proxy Statement describes in detail the reasons for the Merger,
the manner in which the transactions will take place, certain tax consequences
of the Merger and other matters. The action to be taken at the Special Meeting
is of great importance and I urge you to read the accompanying materials
carefully. WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON AND
REGARDLESS OF THE NUMBER OF COMMON UNITS YOU OWN, PLEASE COMPLETE, SIGN AND DATE
THE ENCLOSED PROXY CARD AND MAIL IT AS SOON AS POSSIBLE IN THE BUSINESS REPLY
ENVELOPE PROVIDED.
Very truly yours,
WILLIAM E. GREEHEY,
Chairman of the Board and Chief
Executive Officer
Valero Natural Gas Company,
General Partner of Valero Natural Gas
Partners, L.P.
May 2, 1994
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VALERO
[VALERO LOGO] NATURAL GAS PARTNERS, L.P.
VALERO NATURAL GAS COMPANY, GENERAL PARTNER
530 MCCULLOUGH AVENUE
SAN ANTONIO, TEXAS 78215
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NOTICE OF SPECIAL MEETING OF UNITHOLDERS TO BE HELD
MAY 31, 1994
To the Holders of Common Units of Limited
Partner Interests of
Valero Natural Gas Partners, L.P.
Notice is hereby given that a Special Meeting of the holders of common units of
limited partner interests ("Common Units") of Valero Natural Gas Partners, L.P.
("VNGP, L.P."), will be held at 8:00 a.m. (Central Time) on May 31, 1994 at the
offices of Valero Natural Gas Company ("VNGC"), 530 McCullough Avenue, San
Antonio, Texas 78215 (the "Special Meeting") to consider and approve a proposed
merger of VNGP, L.P. with Valero Merger Partnership, L.P., a Delaware limited
partnership wholly owned by subsidiaries of Valero Energy Corporation ("VEC"),
and formed at the direction of VEC for the purpose of engaging in such
transaction.
By order of the Board of Directors of VNGC, the close of business on April 28,
1994, has been fixed as the record date for determination of holders of Common
Units entitled to notice of, and to vote at, the Special Meeting, or any
adjournments or postponements thereof.
Whether or not you plan to attend the Special Meeting in person and regardless
of the number of Common Units you own, you are urged to sign and date the
enclosed proxy card and mail it as soon as possible in the stamped, addressed
return envelope provided, so that your Common Units may be represented and voted
at the Special Meeting.
By order of the Board of Directors of
Valero Natural Gas Company, General Partner
RAND C. SCHMIDT
Corporate Secretary
May 2, 1994
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VALERO
[VALERO LOGO] NATURAL GAS PARTNERS, L.P.
PROXY STATEMENT FOR SPECIAL MEETING
TO BE HELD ON MAY 31, 1994
This Proxy Statement (the "Proxy Statement") and the accompanying Notice of
Special Meeting of Unitholders (the "Notice") are being furnished to the holders
of common units of limited partner interests ("Common Units") of Valero Natural
Gas Partners, L.P. ("VNGP, L.P." and, together with its consolidated
subsidiaries, the "Partnership"), a Delaware limited partnership, in connection
with the solicitation of proxies for use at the special meeting to be held at
8:00 a.m. (Central Time) on May 31, 1994 at the offices of Valero Natural Gas
Company ("VNGC"), the general partner (in such capacity, the "General Partner")
of VNGP, L.P., 530 McCullough Avenue, San Antonio, Texas 78215, and at any
adjournment or postponement thereof (the "Special Meeting"). Proxies are being
solicited by VNGC. This Proxy Statement and the accompanying form of Proxy are
first being mailed to the holders of the Common Units on or about May 2, 1994.
Holders of the Common Units are entitled to one vote for each Unit held of
record at the close of business on April 28, 1994 (the "Record Date"), with
respect to the proposal described in the Proxy Statement.
Action may be taken on the proposal described in the Proxy Statement on the date
specified herein, or on any date or dates to which, by original or later
adjournment, the meeting may be adjourned.
At the Special Meeting, the holders of the Common Units will consider and vote
upon a proposal to merge VNGP, L.P. with Valero Merger Partnership, L.P.
("Newco"), a Delaware limited partnership wholly owned by subsidiaries of Valero
Energy Corporation ("VEC" and, together with its consolidated subsidiaries, the
"Company") and formed at the direction of VEC for the purpose of engaging in
such transaction. VEC is a publicly traded Delaware corporation that, through
subsidiaries, engages principally in the oil refining and marketing, natural gas
and natural gas liquids ("NGL") businesses. The term "Company" is used herein to
refer to VEC and its various consolidated subsidiaries, including VNGC (but
excluding the Partnership), either individually or collectively, as the context
shall require. Through subsidiaries, VEC owns 8,774,619 Common Units,
representing an approximate 47.5% limited partner interest in VNGP, L.P., and
VNGC and other subsidiaries of VEC hold 1% general partner interests in and
serve as general partners of VNGP, L.P. and its subsidiary partnerships.
Including its general partner interests, the Company holds an effective equity
interest of approximately 49% of the Partnership. The merger (the "Merger") will
be accomplished pursuant to an Agreement of Merger, dated December 20, 1993 (the
"Merger Agreement") among VNGP, L.P., VNGC, Newco and VEC.
Upon the consummation of the Merger and by virtue thereof, (i) the Common Units
held by persons other than the Company (the "Public Unitholders") will be
converted into the right to receive $12.10 in cash per Common Unit from VNGC,
(ii) the Common Units held by subsidiaries of VEC will remain outstanding, (iii)
the 1% general partner interest in VNGP, L.P. held by VNGC will remain
outstanding, (iv) VNGC will acquire additional Common Units from VNGP, L.P. in
consideration of the cash payment to the Public Unitholders, (v) VNGP, L.P.,
together with its consolidated subsidiaries, will become wholly owned
subsidiaries of VEC and (vi) the Public Unitholders will cease to be limited
partners of VNGP, L.P. The Merger will be a taxable event to the Public
Unitholders. Additionally, certain attorneys' fees paid in connection with the
Merger will affect the calculation of each Public Unitholder's basis in his
Common Units and assumed sales price, but is not expected to affect the
Unitholder's gain or loss resulting from the transaction. See "Federal Income
Tax Consequences of the Merger."
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THIS TRANSACTION HAS NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE FAIRNESS OR MERITS OF
THIS TRANSACTION NOR UPON THE ACCURACY OR ADEQUACY OF THE INFORMATION CONTAINED
IN THIS PROXY STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
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VEC has proposed the Merger because it believes that the Partnership, in its
present form, has insufficient financial flexibility to participate fully in
opportunities that are expected to arise in the natural gas and NGL businesses,
that the ability of the Partnership to compete effectively in these businesses
will be enhanced through the Merger and that the Partnership could lose its
competitive position if it does not pursue such opportunities when and if they
become available. VEC also believes that potential conflict of interest
situations between the Partnership and the Company can be eliminated through the
Merger. Prior to proposing the Merger, VEC considered and rejected various
alternative transactions, some of which may have resulted in greater total
consideration to the Public Unitholders than they would receive in the Merger.
The General Partner played no role in VEC's consideration of such alternatives.
See "Special Considerations -- Reasons for the Proposed Merger -- Alternative
Transactions Considered."
The General Partner believes that the Merger is fair to and in the best
interests of the Partnership and the Public Unitholders, based in part upon the
recommendation of a Special Committee of the Board of Directors of the General
Partner, consisting of three members of the General Partner's Board of Directors
who are not employees of the General Partner, VEC or any of their affiliates
(the "Special Committee"). The Board of Directors of the General Partner and the
Special Committee have concluded that the transactions contemplated by the
Merger Agreement are fair to, and in the best interests of, the Public
Unitholders, and have unanimously approved the Merger Agreement. In arriving at
its conclusions, the Special Committee gave due consideration and significant
weight to the opinion of Dillon, Read & Co. Inc., an investment banking firm
acting as the Special Committee's financial advisor ("Dillon Read"), that, based
upon the considerations and subject to the assumptions and limitations set forth
therein, the consideration to be received by the Public Unitholders in the
Merger is fair to the Public Unitholders from a financial point of view. See
"Special Considerations -- Opinion of Financial Advisor to the Special
Committee." THE BOARD OF DIRECTORS OF THE GENERAL PARTNER UNANIMOUSLY RECOMMENDS
THAT HOLDERS OF THE COMMON UNITS VOTE "FOR" APPROVAL OF THE MERGER AGREEMENT AND
THE TRANSACTIONS CONTEMPLATED THEREBY. See "Special
Considerations -- Recommendation of the Board of Directors of the General
Partner; Fairness of the Merger."
The consummation of the Merger is subject to several conditions, including
obtaining lender consents. See "The Merger -- Conditions to the Obligations of
the Parties to the Merger Agreement." The Merger will be effected pursuant to
the Merger Agreement.
On the Record Date, there were outstanding 18,486,538 Common Units, which are
entitled to vote as a single class. Pursuant to the Delaware Revised Uniform
Limited Partnership Act ("DRULPA"), approval of the Merger Agreement will
require the affirmative vote of the holders of a majority of the outstanding
Common Units entitled to vote thereon (the "Majority Vote Requirement"),
including Common Units held by the Company. Additionally, the Merger Agreement
provides that approval of the Merger shall require the affirmative vote of a
majority of the Common Units held by Public Unitholders which are voted at the
Special Meeting (the "Independent Vote Requirement"). The Company has informed
the General Partner that it intends to vote the Common Units that it owns,
representing approximately 47.5% of the outstanding Common Units, "FOR" approval
of the Merger.
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WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON AND REGARDLESS
OF THE NUMBER OF COMMON UNITS YOU OWN, PLEASE COMPLETE, SIGN AND DATE THE
ENCLOSED PROXY CARD AND MAIL IT AS SOON AS POSSIBLE IN THE STAMPED, ADDRESSED
RETURN ENVELOPE PROVIDED.
HOLDERS OF COMMON UNITS SHOULD NOT SEND IN ANY CERTIFICATES REPRESENTING COMMON
UNITS AT THIS TIME.
---------------------
The date of this Proxy Statement is May 2, 1994.
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TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
AVAILABLE INFORMATION.................................................................. 1
ADDITIONAL INFORMATION................................................................. 1
SUMMARY OF THE PROXY STATEMENT......................................................... 1
Purpose of the Special Meeting....................................................... 1
Date, Time and Place of the Special Meeting.......................................... 2
Record Date, Common Units Entitled to Vote, Quorum................................... 2
Vote Required........................................................................ 2
Certain Relationships................................................................ 2
Interests of Certain Persons in the Merger........................................... 3
The Special Committee................................................................ 4
Fairness of the Transaction; Recommendations......................................... 4
Reasons for the Merger............................................................... 5
Terms of the Merger.................................................................. 5
Effective Time....................................................................... 6
Financing of the Merger.............................................................. 6
Market Prices of the Common Units.................................................... 6
No Dissenters' Rights................................................................ 7
Litigation Relating to the Merger.................................................... 7
Summary of Certain Federal Income Tax Considerations................................. 7
SPECIAL CONSIDERATIONS................................................................. 8
Reasons for the Proposed Merger...................................................... 8
Summary........................................................................... 8
Introduction...................................................................... 9
Industry Opportunities and Need for Additional Financing.......................... 10
Prior Financings.................................................................. 12
Limitations on Additional Financing............................................... 13
Selection of Merger............................................................... 14
Alternative Transactions Considered............................................... 14
Considerations Affecting Future Cash Distributions to Unitholders................. 18
Background of the Merger............................................................. 20
Certain Contacts.................................................................. 24
Salomon Brothers' Analysis........................................................... 26
March Preliminary Review.......................................................... 26
Salomon October Report............................................................ 30
Certain Projections.................................................................. 32
Recommendation of the Board of Directors of the General Partner; Fairness of the
Merger............................................................................ 38
Opinion of Financial Advisor to the Special Committee................................ 43
December Events................................................................... 43
February and March Events......................................................... 47
Principal Effects of the Merger...................................................... 49
THE MERGER............................................................................. 51
Basic Terms of the Merger............................................................ 51
Fees and Expenses.................................................................... 52
Effective Time of the Merger......................................................... 52
Source of Cash Consideration......................................................... 52
Conditions to the Obligations of the Parties to the Merger Agreement................. 52
Termination or Amendment of the Agreement of Merger.................................. 54
Certain Rights of Public Unitholders; Litigation Related to the Merger............... 55
Method of Surrendering Unit Certificates for Payment................................. 56
Accounting Treatment of the Merger................................................... 56
</TABLE>
iii
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<TABLE>
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<S> <C>
THE PARTNERSHIP........................................................................ 56
History of the Partnership........................................................... 56
Conflicts of Interest................................................................ 60
Ownership of Common Units............................................................ 63
THE PROXY SOLICITATION................................................................. 64
Voting and Proxy Procedures.......................................................... 64
Solicitation of Proxies.............................................................. 64
No Dissenters' Rights of Appraisal................................................... 65
Conduct of the Special Meeting....................................................... 65
SUMMARY FINANCIAL DATA................................................................. 66
MARKET PRICES OF COMMON UNITS AND DISTRIBUTIONS........................................ 67
FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER.......................................... 68
Introduction......................................................................... 68
IRS Private Letter Ruling............................................................ 68
Backup Withholding................................................................... 69
Forecast of Certain Federal Income Tax Consequences to Public Unitholders............ 69
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE........................................ 70
ANNEX A -- Agreement of the Merger..................................................... A-1
ANNEX B -- Opinion of Dillon Read...................................................... B-1
ANNEX C -- Consolidated Financial Statements of VNGP, L.P.............................. C-1
ANNEX D-1 - D-3 -- Per Unit Tax Bases and Income Allocations........................... D-1
</TABLE>
iv
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AVAILABLE INFORMATION
VNGP, L.P. is subject to the informational requirements of the Securities
Exchange Act of 1934 (the "Exchange Act") and, in accordance therewith, files
reports, proxy statements and other information with the Securities and Exchange
Commission (the "Commission"). The reports, proxy statements and other
information filed by VNGP, L.P. with the Commission can be inspected and copied
at the public reference facilities maintained by the Commission at Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the public
reference facilities maintained by the Commission at Seven World Trade Center,
Suite 1300, New York, New York 10048 and at Room 1400, Northwestern Atrium
Center, 500 West Madison Street, Chicago, Illinois 60661. Copies of such
materials can be obtained at prescribed rates from the Public Reference Section
of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Documents
filed by VNGP, L.P. can also be inspected at the offices of the New York Stock
Exchange, 20 Broad Street, New York, New York 10005, on which exchange the
Common Units are listed. VNGP, L.P.'s Annual Report on Form 10-K for the year
ended December 31, 1993 (the "Form 10-K") has been incorporated by reference
herein. See "Incorporation of Certain Documents by Reference."
All reports and opinions from outside parties described under "Special
Considerations" that are materially related to the Merger will be made available
for inspection and copying at the principal executive offices of VNGC during its
regular business hours by any interested holder of Common Units or his
representative who has been so designated in writing. The executive offices of
VNGC, the general partner of VNGP, L.P., are located at 530 McCullough Avenue,
San Antonio, Texas 78215 (telephone 210-246-2000). Business hours are 8:00 a.m.
to 5:00 p.m., local time. Prescribed rates of $0.15 per page, minimum $5.00 per
request, will be charged for copying.
ADDITIONAL INFORMATION
Pursuant to Rule 13e-3 of the General Rules and Regulations under the Exchange
Act, VNGP, L.P. and VNGC have filed with the Commission a Rule 13e-3 Transaction
Statement on Schedule 13E-3 (the "Schedule 13E-3"), together with exhibits
thereto, furnishing certain additional information with respect to the Merger.
This Proxy Statement does not contain all the information contained in the
Schedule 13E-3, certain portions of which are omitted as permitted by the rules
and regulations of the Commission. Reference is hereby made to the Schedule
13E-3, including the exhibits thereto, for further information with respect to
VNGP, L.P., VNGC, the Company, the Partnership and the Merger. The Schedule
13E-3 may be inspected at the Commission's offices, without charge, or copies
thereof may be obtained from the Commission upon payment of prescribed rates.
Statements contained in this Proxy Statement as to the contents of any contract
or other document filed as an exhibit to the Schedule 13E-3 are not necessarily
complete, and in each instance reference is hereby made to the copy of such
contract or other documents filed as an exhibit to the Schedule 13E-3, each such
statement being qualified in all respects by such reference.
SUMMARY OF THE PROXY STATEMENT
The following is a summary of certain information contained elsewhere in this
Proxy Statement (the "Proxy Statement") and is qualified in its entirety by the
more detailed information elsewhere in this Proxy Statement and the Annexes
hereto. Unless otherwise defined, the capitalized terms used in this Summary
have the meanings ascribed to those terms elsewhere in this Proxy Statement.
Holders of Common Units are urged to read this Proxy Statement and the Annexes
hereto in their entirety.
PURPOSE OF THE SPECIAL MEETING
This Proxy Statement is being furnished to the holders of common units of
limited partner interests (the "Common Units") of Valero Natural Gas Partners,
L.P. ("VNGP, L.P." and, together with its consolidated subsidiaries, the
"Partnership"), a Delaware limited partnership, in connection with the
solicitation of proxies for use at a special meeting (the "Special Meeting") of
the holders of the Common Units. At the Special Meeting, the holders of the
Common Units will consider a proposed merger (the "Merger") involving VNGP,
1
<PAGE> 10
L.P. The Merger will occur pursuant to an agreement of merger (the "Merger
Agreement") among VNGP, L.P., Valero Energy Corporation ("VEC" and, together
with its consolidated subsidiaries, the "Company"), Valero Merger Partnership,
L.P., a Delaware limited partnership ("Newco") which is owned by subsidiaries of
VEC and was formed for the purpose of engaging in the Merger, and Valero Natural
Gas Company, a Delaware corporation ("VNGC"), a wholly owned subsidiary of VEC
and general partner of VNGP, L.P. (in such capacity, the "General Partner").
Pursuant to the terms of the Merger Agreement, if the merger is approved, VNGP,
L.P. would be merged with Newco, with VNGP, L.P. being the entity surviving the
merger. In the Merger, the Common Units held by persons other than the Company
(the "Public Unitholders") would be converted into a right to receive $12.10 in
cash per Common Unit from VNGC. Upon completion of the Merger, the Partnership
will be wholly owned by VEC.
DATE, TIME AND PLACE OF THE SPECIAL MEETING
The Special Meeting of the holders of the Common Units of VNGP, L.P. will be
held at the offices of the General Partner, 530 McCullough Avenue, San Antonio,
Texas 78215, on May 31, 1994 at 8:00 a.m. (Central Time).
RECORD DATE, COMMON UNITS ENTITLED TO VOTE, QUORUM
Only record holders of Common Units at the close of business on April 28, 1994
(the "Record Date") will be entitled to notice of and to vote at the Special
Meeting. On the Record Date, there were outstanding 18,486,538 Common Units,
which are entitled to vote as a single class. Such Common Units were held by
approximately 2,250 holders of record. The presence in person, or by properly
executed proxy, of the holders of more than 50 percent of the issued and
outstanding Common Units is necessary to constitute a quorum at the Special
Meeting.
Each holder of record of Common Units on the Record Date is entitled to cast one
vote per Common Unit on each proposal properly submitted for the vote of the
holders of the Common Units.
VOTE REQUIRED
Pursuant to the Delaware Revised Uniform Limited Partnership Act ("DRULPA"),
approval of the Merger Agreement will require the affirmative vote of the
holders of a majority of the outstanding Common Units entitled to vote thereon
(the "Majority Vote Requirement"), including Common Units held by the Company.
The Company holds approximately 47.5% of the Common Units and has advised the
General Partner that it intends to vote such Common Units "FOR" approval of the
Merger.
Additionally, in order to address the separate interests of the Public
Unitholders, although not required by the Partnership Agreement, approval of the
Merger Agreement has been conditioned upon the affirmative vote of a majority of
the Common Units held by Public Unitholders that are voted at the Special
Meeting (the "Independent Vote Requirement"). The votes of the Company will not
count toward satisfaction of the Independent Vote Requirement. Therefore, the
Merger will not be consummated without the approval of the holders of a majority
of the Common Units held by Public Unitholders and voted at the Special Meeting.
CERTAIN RELATIONSHIPS
VEC is a publicly held Delaware corporation whose common stock is listed and
traded on the New York Stock Exchange. VNGC, which serves as General Partner of
VNGP, L.P., is a wholly owned subsidiary of VEC. The term "Company," as used
herein, refers to VEC and its various consolidated subsidiaries, including VNGC
(but excluding the Partnership), either individually or collectively, as the
context requires. Under the partnership structure, the partnership interest in
VNGP, L.P. consists of a 1% general partner interest, held by VNGC, and a 99%
limited partner interest, represented by the Common Units. VNGP, L.P. holds a
99% limited partner interest in Valero Management Partnership, L.P. (the
"Management Partnership"), while the Management Partnership in turn holds a 99%
limited partner interest in eleven subsidiary operating partnerships formed at
the time of the creation of the Partnership in 1987 and one subsidiary operating
partnership formed in 1992. VNGP, L.P. also holds a 99% limited partner interest
in certain subsidiary
2
<PAGE> 11
operating partnerships established subsequent to the original creation of the
partnership structure in 1987 (the subsidiary operating partnerships of VNGP,
L.P. and Management Partnership are referred to herein individually as a
"Subsidiary Operating Partnership" and collectively as the "Subsidiary Operating
Partnerships"). VNGC also holds a 1% general partner interest in the Management
Partnership, while wholly owned subsidiaries of VNGC hold 1% general partner
interests (in such capacities, the "Subsidiary General Partners") in each
Subsidiary Operating Partnership. Through subsidiaries, including the Subsidiary
General Partners, VEC holds approximately 47.5% of the issued and outstanding
Common Units, while the remaining 52.5% of the Common Units are publicly held.
As a result of its subsidiaries' holdings of Common Units and their general
partner interests in VNGP, L.P., the Management Partnership and the Subsidiary
Operating Partnerships, VEC holds an effective equity interest in the
Partnership of approximately 49%. Under the terms of the Second Amended and
Restated Agreement of Limited Partnership of VNGP, L.P. (the "Partnership
Agreement"), VNGC has exclusive authority to manage the business and operations
of VNGP, L.P. As sole stockholder of VNGC, VEC has the power to elect the Board
of Directors, and therefore may be deemed to effectively control the management
of, VNGC. Because VNGC is wholly owned by VEC, the interests of VEC and VNGC may
be deemed to be substantially aligned and VNGC may be generally deemed to not be
acting independently of VEC. For this reason, the Special Committee, consisting
of three independent directors of VNGC, was created to separately evaluate the
fairness of the proposed Merger. See "Special Considerations -- Background of
the Merger" and "The Partnership -- Conflicts of Interest."
Various management personnel are common to both VEC and VNGC. Mr. William E.
Greehey serves as Chairman of the Board, President and Chief Executive Officer
("CEO") and as a director of both VEC and VNGC. Mr. Edward C. Benninger serves
as Executive Vice President and a director of VEC and as Executive Vice
President and Chief Operating Officer and as a director of VNGC. Mr. Stan L.
McLelland serves as Executive Vice President and General Counsel of VEC and as
Executive Vice President and General Counsel and as a director of VNGC. Mr. Don
M. Heep serves as Senior Vice President and Chief Financial Officer of both VEC
and VNGC. Mr. Steven E. Fry serves as Vice President Administration of both VEC
and VNGC. Mr. John H. Krueger serves as Controller of both VEC and VNGC. Mr.
John D. Gibbons serves as Treasurer of both VEC and VNGC. Mr. Rand C. Schmidt
serves as Corporate Secretary of both VEC and VNGC.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
As of April 1, 1994, approximately 70,181 (0.5%) of the Common Units were
beneficially owned by officers and directors of VNGC or VEC. See "The
Partnership -- Ownership of Common Units." If the Merger is consummated, the
Common Units owned by such persons will be converted into the right to receive
cash in the amount of $12.10 per Common Unit. Such persons have advised the
General Partner that they intend to vote their Common Units "FOR" approval of
the Merger. Such votes will be counted toward satisfaction of the Independent
Vote Requirement.
In addition, VEC is interested in the outcome of the Merger in that, following
the Merger, it would be the sole owner of VNGP, L.P. As sole owner, VEC would
bear the total risk of the Partnership's operations but would also receive the
entire benefit, if any, arising from pursuit of the various industry
opportunities described under "Special Considerations -- Reasons for the
Proposed Merger -- Industry Opportunities and Need for Additional Financing." If
VNGP, L.P. were to be sold to an unrelated third party, VEC would not have any
further participation in any such opportunities, while, if the current ownership
structure were maintained, it would share any such benefits with the Public
Unitholders. See "The Partnership -- Conflicts of Interest."
In proposing and structuring the terms of the Merger, VEC primarily considered
its own interests and not those of the Public Unitholders, recognizing, however,
that the terms and structure of the Merger transaction would be reviewed by the
Special Committee. In considering alternatives to the Merger, VEC did not seek
to maximize the consideration to be received by the Public Unitholders and
rejected certain alternatives which may have resulted in greater total
consideration to the Public Unitholders. See "Special Considerations -- Reasons
for the Proposed Merger -- Alternative Transactions Considered." VEC did not
approach, and requested that its investment advisor and the investment advisor
to the Special Committee not approach, any unaffiliated persons or entities with
respect to the acquisition of the Partnership or any of its assets.
Additionally, VEC rejected a specific proposal, conditioned upon VEC agreeing to
sell its own interest in the
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Partnership, which, if accepted and completed, would have resulted in payment of
$16.00 per Common Unit to the Public Unitholders. See "Special
Considerations -- Background of the Merger -- Certain Contacts." From January
1993, when Salomon Brothers Inc ("Salomon") was engaged to assist VEC in
exploring strategic alternatives, until October 1993, when the Merger proposal
was presented to the VNGC Board and the Special Committee was appointed to
evaluate the fairness of the Merger proposal, no representatives were appointed
to act, or acted, separately on behalf of, the Public Unitholders.
Certain members of the management of VEC involved in structuring the Merger,
including Mr. Greehey, Mr. Benninger, Mr. Heep, Mr. McLelland, Mr. Krueger, Mr.
Schmidt, Mr. Wright and Mr. Zesch, are stockholders of VEC. To the extent that
the Merger were to ultimately prove beneficial to VEC and to positively affect
the price of VEC stock, such persons, as well as all other VEC stockholders,
would benefit from the Merger.
The Public Unitholders who vote in favor of the Merger or accept the benefits of
the Merger by surrendering their Common Units may thereafter be estopped from
challenging the Merger. See "The Merger -- Certain Rights of Public Unitholders;
Litigation Related to the Merger."
THE SPECIAL COMMITTEE
The Board of Directors of VNGC appointed the Special Committee on October 17,
1993, to consider the fairness of the proposed transaction to the Public
Unitholders. The Special Committee consists of Dr. Ronald K. Calgaard, Chairman
of the Special Committee, and Messrs. Ruben M. Escobedo and Mack Wallace, each
of whom is an outside director of VNGC and is not an employee of VEC or VNGC or
otherwise affiliated with the Company. See "Special Considerations -- Background
of the Merger."
FAIRNESS OF THE TRANSACTION; RECOMMENDATIONS
The Special Committee concluded that the transactions contemplated by the Merger
Agreement are fair to, and in the best interests of, the Public Unitholders, and
unanimously approved the Merger Agreement. In arriving at its conclusion, the
Special Committee gave due consideration and significant weight to the written
opinion of Dillon Read (confirmed in writing on April 27, 1994), that, based
upon the considerations and subject to the assumptions and limitations set forth
therein, the consideration to be received by the Public Unitholders in the
Merger is fair to the Public Unitholders from a financial point of view.
The written report of the Special Committee, setting forth its conclusions,
recommendations and the material considerations applicable thereto, was
delivered to the VNGC Board of Directors at a meeting held on December 20, 1993.
The VNGC Board examined the report of the Special Committee, and concurred in
and adopted both the material considerations and the conclusions set forth in
such report. There were no other material considerations applicable to the
deliberations of the VNGC Board. The VNGC Board unanimously approved the Merger
Agreement on the basis of the considerations and conclusions set forth in the
report of the Special Committee. See "Special Considerations -- Recommendation
of the Board of Directors of the General Partner; Fairness of the Merger."
In developing its initial merger proposal of $11.00 per Common Unit, VEC
determined, based upon the advice of its investment banker, Salomon, that such
initial proposal might reasonably be expected to be found by a special committee
of independent directors of the General Partner, and its independent financial
advisor, to be fair to the Public Unitholders from a financial point of view
and, therefore, that such an offer might reasonably be expected to lead to a
successful acquisition by VEC of the publicly held Common Units, but did not
determine at that time whether or not such proposal was fair to the Public
Unitholders. Both VEC and VNGC have interests in the proposed Merger which
conflict with the interests of the Public Unitholders. See "The
Partnership -- Conflicts of Interest." Accordingly, the Special Committee was
appointed by the VNGC Board to make a determination with respect to the fairness
of the transaction to the Public Unitholders. VEC subsequently received and
examined the report of the Special Committee and thereupon concurred in and
adopted both the conclusions of the Special Committee and the material
considerations set forth in the Special Committee report. See "Special
Considerations -- Opinion of Financial Advisor to the Special Committee."
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THE BOARD OF DIRECTORS OF THE GENERAL PARTNER UNANIMOUSLY RECOMMENDS THAT
HOLDERS OF THE COMMON UNITS VOTE "FOR" APPROVAL OF THE MERGER AGREEMENT AND THE
TRANSACTIONS CONTEMPLATED THEREBY.
REASONS FOR THE MERGER
VEC (rather than the General Partner) is the party primarily initiating,
supporting, structuring and negotiating the terms of the Merger. VEC has
proposed the Merger because it believes that the Partnership, in its present
form, has insufficient financial flexibility to participate fully in
opportunities that are expected to arise in the natural gas and NGL businesses,
that the ability of the Partnership to compete effectively in these businesses
will be enhanced through the Merger and that the Partnership could lose its
competitive position if it does not pursue such opportunities when and if they
become available. VEC also believes that potential conflict of interest
situations between the Partnership and VEC can be eliminated through the Merger.
The General Partner believes that the Merger is fair to and in the best
interests of the Partnership and the Public Unitholders, based upon the analysis
and recommendation of the Special Committee. Based upon its review of and
concurrence in the analysis and recommendation of the Special Committee, VEC
also believes that the Merger is fair to and in the best interest of the
Partnership and the Public Unitholders. See "Special Considerations -- Reasons
for the Proposed Merger" and "-- Recommendation of the Board of Directors of the
General Partner; Fairness of the Merger."
TERMS OF THE MERGER
The Merger will be effected pursuant to the terms of the Merger Agreement. A
copy of the Merger Agreement is attached hereto as Annex A. Upon the
consummation of the Merger and by virtue thereof, (i) each Common Unit held by a
Public Unitholder will be converted into the right to receive from VNGC the cash
amount of $12.10 per Common Unit, (ii) the Common Units held by subsidiaries of
VEC will remain outstanding, (iii) the 1% general partner interest in VNGP, L.P.
held by VNGC will remain outstanding, (iv) VNGC will acquire additional Common
Units from VNGP, L.P. in consideration of the cash payment to the Public
Unitholders, and (v) the general and limited partner interests in Newco will be
converted into the right to receive, on a pro rata basis, a cash amount equal to
the capital accounts of the partners, estimated to aggregate $1,000. As a result
of the Merger, VNGP, L.P. and its consolidated subsidiaries will become wholly
owned subsidiaries of VEC and the Public Unitholders will cease to be limited
partners of VNGP, L.P. Because no Common Units will be publicly held after the
Merger, the Common Units will be delisted and will no longer trade on the New
York Stock Exchange, Inc. (the "Exchange"), and VNGP, L.P. will cease to be a
separate reporting company under the Securities Exchange Act of 1934, as amended
(the "Exchange Act").
In the Merger Agreement, VEC and VNGC each represented that, with respect to the
regular quarterly distribution on the Common Units, they intended that such
distributions continue to be declared and paid at the then-established quarterly
intervals and rate through the Effective Date (as hereinafter defined) of the
Merger, and that they knew of no reason why the regular quarterly distribution
scheduled to be paid on or about March 1, 1994 could not be declared and paid.
Such March 1, 1994 distribution was subsequently declared and paid. In addition,
VEC and VNGC each represented that, if the closing of the Merger occurred more
than 30 days after the last record date for a regular quarterly distribution,
VNGP, L.P. intends and expects to declare and pay to the holders of the Common
Units of record as of the Effective Date of the Merger a one-time special cash
distribution equal to the product of the regular quarterly distribution per
Common Unit of $.125 and a fraction the numerator of which is the number of days
from and excluding the record date in respect of which the last regular
distribution has been paid to and including the Effective Date, and the
denominator of which is 90. Such representations were based upon the facts and
circumstances in existence at December 20, 1993, the date of the Merger
Agreement, and as such were necessarily subject to the possible effect of
subsequent developments upon the ability of VNGP, L.P. to declare and pay
distributions. Cash distributions on the Common Units can be declared only by
the Board of Directors of VNGC, acting pursuant to the provisions of the
Partnership Agreement, and can be declared only from the Distributable Cash Flow
(as defined in the Partnership Agreement) of VNGP, L.P. See "The Partnership --
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History of the Partnership." The Partnership is subject to a requirement, more
fully described under "The Partnership -- History of the Partnership", that
short-term borrowings be reduced to zero for a period of 45 consecutive days
during each period of 16 consecutive calendar months. Under this requirement,
the Partnership must complete such a "clean-up" period in September 1994.
Additionally, during the period since execution of the Merger Agreement, the
Partnership's results of operations have continued to deteriorate and the
Partnership has reported substantially reduced operating income and a net loss
for the first quarter of 1994. On April 27, 1994, the VNGC Board declared a
regular quarterly cash distribution of $0.125 per Common Unit, such distribution
to be paid on May 31, 1994, to holders of record of the Common Units on May 16,
1994. However, in light of the Partnership's deteriorating operating results and
the above-described clean-up requirement, neither VEC nor VNGC can provide
assurance that future quarterly cash distributions can be so declared and paid,
or that, if applicable, the one-time special cash distribution described above
can be declared and paid. See "The Merger -- Basic Terms of the Merger."
EFFECTIVE TIME
Under the Merger Agreement, the Merger will become effective on the date (the
"Effective Date") and at the time (the "Effective Time") that a Certificate of
Merger is filed pursuant to Delaware law. It is anticipated that the Effective
Date will occur on or about May 31, 1994, although there can be no assurance in
this regard. The Common Unit transfer books of the Partnership will be closed as
of the close of business on the Effective Date and no transfer of record can be
made of certificates representing the Common Units thereafter other than
registrations of transfer reflecting transfers occurring before the close of
business on the Effective Date. If the Merger cannot be concluded by June 1,
1994 (see "The Merger -- Termination or Amendment of the Agreement of Merger"),
the Special Committee and the parties to the Merger Agreement may consider
whether or not to extend the time for consummation of the Merger by amendment or
waiver of the applicable condition in the Merger Agreement to provide additional
time to conclude the settlement of litigation or for any other appropriate
reason. See "The Merger -- Certain Rights of Public Unitholders; Litigation
Related to the Merger." In such event, no further approval of the Unitholders
would be required. See "The Merger -- Effective Time of the Merger."
FINANCING OF THE MERGER
In order to fund the cash payment to the Public Unitholders contemplated by the
Merger Agreement, VEC has issued and sold in an underwritten public offering
(the "Public Offering") 3,450,000 shares of its $3.125 Convertible Preferred
Stock and received net proceeds of $168.2 million. See "The Merger -- Source of
Cash Consideration."
MARKET PRICES OF THE COMMON UNITS
Prior to May 30, 1992, the limited partner interests in VNGP, L.P. not held by
subsidiaries of VEC were represented by preference units of limited partner
interests ("Preference Units"). On May 30, 1992, the Preference Units were
automatically converted into Common Units in accordance with the terms of the
Partnership Agreement. See "The Partnership -- History of the Partnership." The
Preference Units and Common Units are sometimes collectively referred to herein
as "Units" and holders of such Units are referred to herein as "Unitholders."
The Common Units have been traded on the Exchange since June 1, 1992. As
reported by the Exchange, during the third quarter of 1993, the closing prices
of the Common Units on the Exchange ranged from $8.25 to $9.375 per Common Unit,
and the average trading volume for such period was approximately 19,200 Common
Units per day. During the two trading days ended October 13, 1993, average daily
trading volume in the Common Units increased to approximately 114,000 Units and
the closing price per Common Unit on the Exchange increased from $9.25 on
October 11, 1993 to a closing price of $10.25 on October 13, 1993. Heavy trading
activity continued and the price of the Common Units further increased on the
morning of October 14, 1993. In response to such activity, on October 14, 1993,
VEC issued a public announcement that its Board of Directors would meet on
October 16, 1993 for the purpose of considering management's recommendation that
the Merger be proposed to the Board of Directors of the General Partner. On
October 14, 1993, the day of such public announcement, the closing price of the
Common Units on the Exchange was $11.00 per Common Unit. See "Market Prices of
Common Units and Distributions."
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NO DISSENTERS' RIGHTS
In accordance with the DRULPA, the Public Unitholders will have no dissenters'
rights of appraisal in connection with the Merger. See "The Merger -- Certain
Rights of Public Unitholders; Litigation Related to the Merger."
LITIGATION RELATING TO THE MERGER
Seven lawsuits were filed in Chancery Court in Delaware in response to the
announcement by VEC on October 14, 1993 of its proposal to acquire the
publicly-traded Common Units pursuant to the proposed Merger. The suits, which
were consolidated into a single proceeding, requested the court to certify the
litigation as a class action. The plaintiffs sought to enjoin or rescind the
proposed Merger, alleging that the corporate defendants and the individual
defendants, as officers or directors of the corporate defendants, engaged in
actions in breach of the defendants' fiduciary duties to the Public Unitholders
by proposing the Merger. The plaintiffs alternatively sought an increase in the
proposed merger consideration, compensatory damages and attorneys' fees.
Attorneys representing the plaintiffs communicated with counsel for the Special
Committee in the course of the Special Committee's deliberations, and reviewed
Dillon Read's analysis referred to under "Opinion of Financial Advisor to the
Special Committee." Prior to the approval of the Revised Proposal by the Special
Committee, such attorneys advised the General Partner that they were satisfied
with the agreement reached with the Special Committee and had agreed in
principle to recommend that the Chancery Court approve a settlement based upon
the terms of the Merger as described herein. On December 21, 1993, VEC, VNGP,
L.P. and counsel for the plaintiffs executed a memorandum of understanding (the
"Memorandum of Understanding") to such effect. Subsequently, having been
generally advised of the matters discussed under "Special
Considerations -- Background of the Merger -- Certain Contacts" attorneys for
the plaintiffs and counsel to the Special Committee obtained VEC's agreement
that, if it disposes of its interest in VNGP, L.P., within a period of two years
from the Effective Date, the Public Unitholders who are holders of Units at the
Effective Date will receive an additional cash payment in an amount per Unit
equal to the difference between (a) an amount equal to (i) (A) the product of
the percentage of the Units held by the Public Unitholders immediately prior to
consummation of the Merger and (B) the value of the total consideration received
by VEC in such second transaction, reduced by the amount of any capital
contributions made by VEC to VNGP, L.P. between the closing dates of the Merger
and such second transaction, divided by (ii) the number of Units held by Public
Unitholders immediately prior to consummation of the Merger, and (b) $12.10. The
right to such payment will be nontransferable. See "The Merger -- Certain Rights
of Public Unitholders; Litigation Related to the Merger." VEC has no obligation
to attempt to dispose of its interest in VNGP, L.P., and does not intend to do
so. VEC has agreed to pay attorneys fees aggregating not in excess of $1.2
million in connection with the Memorandum of Understanding. See "Federal Income
Tax Consequences of the Merger." Certain covenants in VEC's current principal
bank credit agreements would not permit the Merger, and VEC has negotiated a new
$250 million unsecured bank credit agreement that would become effective upon
completion of the Merger. Settlement of the above-described litigation is a
condition required by VEC's banks to the effectiveness of the new bank credit
agreement. Unless such condition were to be waived, the new bank credit
agreement would not become effective, and the Merger could not be completed,
until such litigation is settled. Notice of the proposed settlement of such
litigation upon the basis described in the Memorandum of Understanding has been
given to the Public Unitholders. It is expected that a hearing to finally
approve such settlement will occur in Delaware Chancery Court on or about May
31, 1994, and that subject to the approval of the Chancery Court, and to the
satisfaction of all other preconditions to the Merger, the Merger would become
effective at or about such date.
SUMMARY OF CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The Merger will be a taxable transaction to the Public Unitholders. Each Public
Unitholder will be required to recognize taxable gain or loss equal to the
difference between the Unitholder's adjusted tax basis for the Common Units and
the amount of cash received as a result of the Merger. Certain Public
Unitholders may realize both ordinary income and capital loss as a result of the
Merger. The utilization of any such capital loss for federal income tax purposes
is subject to certain limitations. Additionally, the attorneys' fees paid in
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connection with the Merger, as described above, will affect the calculation of
each Public Unitholder's basis in his Common Units and assumed sales price, but
are not expected to affect the Unitholder's gain or loss resulting from the
transaction. See "Federal Income Tax Consequences of the Merger".
SPECIAL CONSIDERATIONS
REASONS FOR THE PROPOSED MERGER
Summary
VEC has proposed the Merger at the present time because, as is more fully
described below, it believes that the ability of the Partnership to sustain,
improve and expand its operations, maintain and improve its competitive
position, service its debt obligations and, at the same time, maintain cash
distributions to Unitholders, has been impaired and that the Partnership no
longer has the financial flexibility necessary to achieve these objectives. As a
result, VEC believes that the original goals and objectives of the Partnership
are no longer consistent with the realities of competition in the current
natural gas industry environment or with the Partnership's current financial
position. VEC has proposed the Merger as a means to provide necessary financial
flexibility to the Partnership, as well as resolve potential conflict of
interest situations between VEC and the General Partner, on the one hand, and
the Public Unitholders, on the other hand. VEC (rather than the General Partner)
is the party primarily initiating, supporting, structuring and negotiating the
terms of the Merger. VEC and the General Partner believe that the natural gas
and NGL businesses are undergoing a period of consolidation and restructuring
that may create opportunities for acquisitions, business alliances and capital
investments, but that the Partnership does not have the financial flexibility to
make the capital expenditures necessary to successfully pursue such
opportunities. While the Partnership has been able to pursue some opportunities
through leasing transactions with subsidiaries of VEC, additional significant
leasing transactions are not desirable to VEC. As a result, VEC and the General
Partner believe that the sources of cash available to the Partnership, in its
current form and condition, will be primarily limited to cash flows generated
from operations.
VEC and the General Partner believe that the Partnership cannot raise
significant additional equity capital, and that any additional equity
securities, if feasible to be issued, would likely be preferred Units with a
priority distribution requirement which would have a negative impact on the
value of the Common Units. Additionally, the Management Partnership's Indenture
of Mortgage, Deed of Trust and Security Agreement, dated as of March 25, 1987,
as amended (the "Indenture"), as well as financial market conditions, severely
limit the Partnership's ability to issue additional first mortgage notes
("Notes") under the Indenture, or other indebtedness. VEC and the General
Partner also believe that leasing assets from third parties is not efficient or
cost effective, and that substantially all of the assets currently owned by the
Partnership are core assets, so that asset sales are also not a viable financing
alternative.
VEC and the General Partner believe that the Partnership's cash flows from
operations will be fully utilized to fund debt service and lease obligations and
to meet minimum capital expenditure requirements, and that such cash flows will
not be sufficient to pursue emerging industry opportunities. VEC and the General
Partner also believe that the Partnership will be unable to maintain its
competitive position if it does not pursue such opportunities when and if they
arise. The proposed Merger is expected to provide the financial flexibility
necessary for the Partnership to pursue opportunities in the natural gas and NGL
businesses that would otherwise be unavailable to it. At the same time, VEC and
the General Partner believe that potential conflict of interest situations can
be eliminated and that some administrative efficiencies can be realized through
the Merger. The Board of Directors of the General Partner believes that the
Merger is fair to and in the best interests of the Partnership and the Public
Unitholders, based upon the analysis and recommendation of the Special
Committee.
The following paragraphs describe in greater detail the reasons for the Merger
proposal. Under the heading "Introduction" is a description of VEC's
expectations at the time the Partnership was created, the Partnership's capital
expenditure requirements and the effect of certain so-called take-or-pay
settlements upon the Partnership's ability to finance capital projects. Under
the heading "Industry Opportunities and Need for
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<PAGE> 17
Additional Financing" is a description of changes in the natural gas industry
and other factors that are expected to create opportunities for the Partnership
to improve and expand its operations but which will require substantial
additional capital. Under the heading "Prior Financings" is a description of the
leasing transactions, equity and debt issuances, asset sales and working capital
management that the Partnership has used in the past to finance its cash
requirements. Under the heading "Limitations on Additional Financing" is an
explanation of the limitations which the Partnership now faces in raising
additional capital, including considerations which make it disadvantageous to
the current Public Unitholders for VNGP, L.P. to issue new equity securities.
Under the heading "Selection of Merger" is an explanation of the considerations
that led VEC to propose the Merger and a description of the Public Offering that
VEC has undertaken in connection with the Merger. Under the heading "Alternative
Transactions Considered" is an explanation of various alternatives considered
and rejected by VEC before proposing the Merger. Under the heading
"Considerations Affecting Future Cash Distributions to Unitholders" is a
discussion of the reduction in the cash distribution to Unitholders which
occurred in 1992, certain financial and other considerations which may require
cash distributions to be further reduced or eliminated and certain litigation
which, if finally determined in a manner materially adverse to the Partnership,
could also affect future cash distributions.
Introduction
At the time of formation of the Partnership, VEC expected that the Partnership
would continue to operate the natural gas and NGL businesses of the Company
substantially in the manner previously conducted and, using internally generated
funds as well as capital available in the public and private markets, would be
able to sustain, improve and expand such operations, while at the same time
providing a cash distribution to Unitholders. VEC estimated that capital
expenditures of approximately $30 million to $35 million annually would be
sufficient to maintain the operations of the Partnership and that the operating
cash flows of the Partnership would be sufficient to allow some additional level
of capital expenditures to sustain, improve or expand operations. In maintaining
asset reliability and pursuing some of these opportunities, the Partnership's
capital expenditures totalled $33.1 million in 1991, $35.9 million in 1992, and
$36.1 million in 1993. In its November 10, 1993 projections, VEC had assumed
that the Partnership's capital expenditures for 1994 would be $56.2 million. See
"-- Certain Projections." However, as a result of deteriorating industry
conditions, Partnership capital expenditures in 1994 are now expected to be
approximately $35 million, subject to consummation of the Merger. In addition,
lease transactions were entered into with VEC subsidiaries for certain newly
constructed facilities with approximate total costs of $75 million for leases
commencing in 1991 and $26 million for leases commencing in 1992. VEC and the
General Partner believe that, due to the Partnership's lack of financial
flexibility, described below, if the Merger is not completed the Partnership
will not be able to continue making capital expenditures at these levels and,
therefore, is likely to be unable to participate fully in opportunities to
improve and expand its operations or to take advantage of the types of
opportunities, such as those described herein, that may arise in the natural gas
and NGL businesses over the next several years. While VEC could continue to
pursue investment opportunities after the Partnership declines to participate in
them, a continued expansion of VEC's natural gas and NGL businesses outside of
the Partnership creates potential conflicts of interest that VEC considers
undesirable. See "The Partnership -- Conflicts of Interest."
One factor limiting the Partnership's financial flexibility is the Partnership's
assumption of certain liabilities of the Company with respect to claims and
lawsuits involving allegations that the Company had failed to take, or pay for,
natural gas under gas purchase contracts. These liabilities were assumed by the
Partnership when the Preference Units were publicly offered in 1987. At that
time, pending lawsuits involving such so-called take-or-pay claims aggregated
approximately $190 million for alleged actual damages and $20 million for
alleged consequential damages. In addition, one lawsuit involved claims of $118
million for alleged punitive or treble damages relating to fraud or antitrust
claims, and producers had invoiced the Company for approximately $125 million in
additional claims with respect to which lawsuits had not then been initiated.
The Partnership stated at the time of the offering of the Preference Units that
additional take-or-pay claims might be asserted. The Partnership also stated
that, if any payments were made in resolution of such take-or-pay claims, the
General Partner believed that such costs should be recoverable in the weighted
average cost of gas sold to the customers of Valero Transmission, L.P.
("Transmission"), a Subsidiary Operating Partnership; however, as a
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<PAGE> 18
result of market conditions and prior contracting practices, Transmission's
weighted average cost of gas and gas sales prices exceeded market clearing
levels and sales of gas by Transmission were declining in favor of sales by
other Subsidiary Operating Partnerships, which sold gas at market-related
prices. Accordingly, the Partnership indicated that Transmission could be
required to amortize the amounts of any take-or-pay settlements over a
considerable period and provide financing for such amounts until fully
recovered. Amounts paid in settlement of take-or-pay claims are treated as
deferred gas costs and are included in the Partnership's "deferred charges and
other assets" until recovered through sales of gas by Transmission. The
Partnership has settled substantially all of the take-or-pay claims previously
brought against it, and believes that it has settled substantially all of the
significant take-or-pay claims that are likely to be made. However, the
resolution of such claims resulted in deferred gas costs that were greater, and
have been recovered more slowly through sales, than had been anticipated at the
time of formation of the Partnership. At December 31, 1993, the unrecovered
balance of deferred gas costs was $67 million, compared with $72 million at
December 31, 1992. (For additional information regarding settlement of a
customer audit claim relating to deferred gas costs, see Note 6 of Notes to
Consolidated Financial Statements, included in Annex C.) Additionally, during
1988, 1989 and the first half of 1990, the Partnership's operating income from
NGL operations was substantially below prior (and subsequent) levels. As a
result of these factors, capital that might otherwise have been available for
capital projects has been used to make take-or-pay settlements and finance
deferred gas costs, and the ability of the Partnership to maintain, improve and
expand the Partnership's business has been less than originally expected. In
addition, in order to resolve certain contractual claims, the Partnership has
agreed to provide discounted gas transportation services to some customers in
lieu of cash settlements. Certain of these arrangements will continue until
2000. For information regarding additional litigation in which the Partnership
is currently engaged and certain claims that have been made against the
Partnership, see "-- Considerations Affecting Future Cash Distributions to
Unitholders."
Industry Opportunities and Need for Additional Financing
VEC and the General Partner believe that the natural gas and NGL businesses are
undergoing a period of consolidation as major energy companies divest operations
that are not a part of their core operations and smaller entities combine to
compete more effectively in the competitive natural gas environment that
prevails today. Several such transactions have recently occurred, including the
sale by Oryx Energy Company ("Oryx") of certain NGL assets in 1992 (including
certain assets acquired by the Company); the sale by Tenneco, Inc. ("Tenneco")
of certain NGL and gas gathering assets in 1992 and the sale by Tenneco of its
wholly-owned subsidiary Dean Pipeline Company in 1993; the purchase of United
Gas Pipe Line, Inc. ("United") in 1992 by Koch Industries, Incorporated
("Koch"); the acquisition of certain assets of Exxon Gas Systems, Inc. ("EGSI")
by Tejas Gas Corporation ("Tejas") in 1993; and sales in 1993 of Louisiana
Resources Company ("LRC") and Louisiana Intrastate Gas Corp. ("LIG"). In
addition, the Partnership has recently reached agreement with a subsidiary of
Shell Oil Company to acquire a pipeline in South Texas from such producer and
make other capital expenditures necessary to process such producer's natural gas
production in return for a ten-year dedication of such production to the
Partnership. VEC and the General Partner believe that other similar
opportunities will arise in the future that, if pursued, could maintain or
improve the Partnership's competitive position. The types of assets that could
become available for possible acquisition include natural gas and NGL pipelines,
gathering facilities, gas processing plants, NGL fractionation facilities and
related facilities and equipment. In addition to opportunities for acquisitions,
VEC and the General Partner believe that existing trends in the natural gas
industry will create additional capital requirements and business opportunities.
These trends include an emerging west-to-east movement of natural gas across the
United States, the increasing importance of South Texas as a major natural gas
supply area and opportunities created by Federal Energy Regulatory Commission
("FERC") Order 636.
In the late 1980's, VEC and the General Partner determined that a shift in
natural gas movement across the United States was likely to occur as projected
pipeline expansions from Canada and the Rocky Mountain states into California
caused gas sources in the southwestern part of the United States to seek markets
further east. In 1991, the Partnership implemented a project (the "East Texas
Expansion Project") to extend the Partnership's North Texas pipeline system 105
miles to Carthage, in East Texas, to take advantage of this projected shift in
supply patterns. The East Texas Expansion Project enabled the Partnership to
physically
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transport gas across the state of Texas, from Waha, an important pipeline hub in
West Texas, to Carthage, an important hub in East Texas. For information
regarding the financing of the East Texas Expansion Project, see "The
Partnership -- History of the Partnership." VEC and the General Partner believe
that the west-to-east shift in natural gas supply patterns is well underway, and
that in many of the pipelines able to serve this market, including pipelines
owned by the Partnership, west-to-east capacity is becoming constrained. VEC and
the General Partner believe that, over time, improving transportation margins
resulting from these capacity constraints may warrant additional west-to-east
capacity additions and that the Partnership, but for its lack of financial
flexibility, would be positioned to make the capital expenditures necessary to
participate in such opportunities.
South Texas is a core supply area that supports the Partnership's natural gas
and NGL operations. Approximately 80% of the Partnership's NGL production comes
from plants in South Texas and the Texas Gulf Coast. Over the past several
years, the Partnership has been successful in expanding its NGL production and
fractionation capacity in South Texas, including the addition of a gas
processing plant at Thompsonville and the completion of a fractionator expansion
project. For additional information describing these projects and the funding of
these projects through leasing arrangements with the Company, see "The
Partnership -- History of the Partnership." VEC and the General Partner believe
that opportunities to develop incremental NGL production in South Texas will
arise, both through expansion of existing facilities and through acquisitions.
However, any significant increases in NGL production capacity will require
substantial capital expenditures, not only to build or purchase actual plant
capacity but also for required infrastructure expansion. As a result of capital
additions and expansions which have substantially increased the Partnership's
production of NGLs over the past several years, the Partnership's NGL pipelines
and fractionation facilities necessary to handle such increased volumes are
operating at or near capacity. Additional NGL pipeline capacity may also be
needed to move NGLs to markets that may develop in Mexico, to move additional
volumes to Texas Gulf Coast markets or to provide an alternative method for
transporting existing production.
As NGLs are extracted from a "rich" or NGL-laden gas stream, the resulting lean
gas must be moved to market without being commingled with processable rich gas
streams. Due to the recent NGL processing capacity additions that have led to
increased production of lean gas in South Texas, the Partnership is also
capacity-constrained in moving lean gas out of South Texas and is currently
utilizing third-party facilities to move a portion of this gas to market. Any
increase in NGL volumes would lead to a commensurate increase in lean gas
volumes. In order to avoid additional third-party transportation charges, the
Partnership would be required to make the capital expenditures necessary to add
additional natural gas pipeline capacity.
In 1992, the FERC issued Order 636 related to restructuring of the interstate
natural gas pipeline industry. Order 636, which is now implemented, requires,
among other things, that pipelines subject to FERC jurisdiction provide
"unbundled" transportation, storage and load balancing services on a
nondiscriminatory basis to producers and end users instead of offering only
combined packages of services. This change has resulted in increased competition
in the natural gas industry. As a result of Order 636, the Partnership can more
effectively compete for sales of natural gas to local distribution companies
("LDCs") and other potential natural gas sales customers located outside of
Texas. The Partnership has had some success in entering into contractual
arrangements with such customers. At the same time, VEC and the General Partner
believe that contracting practices in the natural gas industry are moving away
from the spot, interruptible type of sales that have been prevalent over the
past several years and toward "firm" and term contracts that require a gas
supplier to commit to specified deliveries without the option of interrupting
service and with specified financial penalties for those suppliers that do not
perform in accordance with their contractual commitments. VEC and the General
Partner believe that, to LDCs and others who are contracting for firm supplies
of natural gas, the financial strength of potential suppliers is an important
consideration that can affect the awarding of supply contracts. Additionally,
VEC and the General Partner believe that substantial amounts of working capital
and capital expenditures for gas inventories, storage facilities, pipeline
connections and related facilities, and for financial hedging products, such as
gas futures contracts, will be required to compete effectively for additional
business under Order 636. Because of the limited ability of the Partnership to
raise additional debt or equity capital, VEC and the General Partner believe
that, unless the proposed Merger is
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approved, the Partnership will not be able to significantly improve its ability
to compete in the deregulated natural gas industry environment and that its
competitive position may erode.
Prior Financings
The Partnership has in the past generated cash to meet its capital expenditure
and debt service requirements, and to pay cash distributions to Unitholders,
through a combination of sources, including (i) operating income, (ii) issuance
of additional Notes, (iii) financial support from VEC through capital leases and
other transactions, (iv) reductions in working capital requirements and (v)
asset sales.
At the time of formation of the Partnership, the Management Partnership issued
$550 million principal amount of Notes under the Indenture. The Management
Partnership then issued another $75 million principal amount of Notes in 1988.
As is more fully described under "-- Limitations on Additional Financings," the
Management Partnership may not issue additional Notes under the Indenture unless
other debt or equity funds are first raised and utilized for capital
expenditures by the Management Partnership or its Subsidiary Operating
Partnerships.
In 1989, in accordance with the provisions of the Partnership Agreement, VEC
purchased 400,000 Common Units directly from VNGP, L.P. for an aggregate of $6.5
million, or $16.24 per Common Unit and made a simultaneous capital contribution
to VNGP, L.P., thereby increasing its effective equity interest in the
Partnership from approximately 48% to over 49%. However, VEC cannot purchase any
significant number of additional Common Units without exceeding an effective 50%
ownership interest in the Partnership and being required under applicable
accounting rules to consolidate the operations and indebtedness of the
Partnership for financial reporting purposes. VEC does not desire to consolidate
the operations and indebtedness of the Partnership without owning all of the
Partnership's business and assets.
Commencing in 1991, VEC subsidiaries entered into a series of leasing
transactions with the Partnership to provide financial support for capital
expenditure projects that were approved by the Board of Directors of the General
Partner. These projects consisted of the East Texas Pipeline Extension,
Fractionator Expansion Project and Thompsonville Plant, described under "The
Partnership -- History of the Partnership." These projects had a total cost of
approximately $101 million and have been leased by the Company to the
Partnership under capital leases. The leasing transactions between the Company
and the Partnership have enabled the Partnership to engage in capital expansions
and business opportunities that would otherwise have been unavailable to it.
However, apart from any indirect benefits, the rate of return available to the
Company from such transactions is limited to the lease payments specified in the
lease and any related tax benefits. Additionally, in 1991, a Unitholder
commenced a class action and derivative lawsuit against the General Partner, VEC
and certain of their respective officers and directors relating, in part, to
such leasing transactions. See "The Partnership -- Conflicts of Interest." As a
result of these and other factors, VEC believes that any significant additional
leasing transactions with the Partnership would not be desirable to VEC.
From time to time, the Partnership has also generated cash to reinvest in its
business through the sale of nonstrategic assets. In 1990 and 1991, the
Partnership sold its interest in two off-system natural gas processing plants in
Oklahoma and related contract rights and realized net cash proceeds of
approximately $22 million. VEC and the General Partner believed that the sale of
these assets was desirable because the plants were located off system and they
were not a part of the Partnership's core businesses, and because the
Partnership was able to sell the assets at an attractive price. However, VEC and
the General Partner believe that sales of assets are not a dependable source of
cash that can be relied upon in planning the Partnership's investment
activities.
The Partnership and the Company enter into various types of transactions in the
normal course of business on market-related terms and conditions, including
natural gas and NGL sales from the Partnership to the Company, purchases of NGLs
and natural gas from the Company and transportation and other services provided
to or by the Company. The Partnership pays the Company for management fees
billed by the Company pursuant to the Partnership Agreement and makes lease
payments under the leases with the Company. To the extent that net amounts are
payable by the Partnership to the Company from time to time,
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<PAGE> 21
these transactions also constitute a type of working capital funding provided by
the Company to the Partnership. The net amount owed by the Partnership to the
Company was $13.5 million at December 31, 1992 and $31.8 million at December 31,
1993.
The Partnership has not historically required significant amounts of working
capital because cash receipts on billings for sales and cash payments for
purchases occur principally in the same month. Since the inception of the
Partnership, the General Partner has significantly reduced the Partnership's
working capital position (current assets less current liabilities) from a level
of $29.5 million at March 31, 1987 to a negative $33 million at December 31,
1992 and a negative $48.3 million at December 31, 1993. The reduction in working
capital requirements has generated a significant amount of cash, which the
Partnership has been able to use for capital expenditures, debt service and cash
distributions. However, VEC and the General Partner believe that, not only is a
significant further reduction in the Partnership's working capital requirements
unlikely to be realized, but that working capital requirements are likely to
increase in the future due to increasing gas storage inventories resulting from
the Partnership's efforts to compete for interstate sales under FERC Order 636.
As a result, working capital reductions are not likely to serve as a future
source of cash to the extent that they have in the past.
Limitations on Additional Financing
The Indenture permits the Management Partnership to issue up to $625 million
principal amount of Notes, plus additional Notes to the extent that additional
debt or equity funds are raised by VNGP, L.P. and contributed to the Management
Partnership and used for additional capital improvements. As noted above, the
Partnership issued $550 million principal amount of Notes in 1987 and an
additional $75 million in 1988. However, without additional equity financing,
the Management Partnership is not permitted under the terms of the Indenture to
issue any additional debt, other than up to $50 million of short-term debt for
working capital purposes. The Indenture has a "clean-up" provision requiring
that such borrowings for working capital must be reduced to zero for a period of
45 consecutive days during each period of 16 consecutive months. See "The
Partnership -- History of the Partnership."
Substantially all of the assets owned by the Partnership are pledged as security
for the Notes. Because the Management Partnership and its Subsidiary Operating
Partnerships cannot effectively issue any new indebtedness other than short-term
borrowings for working capital purposes and, subject to the limitations
described herein, additional Notes, any other indebtedness issued by the
Partnership would likely be issued at the VNGP, L.P. level as unsecured
obligations. The General Partner and VEC have been informally advised by
investment bankers that such indebtedness would likely be rated below investment
grade and, if issuable, would necessarily bear a high interest rate. The General
Partner has viewed the issuance of such indebtedness as an expensive and
unattractive financing vehicle, and has not pursued the issuance of such
indebtedness.
The General Partner believes that the market for issuance of equity by limited
partnerships has been and continues to be limited due to changes in the tax laws
since the formation of the Partnership in 1987 affecting the deductibility of
publicly traded partnership losses. In general, before complete disposition by a
Unitholder of all interests in the Partnership, any such losses may be
deductible only from income allocated by the Partnership. Based upon informal
advice received from time to time from investment bankers, and internal analyses
performed by the Company's staff, VEC and the General Partner believe that
conditions in the financial markets for limited partnership equity securities
would require that any additional Partnership equity securities issued have cash
distributions which are competitive with the distributions paid by other
publicly traded limited partnerships. In general, the percentage yield of
publicly traded limited partnership securities is relatively high, in comparison
with the dividend yield of publicly traded corporations engaged in similar
businesses. The requirement to pay such distributions at market-determined rates
would reduce the Partnership's ability to utilize future cash flows for capital
investments. Additionally, in order to effectively market any such new equity
securities, VEC and the General Partner believe it is likely such new securities
would be preference Units, structured so as to have a priority, in respect of
distributions, over the existing Common Units. Such a priority would, in the
opinion of VEC and the General Partner, impair distributions on the Common Units
and result in a potential loss in value to the existing holders of the Common
Units. See "-- Alternative Transactions Considered," "-- Considerations
Affecting Future Cash Distributions to
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<PAGE> 22
Unitholders" and "-- Background of the Merger." Neither VEC nor the General
Partner has received or solicited any proposal from an investment banking firm
to underwrite or otherwise market any new Partnership equity securities, nor has
any such offering been discussed with the Public Unitholders or their
representatives, including the Special Committee. As no specific terms for any
equity securities of the Partnership have been proposed, the Public Unitholders
have not been requested to consider the possible advantages or disadvantages of
any such financing, if feasible.
Selection of Merger
The VEC Board determined that the proposed Merger was the most appropriate means
of providing financial flexibility to the Partnership while at the same time
achieving the Company's business objective of remaining in the natural gas and
NGL businesses and structuring a transaction that would be nondilutive to VEC's
shareholders and would be determined to be fair to the Public Unitholders. Upon
completion of the Merger, subsidiaries of VEC will own all of the general
partner and limited partner interests in the Partnership, and the Public
Unitholders will be entitled to receive $12.10 per Common Unit from VNGC. The
General Partner anticipates that the Partnership would then significantly reduce
or eliminate cash distributions and retain cash for its internal use for capital
expenditures, debt service and working capital without having to consider
possible adverse effects on the market price of the Common Units.
VEC has issued additional equity to partially offset the substantial additional
indebtedness that would be consolidated upon acquisition of the entire
Partnership interest. See "The Merger -- Source of Cash Consideration." While
the Merger would result in VEC's consolidated debt-to-capitalization ratio
increasing from approximately 37.5% at December 31, 1993 to approximately 51% at
such date on a pro forma basis, such increase is less than would occur if the
publicly-traded Common Units were acquired for cash obtained through additional
borrowings.
In connection with the proposed Merger, VEC has reached agreement with its
principal bank lenders that the Company's existing committed revolving credit
facilities, aggregating up to $190 million principal amount of borrowing and
letter of credit capacity, and the Partnership's committed revolving credit and
letter of credit facilities, aggregating $80 million principal amount of
borrowing and letter of credit capacity (of which not more than $50 million may
be outstanding at any time under covenants contained in the Indenture), be
combined into a single unsecured $250 million revolving credit and letter of
credit facility. VEC expects that such facility would become effective at the
same time that the Merger, if approved, is completed.
Alternative Transactions Considered
In addition to the proposed transaction, the management of VEC considered
several other alternative transactions. For the reasons discussed below, these
alternative transactions were rejected, even though certain of them, if pursued,
may have resulted in greater total consideration to the Public Unitholders than
they will receive in the Merger. VEC did not pursue any of such alternative
transactions and, therefore, cannot determine what transactions would actually
have resulted in greater total consideration to the Public Unitholders or
quantify the extent, if any, to which the total consideration to be received in
any such transactions might have exceeded the consideration to be received in
the Merger. For information with respect to one specific prospect rejected by
VEC, see "-- Background of the Merger -- Certain Contacts." The Board of
Directors of VNGC was not advised of VEC's consideration of these various
alternatives until October 17, 1993, and VNGC, as General Partner, played no
role in VEC's consideration of such alternatives. See "-- Background of the
Merger" and "The Partnership -- Conflicts of Interest." The alternatives
considered by VEC and the reasons for their rejection are as follows:
VEC considered the possibility of converting the Partnership to a corporation,
including variations under which the Partnership would merge with VNGC, acquire
other natural gas-related assets of VEC and/or engage in a public offering of a
corporate security. Conversion to a corporation could benefit the Partnership
and the Public Unitholders by improving the attractiveness of the Partnership's
equity securities to institutional investors and increasing analysts' following
of the Partnership. VEC has been advised by investment bankers that many
institutional investors prefer to invest in corporate, as opposed to limited
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<PAGE> 23
partnership, securities and that, because of this limit on institutional
interest, many analysts do not follow limited partnership securities. A
conversion from limited partnership to corporate form might therefore be
expected to increase institutional and analyst interest, which in turn could
result in increased access to equity markets, enabling the Partnership to raise
capital in the future. The conversion to a corporation could also enable the
Partnership to conserve cash for investment in its business by reducing
distributions/dividends to Unitholders/stockholders.
In this regard, VEC has been advised by investment bankers that, due to the
limited institutional interest, limited partnership securities are principally
sold to "retail" investors interested in high current income, rather than
long-term capital appreciation. For this reason, as noted above, limited
partnership securities tend to have a higher percentage yield than securities of
corporations engaged in similar businesses. If the conversion of the Partnership
to a corporation were to attract sufficient interest from institutional
investors, VEC has been advised that it might be possible for the resulting
entity to pay a dividend rate with respect to its newly-converted capital stock
below the distribution rate paid on the Common Units without impairing market
price for such security. To the extent that the Partnership's cash distributions
to Unitholders could be so reduced, the Partnership would be able to conserve
cash for capital investments and other Partnership purposes. Conversion to a
corporation would likely be accomplished in connection with an equity offering
by the resulting corporate entity. As a result, such entity might be more
capital self-sufficient than the Partnership has been, with a greater capacity
for growth. Additionally, depending upon market conditions, equity securities of
the resulting entity may or may not benefit from higher market valuations
sometimes placed on securities of gas gatherers and NGL companies. If these
results occurred, the improved growth and higher securities values could be
beneficial to the Public Unitholders. Conversion to a corporation might also
eliminate the possible liability exposure to the Company as general partner and
reduce some administrative costs. However, the conversion to a corporation would
also likely result in greater overall federal income tax liabilities.
Greater federal income tax liabilities could result because a corporation,
unlike a limited partnership, is subject to federal income taxation. Taxation of
earnings at the corporate level would reduce cash available for reinvestment in
the business or distribution in the form of dividends. Public Unitholders are
not subject to taxation on Partnership distributions but, instead, are taxed
based upon their proportionate share of Partnership income. Because most of the
Partnership's depreciation expense has been allocated to the Public Unitholders,
pursuant to the terms of the Partnership Agreement, and because the
Partnership's taxable income has been reduced by the deduction of unrecovered
take-or-pay settlement payments, the Public Unitholders have experienced little,
if any, taxable income to date, and most of the Partnership's distributions have
been treated as return of capital to the Public Unitholders. Corporate
stockholders are taxed on dividends received, as opposed to a proportionate
share of corporate income. While, under some circumstances, corporate dividends
may be treated, in whole or in part, as a return of capital, it would not be
possible for a corporation to allocate depreciation expense to the Public
Unitholders in the same manner that the Partnership has done. Conversion to
corporate form would therefore result in potential federal income tax liability
at both the corporate level, based upon the resulting corporation's taxable
income, and at the stockholder level, based upon dividends received by the
stockholders/Unitholders.
VEC has also been advised by investment bankers that, while over the longer
term, conversion to corporate form should improve access to capital markets,
there could be no assurance that such improvement would be immediate.
Additionally, investment bankers have advised VEC that in other instances where
a corporation has successfully established a separate market for securities of a
subsidiary, it has been necessary to establish a separate, independent
management team for the subsidiary in order to provide assurance to the
financial markets that the subsidiary will be managed with a view to the
interests of the public shareholders. Currently, the officers of VEC and VNGC
are substantially identical. Establishment of a separate management team at the
VNGC level would therefore give rise to additional expense, create difficult
issues regarding the assignment of personnel and risk the possibility of
management changes that might or might not prove to be beneficial to VEC, or to
VNGC, or both.
Additionally, the viability of the Partnership in corporate form could
necessitate the Company transferring its natural gas and NGL-related assets,
including the assets leased from VEC subsidiaries, to the Partnership. Potential
difficulties in valuing such assets also militated against this alternative. In
the end, this alternative
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<PAGE> 24
was rejected because it would not resolve the potential conflict of interest
issues involved in transactions between the Company and the Partnership, because
it would involve significant transaction costs and because it was not clear that
merely changing the organizational form of the Partnership would improve the
financial flexibility of the Partnership, result in an entity that was
significantly more attractive to Unitholders and other investors, or better
enable the Partnership to improve and expand its businesses to compete in the
current natural gas industry environment. Also, conversion to a corporation
would likely result in increased federal income tax liability on the taxable
income of the Partnership, reduced distributions to Unitholders in the form of
dividends and further reductions due to Unitholders being taxed on such
dividends. For additional information regarding possible advantages and
disadvantages of a conversion to corporate form, see the discussion of the March
Preliminary Review under "Special Considerations -- Salomon Brothers'
Analysis -- March Preliminary Review."
VEC also considered transactions in which it disposed of its interest in the
Partnership, including transactions in which either (i) the Company's interest
in the Partnership is "spun off" to the VEC stockholders, (ii) VNGC and the
Company's other gas-related assets, including its interest in the Partnership,
are sold to a third-party buyer, or (iii) the Partnership merges with another
"strategic" company, with VEC receiving a minority interest and/or surrendering
all or part of its subsidiaries' managerial control over the Partnership's
assets. VEC viewed these possible transactions as variations of a principal
alternative in which VEC disengaged, wholly or partially, from the businesses
conducted through the Partnership. Analysis of the various types of possible
transactions prepared by Salomon and delivered to VEC in the March Preliminary
Report indicated that a preliminary rough estimate of the implied value of all
of VEC's and the Partnership's natural gas assets (including natural gas-related
assets held outside the Partnership) could be highest in a transaction involving
a sale of all such assets to a third party. In reaching this conclusion, Salomon
analyzed prices paid by acquiring companies in four recent transactions
involving acquisitions of smaller natural gas assets, and applied the apparent
multiples of earnings (before depreciation, interest and taxes) paid in such
transactions, with appropriate adjustments, to VEC's natural gas assets but did
not make any adjustment to the net value received by VEC to reflect taxes
payable by VEC in such a transaction. See "-- Background of the Merger --
Certain Contacts."
A sale of VEC's interest in the Partnership to a third party or a spin-off of
VEC's interest in the Partnership to VEC stockholders would not directly benefit
the Public Unitholders since the Common Units would continue to trade as a
separate security unless the buyer or a third party also made an offer for the
publicly held Common Units. See "-- Background of the Merger -- Certain
Contacts." The management and Board of Directors of VEC have determined that it
is in the best interest of VEC and its stockholders that VEC remain engaged in
the natural gas and NGL businesses and that its subsidiaries continue to manage
the assets controlled by the Partnership, and that a sale, spin-off or other
disposition of the Company's interest in the Partnership would therefore not be
in the best interests of VEC and its stockholders. Additionally, the Company's
debt-to-capitalization and other financial ratios would be negatively impacted
in the event of a spin-off, which could adversely affect the rating of VEC's
securities. There would also be no assurance that VEC's banks and other lenders
would approve a spin-off of assets or that they would not condition a spin-off
upon financial agreement amendments deemed onerous by VEC.
Because the Partnership has no employees of its own and employees of the Company
are responsible for all aspects of the Partnership's operations, a sale or
spin-off would also create difficult issues relating to the allocation of
employees and facilities between the Company's ongoing operations and the sold
or spun-off operations. In this regard, the Partnership's gas control
facilities, as well as a substantial number of the employees of the Company that
deal primarily with Partnership matters, are located in VEC's principal
headquarters building in San Antonio, Texas. The primary term of the lease for
this building expires in 1996, but at that time the Company must either renew
the lease or offer to purchase the building at a price which is currently
estimated to exceed market value. Allocation of the obligations under this lease
between VEC and the Partnership could involve renegotiation of the lease
transaction, which could be difficult and time-consuming. Currently, the
Partnership is bearing a part of the cost of this lease, and transfer of VEC's
interest in the Partnership without also allocating a portion of the future
lease expense to the Partnership would effectively reduce the economic benefit
resulting to VEC from any such sale. A merger of the Partnership with
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<PAGE> 25
another "strategic" company would reduce the Company's effective economic
interest in the Partnership and would likely result in VEC having a minority
interest and the loss of managerial control over the Partnership's operations.
For the reasons discussed below, VEC rejected the alternative of liquidating the
Partnership and distributing the proceeds to the Unitholders. As indicated
above, VEC's management and Board determined that it was in the best interests
of VEC and its stockholders that VEC remain engaged, through subsidiaries, in
each of its three current principal businesses, namely: the petroleum refining
and marketing business, the natural gas business and the NGL business, and that
VEC's subsidiaries continue to manage the assets owned by the Partnership. In a
liquidation, assets of the Partnership would be sold and the proceeds
distributed to the Unitholders. Thus, in a liquidation, the Unitholders,
including VEC subsidiaries, would receive a cash payment and would not remain
engaged in the natural gas and NGL businesses through the Partnership. In
addition to its interest in the Partnership, VEC also owns, through
subsidiaries, other natural gas-related assets, including the pipeline,
fractionation and natural gas processing facilities leased to the Partnership,
as well as certain natural gas processing plants and related assets operated by
the Partnership for the account of VEC. VEC also believes that a buyer of the
Partnership's assets might condition such acquisition upon the acquisition, or
control, of VEC's other natural gas-related assets. Accordingly, liquidation of
the Partnership would likely necessitate VEC's disposition of these other
natural gas and NGL assets as well. VEC does not wish to liquidate its own
assets, even if such liquidation might be beneficial to the Public Unitholders.
As is more fully described under "The Partnership -- History of the
Partnership," substantially all of the assets of the Partnership are subject to
the lien of the Indenture, which secures approximately $506 million of
outstanding Notes of the Management Partnership. The terms of the Indenture
effectively preclude optional redemption of the Notes by the Partnership.
Accordingly, a buyer of the Partnership's assets would be required to assume the
indebtedness represented by the Notes and the obligations of the Management
Partnership and its Subsidiary Operating Partnerships under the Indenture; such
assumption of indebtedness would require the consent of holders of two-thirds of
the Notes outstanding. There could be no assurance that such consent could be
obtained. Since the Notes were issued, prevailing interest rates have declined
substantially. For this reason, VEC believes that the obligation to assume the
Notes would be unattractive to prospective buyers of the Partnership's assets
and could impair the marketability of such assets. Additionally, the business of
the Partnership is different from that of many other publicly traded limited
partnerships; some publicly traded limited partnerships were formed to
securitize oil or gas royalty interests or other self-liquidating assets.
Liquidation through sale could be viewed as consistent with the original purpose
of such an entity. However, liquidation would not be consistent with the
original purpose of the Partnership, which was to continue and operate, as an
ongoing business, the natural gas and NGL operations previously conducted by VEC
subsidiaries.
VEC also considered the possibility of making a cash tender offer or exchange
offer for the outstanding Common Units, rather than proposing a merger
transaction. VEC determined that a cash tender offer was not desirable because
it was likely that not all outstanding Common Units would be tendered,
necessitating a merger subsequent to the tender or exchange, and because of
legal and timing issues. VEC determined that an exchange offer involving
convertible Preferred Stock or other securities of VEC was not desirable because
the Public Unitholders, the Special Committee and its financial advisors might
have difficulty valuing the security to be offered in such transaction.
Additionally, because holders of Common Units might require cash for tax
purposes or might not otherwise wish to hold the security offered, such security
and, if convertible, VEC's Common Stock, might experience undue selling pressure
in the market.
In considering the various alternatives for its investment in the Partnership,
VEC recognized that any transaction involving its interest in the Partnership
was likely to involve an inherent conflict of interest between VEC and the
General Partner, on the one hand, and the Public Unitholders, on the other hand.
Under the terms of the Partnership Agreement, whenever a potential conflict of
interest exists or arises between the General Partner or any of its affiliates,
including VEC, and the Public Unitholders, the General Partner is required to
resolve the conflict of interest on a fair and reasonable basis in light of its
fiduciary position, considering, in each such case, (i) the relative interests
of each party to such conflict and the benefits and burdens relating to such
interests, and (ii) such additional circumstances as the General Partner deems
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relevant, reasonable or appropriate under the circumstances. The Partnership
Agreement provides that, in the absence of bad faith, any determination made by
the General Partner in accordance with such provisions shall not constitute a
breach of the Partnership Agreement. The Partnership Agreement does not preclude
VEC from considering its own interests, so long as any conflict is resolved in
accordance with the Partnership Agreement. In proposing the Merger, VEC
considered the obligations of the General Partner under the Partnership
Agreement, and also gave appropriate recognition to the fact that the VNGC Board
would appoint a Special Committee to consider the fairness of the proposed
transaction to the Public Unitholders. However, in rejecting each alternative
other than the proposed Merger, VEC principally considered the anticipated
effects of such alternative upon VEC and its stockholders, rather than the
Public Unitholders.
In selecting the Merger, the VEC Board considered its fiduciary duty to VEC
stockholders, its business objective of remaining in the natural gas and NGL
businesses and its objective of structuring a transaction that is fair to the
Public Unitholders. The desire to remain in the natural gas and NGL businesses
precluded consideration of such alternatives as liquidation of the Partnership
or a sale of the Company's interest in the Partnership to third parties. The VEC
Board also considered various effects that the alternate transactions might have
on VEC's financial condition as the foregoing description reflects. In
connection with the structuring of the Merger proposal, VEC also recognized that
both VEC and VNGC had directly conflicting fiduciary duties to their respective
stockholders, on the one hand, and the Public Unitholders, on the other hand.
Such conflict was especially apparent in determining the cash amount into which
the Common Units would be converted in the Merger. VEC, as the sole stockholder
of VNGC, recognized that its fiduciary duty to the Public Unitholders might be
deemed to be substantially the same as that of VNGC, as the General Partner of
the Partnership. VEC addressed this conflict by conditioning its initial
proposal upon the determination by the Special Committee that the proposed
transaction is fair to the Public Unitholders and, in response to a subsequent
request by the Special Committee, included in the Merger Agreement as an
additional condition the Independent Vote Requirement. For additional
information related to the duties of VEC and the General Partner, the rights of
the Public Unitholders and certain litigation related to the Merger, see "The
Merger -- Certain Rights of Public Unitholders; Litigation Related to the
Merger."
Considerations Affecting Future Cash Distributions to Unitholders
Due to the extremely competitive environment prevailing in the natural gas
industry since 1987 and the other factors discussed herein, the Partnership's
Distributable Cash Flow (as defined in the Partnership Agreement) declined and
the Partnership was unable to maintain the initial $2.50 per Unit per annum
level of distributions to Unitholders, while at the same time servicing the
Partnership's debt and making capital expenditures necessary to access supplies
and markets and to expand the Partnership's NGL processing capabilities.
Accordingly, beginning in August 1992, the Partnership's quarterly distribution
was reduced from $0.625 per Unit per quarter to $0.125 per Unit per quarter. To
enable the Partnership to maintain its capacity to compete in the current
industry environment, the General Partner believes that the Partnership must
continue to make substantial capital investments in natural gas and NGL
facilities. At the same time, the Partnership's scheduled debt service payments
on the Notes and on capital lease obligations will continue at high levels, with
debt service and lease payment requirements aggregating $90.8 million in 1993,
$93.9 million in 1994, $93.7 million in 1995, $94.3 million in 1996, $94.8
million in 1997 and $91.3 million in 1998.
The Partnership has incurred a net loss for the first quarter of 1994 (see
"Special Considerations -- Certain Projections") and the General Partner expects
that the Partnership's operating requirements, debt service, lease obligations,
minimum capital expenditure requirements, any cash distributions on the Common
Units, any increases in working capital requirements and any capital
expenditures necessary to pursue possible industry opportunities, as described
above, will require additional supplemental funding, such as further borrowings
under the short-term credit lines described above. During 1993, the Partnership
had as much as $39.9 million outstanding under such short-term lines. Although
no borrowings were outstanding under such lines at December 31, 1993, the
Partnership has incurred borrowings of up to $46 million in 1994 in order to
fund working capital requirements. However, because of the reluctance of VEC to
provide additional financial support to the Partnership and a recent decline in
NGL prices described below under "Special Considerations -- Background of the
Merger," the General Partner believes that the clean-up requirement discussed
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above can be met, but that meeting such requirement would require significant
capital expenditure and working capital reductions, the elimination of cash
distributions on the Common Units, the sale of core assets or other measures
likely to have adverse effects on the Partnership and the Unitholders. When and
if the Merger is completed, the General Partner anticipates that distributions
to the Company from the Partnership would be significantly reduced or
eliminated, with such funds utilized for working capital, capital expenditures,
debt service or other Partnership purposes.
The Partnership is involved in one lawsuit, and has received notice of an
additional claim, which, if ultimately resolved in a manner materially adverse
to the Partnership, could have a material adverse effect upon the Partnership's
results of operations and impair its ability to pay cash distributions. In a
letter dated September 1, 1993 from the City of Houston (the "City") to Valero
Transmission Company ("VTC"), the City stated its intent to bring suit against
VTC for certain claims asserted by the City under the franchise agreement
between the City and VTC. VTC is the general partner of Transmission. The
franchise agreement was assigned to and assumed by Transmission upon formation
of the Partnership in 1987. In the letter, the City also declared a conditional
forfeiture of the franchise rights based on the City's claims. In a letter dated
October 27, 1993, the City claimed that VTC owes to the City franchise fees and
accrued interest thereon aggregating approximately $13.5 million. In a letter
dated November 9, 1993, the City claimed additional damages of $18 million,
related to the City's allegations that VTC engaged in unauthorized activities
under the franchise agreement by transmitting gas for resale and by transporting
gas for third parties on the franchised premises. The City has not filed a
lawsuit. The Company and the City have engaged in formal discussions regarding
the possible settlement of the City's claims, but no agreement has been
concluded. Any liability of VTC with respect to the City's claims has been
assumed by the Partnership.
VTC, as buyer, and Tejas, as seller, are parties to various gas purchase
contracts which were assigned to and assumed by Transmission upon formation of
the Partnership in 1987. In turn, Tejas has entered into a series of gas
purchase contracts between Tejas, as buyer, and certain trusts ("The Long
Trusts"), as seller. Various claims and disputes have arisen between Tejas and
The Long Trusts under the Tejas/Long Trusts contracts, which have resulted in
litigation by The Long Trusts against Tejas (The Long Trusts v. Tejas Gas
Corporation, 123rd District Court, Panola County, Texas, filed March 1, 1989
("The Long Trusts Litigation"). Neither the Partnership nor VTC was originally a
party to The Long Trusts Litigation or the Tejas/Long Trusts contracts. Because
of the relationship between the Transmission/Tejas contracts and the Tejas/Long
Trusts contracts, and in order to resolve existing and potential claims and
disputes, Tejas, VTC and Transmission have entered into an agreement pursuant to
which, among other things, Tejas, VTC and Transmission will cooperate in the
conduct of The Long Trusts Litigation and VTC and Transmission will bear a
substantial portion of the costs of any appeal and of the amount of any
nonappealable final judgment rendered against Tejas. In The Long Trusts
Litigation, The Long Trusts have asserted claims against Tejas for the alleged
breach of various minimum take, take-or-pay and other contractual provisions of
the Tejas/Long Trusts contracts, and a statutory nonratability claim, and are
seeking alleged actual damages including interest, of approximately $30 million.
The District Court has ruled on the plaintiff's motion for summary judgment,
finding, among other things, that as a matter of law the three gas purchase
contracts at issue were fully binding and enforceable, Tejas breached the
minimum take obligations under one of the contracts, Tejas is not entitled to
claimed offsets for gas purchased by third parties and the "availability" of gas
for take-or-pay purposes is established solely by the delivery capacity testing
procedures in the contracts. However, damages, if any, have not been determined.
On April 15, 1994, plaintiffs named VTC and Valero Transmission, L.P. as
additional defendants, alleging that they maliciously interfered with the
trust's contracts with the supplier. This litigation is not currently set for
trial.
In each of the foregoing cases, the General Partner believes that the claims
have been overstated, and that there are meritorious defenses to the claims and
allegations, including various regulatory, statutory, contractual and common law
defenses. However, due to the inherent uncertainty of litigation, there can be
no assurance that the resolution of the foregoing matters would not have a
material adverse effect upon the Partnership's results of operations for the
fiscal period in which the resolution occurred. In the event of an adverse
determination involving VEC or its subsidiaries, it is anticipated that VEC
would seek indemnification from the Partnership under the terms of the
Partnership Agreement and other applicable agreements between
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the Partnership and the Company. The General Partner believes that a materially
adverse determination in any one or more of the foregoing matters could further
impair the Partnership's ability to pay cash distributions.
For additional information regarding litigation affecting the Partnership, see
the Form 10-K, incorporated by reference herein. See "Incorporation of Certain
Documents by Reference."
BACKGROUND OF THE MERGER
For the reasons discussed above, VEC and the General Partner have from time to
time considered a number of alternatives that might be available to the
Partnership. See "-- Reasons for the Proposed Merger -- Alternative Transactions
Considered." From time to time in 1992 and 1993, various investment banking
firms, including Salomon, provided solicited or unsolicited proposals, or made
unsolicited proposals to provide advice, with respect to one or more of such
alternatives. Such proposals related to the outlook for and the financial
flexibility of the Partnership and considered various possible financial
restructuring options, focusing on the same alternatives later identified by
Salomon in its March Preliminary Review (hereinafter defined). See "-- Salomon
Brothers' Analysis -- March Preliminary Review." Some proposals included an
analysis of the market performance of the Common Units and an analysis of the
Partnership's operations, compared with a "peer group" of other companies in the
natural gas industry. Some analyses also focused on the possibility of issuing
VEC securities in connection with various restructuring options. None of the
firms' analyses or recommendations were materially different from the matters
covered in Salomon's March Preliminary Review and none of the firms making
proposals or presentations was engaged by VEC to thereafter provide investment
banking services with respect to any strategic transaction involving the
Partnership. Except as set forth below, none of such firms engaged in a
valuation of the Partnership or the Units, or made a recommendation of a price
at which VEC might seek to acquire the Units held by the Public Unitholders.
Members of the management of VEC from time to time involved in such discussions,
as specified below, included Mr. Greehey, Mr. Benninger, Mr. McLelland, Mr.
Heep, Mr. Krueger, Mr. Schmidt, Mr. Greg Wright, director of Financial Planning
for VEC, and Mr. William H. Zesch, Assistant Controller of VEC. While most of
such persons are also officers of VNGC, they represented VEC in the various
negotiations and discussions mentioned herein.
During 1992, the staff of the Company evaluated possible options relating to the
Partnership, including (i) the merger of VNGP, L.P. or VNGC with another
pipeline company, (ii) acquisition of the publicly held Units for VEC stock,
cash or a combination thereof, (iii) a dividend of Units held by the Company to
VEC's shareholders, (iv) a spin-off of VNGC (alone or together with the
Company's other gas-related assets) to VEC shareholders and (v) sale of the
Company's gas-related assets to a third party.
Also in 1992, Salomon prepared for internal purposes a preliminary unsolicited
analysis of the strategic alternatives available to VEC with respect to the
Partnership, one copy of which was sent to Mr. Heep for his information.
(Although Salomon had previously furnished investment banking services to VEC
from time to time, for which Salomon received customary compensation, and
Salomon continued to be in contract with VEC, there was no formal relationship
between VEC and Salomon with respect to the Partnership in 1992.) The internal
Salomon analysis mentioned four principal alternatives to the status quo: (i)
VEC reacquiring complete ownership of the Partnership, (ii) the merger of the
Partnership with another "strategic" company, (iii) the spin-off of the
Partnership to VEC's public shareholders, and (iv) the conversion of the
Partnership into a corporation and its merger with VNGC. The analysis mentioned
possible credit, valuation and tax issues related to these alternatives, but did
not reach any conclusions. VEC provided no instructions to Salomon in connection
with preparation of this preliminary analysis.
In the first quarter of 1993, Salomon was requested by VEC to prepare a report
of strategic alternatives with respect to the Partnership. No limitations were
placed on Salomon with respect to its report. While VEC had not yet formally
engaged Salomon at the time of such request, it was understood that if VEC
decided to proceed with a transaction with respect to the Partnership requiring
an investment banker, it would retain Salomon. Subsequently, pursuant to an
engagement letter dated August 30, 1993, Salomon was formally engaged as of
January 15, 1993.
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From the date of Salomon's engagement until the delivery of VEC's Merger
proposal to the VNGC Board on October 17, 1993, as described below, no
representatives of the General Partner were appointed to act, or acted,
separately on behalf of the Public Unitholders.
Salomon has from time to time provided investment banking services to the
Company. At the effective time of its engagement in January 1993, as well as at
the time of preparing and delivering the March 1993 review and October 1993
report hereinafter described, Salomon was serving as placement agent for
medium-term notes of VEC with respect to which a registration statement was
previously filed and had become effective. Additionally, Salomon has served as
lead underwriter with respect to VEC's $3.125 Convertible Preferred Stock issued
in March 1994 to fund the proposed Merger. See "The Merger -- Source of Cash
Consideration" and "-- Reasons for the Proposed Merger -- Conditions to the
Obligations of the Parties to the Merger Agreement."
On March 30, 1993, representatives of Salomon presented Salomon's preliminary
review of strategic alternatives to Messrs. Heep, Wright and Zesch of VEC. The
Salomon review was conducted with a view to determining the potential positive
and negative implications of various possible transactions to VEC and its
stockholders, and not with the purpose of determining maximum value to the
Public Unitholders. The Salomon review did not have the focus or purpose of
discussing value to the Public Unitholders with respect to any of the possible
alternative transactions. For a description of such preliminary review, see
"-- Salomon Brothers' Analysis -- March Preliminary Review."
In the summer of 1993, VEC's senior management requested that the staff of the
Company make a detailed presentation and recommendation regarding the various
alternative transactions. During July and August 1993, the staff of the Company
prepared a detailed evaluation, based, among other things, upon the work
previously done by Salomon, and presented such evaluation to Messrs. Greehey,
Benninger, McLelland and Heep on August 23, 1993. The General Partner was not
involved in the preparation of this recommendation.
Following the staff presentation on August 23, 1993, VEC's management, including
Messrs. Greehey, Benninger, McLelland and Heep, determined that, in light of
VEC's long-term strategic objectives and its desire to remain in the natural gas
and NGL businesses, VEC would focus its evaluation efforts on the possible
acquisition by VEC of the Common Units owned by the Public Unitholders. See
"-- Reasons for the Proposed Merger -- Selection of Merger" and "-- Alternative
Transactions Considered." With the exception of the preparation of the Salomon
and Company staff presentations described above, no formal steps were involved
in reaching the determination that VEC management would focus on the possible
acquisition of the publicly held Common Units and no formal record was made of
such determination.
Subsequently, Salomon was requested to make a recommendation to VEC as to the
form and amount of consideration that VEC should propose to pay to the Public
Unitholders in such an acquisition and the structure of such an acquisition.
On August 30, 1993, representatives of Salomon met at the request of VEC with
Messrs. Heep, McLelland, Krueger, Schmidt, Wright and Zesch and with VEC's
outside counsel and certain staff members of VEC to gather information in
connection with the preparation of Salomon's study and recommendations to the
VEC Board of Directors (the "VEC Board") and had numerous subsequent meetings
and telephone conversations during September 1993 with VEC's management.
At a meeting on October 8, 1993, representatives of Salomon presented to Messrs.
Greehey, Benninger, Heep, Krueger, Schmidt, Wright and Zesch and certain staff
members of VEC and VEC's outside counsel, Salomon's analysis and recommendations
with respect to the form and amount of consideration that VEC should propose to
pay to the Public Unitholders in a potential acquisition by VEC of the
publicly-held Common Units, and the structure of such an acquisition. See
"-- Salomon Brothers' Analysis -- Salomon October Report" below. Based on the
analysis set forth in the Salomon October Report (hereinafter defined), Salomon
concluded that a value of $11.00 per Common Unit might reasonably be expected to
be found by a special committee of independent directors of the General Partner,
when appointed, and its independent financial advisor, to be fair to the Public
Unitholders from a financial point of view and, therefore, that such an offer
might reasonably be expected to lead to a successful acquisition by VEC of the
publicly traded Common
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Units. Salomon's analysis and recommendation was based, in part, upon certain
financial projections and assumptions, dated October 5, 1993, prepared by the
Company's staff. See "-- Reasons for the Proposed Merger -- Certain
Projections."
At the conclusion of the October 8, 1993 meeting, Messrs. Greehey, Benninger,
McLelland and Heep, acting on behalf of VEC, decided to recommend to the VEC
Board at a meeting scheduled for October 29, 1993 that VEC propose to the Board
of Directors of VNGC (the "VNGC Board") a cash merger for consideration of
$11.00 per Common Unit. No formal record was made of such determination. In so
doing, the management of VEC also did not determine that the consideration
proposed to be paid to the Public Unitholders would be fair, from a financial
point of view.
In response to an increase in the trading volume and price of the Common Units
on October 12, 13 and 14, 1993, VEC publicly announced on October 14, 1993, that
its management intended to propose to the VEC Board at a special meeting to be
held on October 16, 1993 that VEC offer to the VNGC Board a cash merger for
consideration of $11.00 per Common Unit. See "Market Prices of Common Units and
Distributions."
On October 16, 1993, the VEC Board met to receive and consider such
recommendation. At such meeting, Messrs. Greehey, Benninger, McLelland and Heep
of VEC discussed the formation and business history of the Partnership, factors
that had affected the operating results and financial condition of the
Partnership, factors affecting the Partnership's ability to raise additional
capital and the financial assistance provided by VEC to the Partnership,
including the various leasing transactions described in "The
Partnership -- History of the Partnership." They also discussed the various
alternatives considered for the Partnership, and the various interrelationships
that existed between the operations of the Partnership and the other operations
of the Company. The members of VEC's management recommended, and the VEC Board
determined, that a sale, spin-off or other disposition of the Company's interest
in the Partnership would not be in the best interests of VEC or its
stockholders. Mr. Heep of VEC reviewed the financial and accounting effects of
the proposed transaction on VEC and also discussed the anticipated financial
effects on VEC of a public offering of a convertible preferred stock and the use
of the proceeds thereof to finance the Merger. Neither the VEC Board nor VEC
management discussed whether the proposed consideration was fair to the Public
Unitholders, but they recognized that a determination of fairness would
subsequently have to be made.
Representatives of Salomon attended the October 16, 1993 meeting and summarized
that firm's analysis and recommendation made to VEC's management on October 8,
1993, as described above. Salomon's representatives expressed the view that a
cash price of $11.00 per Common Unit might reasonably be expected to be found by
a special committee of independent directors of the General Partner and its
independent financial advisor, when chosen, to be fair to the Public Unitholders
from a financial point of view and, therefore, that such an offer might
reasonably be expected to lead to a successful acquisition by VEC of the
publicly traded Common Units. At the conclusion of such meeting, the VEC Board
authorized management to propose to the VNGC Board a cash merger at $11.00 per
Common Unit, subject to (i) receipt by the Special Committee of an opinion from
its financial advisor that the proposed transaction is fair to the Public
Unitholders from a financial point of view, (ii) a determination by the Special
Committee that such transaction is fair to the Public Unitholders, (iii)
approval and recommendation of the proposed transaction to the Public
Unitholders by the VNGC Board and the Special Committee, (iv) satisfactory
amendment of VEC's bank credit and other financing arrangements and (v) receipt
of the requisite approval of the holders of the Common Units. The VEC Board also
authorized an offering of convertible preferred stock to fund the transaction.
Until October 17, 1993, all discussions and determinations were internal VEC
discussions and determinations in which VEC, with the advice of its own
advisors, determined whether to make a proposal to VNGC, as General Partner,
and, if so, the exact terms and conditions of such proposal. Since the proposed
Merger was initiated solely by VEC, VNGC, in its capacity as General Partner,
was not requested by VEC to play, and did not play, a separate role in these
discussions and determinations. See "The Partnership -- Conflicts of Interest."
On October 17, 1993, the VNGC Board met to receive the VEC proposal. At such
meeting, it appointed the Special Committee, comprised of unaffiliated directors
of such Board, (a) to consider the proposal (the "Initial Proposal") of VEC that
the Partnership merge with a subsidiary partnership of VEC in a transaction
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pursuant to which the Common Units would be converted into the right to receive
$11.00 in cash, subject to certain terms and conditions; and (b) to report to
the VNGC Board regarding the fairness of the Initial Proposal to the Public
Unitholders and whether the Initial Proposal should be approved. The Special
Committee was also authorized and directed to engage and indemnify a financial
advisor and a legal advisor of its own selection to assist it in evaluating the
Initial Proposal. The Special Committee and its advisors were not authorized by
the VNGC Board to seek, and they did not seek, alternative proposals for the
acquisition of the Partnership from third parties.
The Special Committee consists of Dr. Ronald K. Calgaard, Chairman, President of
Trinity University, San Antonio, Texas; Mr. Ruben M. Escobedo, of Ruben M.
Escobedo & Company, a public accounting firm in San Antonio, Texas; and Mr. Mack
Wallace, a former member and Chairman of the Railroad Commission of Texas who is
of counsel to the Austin, Texas law firm of Hughes & Luce. The three members of
the Special Committee are not employees of the Company or, except for their
positions as directors of VNGC, otherwise affiliated with the Company.
The Special Committee retained the law firm of Wachtell, Lipton, Rosen & Katz to
act as special counsel and to advise it with respect to legal matters relating
to the Initial Proposal, and retained the investment banking firm of Dillon Read
to act as financial advisor to advise the Special Committee with respect to
financial matters and with respect to the fairness, from a financial point of
view, of the consideration to be received by the Public Unitholders pursuant to
the proposed transactions.
During November and December 1993, at the request of the Special Committee,
representatives of Dillon Read, counsel to the Special Committee and counsel to
Dillon Read met with or spoke to various officers and representatives of VEC and
the General Partner and their respective subsidiaries, and their counsel, and of
Salomon, and of Arthur Andersen & Co., the independent accountants for the
Partnership and the General Partner; reviewed various documents, financial
statements and projections and other reports and materials provided by such
parties, including initial and revised drafts of the proposed Merger Agreement;
discussed such documents with representatives of and counsel for VEC; proposed
changes in the Merger Agreement; and held several meetings and consultations
with members of the Special Committee.
The Special Committee, which advised VEC and stated in its final report that it
viewed its role as representing the Public Unitholders, negotiated diligently on
their behalf. On December 10, 1993, having determined that the $11.00 price
contained in the Initial Proposal was inadequate (based, among other things, on
the Special Committee's view that VEC would be likely to pay more than that
indicated by the Initial Proposal, on the fact that the Common Units had been
trading on the Exchange at prices above $11.00 per Unit, on Dillon Read's
statement that it was not prepared to render an opinion that the Initial
Proposal was fair to the Public Unitholders from a financial point of view and
Dillon Read's advice that the Special Committee consider negotiating with VEC
for a higher price per Unit and that the Special Committee should consider
opening these negotiations by asking for $15.00 per Unit) and that other terms
of the Initial Proposal were undesirable (including that the Initial Proposal
would not have been subject to the approval of a majority of the Public
Unitholders voting at the Special Meeting), the Special Committee determined
that it would recommend that the Initial Proposal be rejected. Subsequent to
December 10, 1993, the Special Committee and its legal and financial advisors
pursued further discussions and negotiations with VEC and its representatives.
All of the members of the Special Committee participated in such discussions and
negotiations, rather than appointing a spokesman or representative. As a part of
these negotiations, the Special Committee noted to VEC that VEC would be
unlikely, as a practical matter, to effect the Merger if the Special Committee
did not recommend that the Initial Proposal be accepted. On December 17, 1993,
following the Special Committee's statement that it was not prepared to
recommend that the Initial Proposal be accepted and the Special Committee's
request for an increase in the price to $15.00 per Unit and for the revisions to
the Merger Agreement described in this Proxy Statement (see "-- Recommendation
of the Board of Directors of the General Partner; Fairness of the Merger"), VEC
made a revised proposal of $12.10 per Unit (the "Revised Proposal") and made a
number of revisions to the Merger Agreement. For information regarding the
latter, see "-- Recommendation of the Board of Directors of the General Partner;
Fairness of the Merger." In connection with making the Revised Proposal,
representatives of VEC stated that $12.10 represented the highest price that VEC
would be prepared to pay per Unit, and this statement was reiterated on several
occasions during the period
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December 17, 1993, to December 20, 1993, during which time the Special Committee
sought to have VEC further improve the terms of VEC's proposal.
On December 17, 1993 and December 20, 1993, members of the Special Committee
reviewed the Revised Proposal and, on December 20, 1993, the Special Committee
determined that it was the unanimous recommendation of the Special Committee
that the VNGC Board accept the Revised Proposal as being fair to and in the best
interests of the Public Unitholders, based on the considerations discussed under
"Recommendation of the Board of Directors of the General Partner; Fairness of
the Merger."
Certain Contacts
On January 21, 1994, VEC's CEO was contacted by Mr. Charles L. Watson, the
Chairman of the Board of Natural Gas Clearinghouse, Houston, Texas ("NGC")
requesting that a meeting between them be scheduled. Mr. Watson did not explain
the purpose of the meeting. A meeting was scheduled for January 24, 1994. On
January 24, 1994, VEC's CEO received a telephone call from NGC cancelling the
meeting and a letter from the Chairman of NGC indicating that NGC was interested
in pursuing joint venture arrangements on or off the Partnership's pipeline
system. The letter further stated that NGC believed that the value of the
Partnership's assets was not being maximized in its current operating structure
and that NGC believed that, through its own nationwide gas marketing
infrastructure, it could increase utilization of the Partnership's gathering,
processing, storage and transmission facilities. NGC further indicated that it
had had substantial discussions regarding the Partnership with its two principal
owners, British Gas plc and NOVA Corporation of Alberta, and was confident that
it could offer VEC an attractive alternative to the Merger transaction proposed
and described in this Proxy Statement. On January 28, 1994, the CEO of VEC
received another letter from NGC proposing that NGC acquire the Units of VNGP,
L.P. held by VEC subsidiaries for $16.00 per Unit; the letter further stated
that the proposal was not subject to financing or other conditions, and that, if
VEC agreed to such proposal, NGC would make a similar offer for the publicly
held Common Units at the same price. Accordingly, insofar as the proposal
related to Common Units held by Public Unitholders, it was contingent on VEC
first agreeing to sell the Units controlled by its subsidiaries. VEC's CEO was
also contacted by telephone by the NGC Chairman. However, no substantive
discussions or negotiations occurred between the VEC CEO and the NGC Chairman.
As described above, the VEC Board had previously determined that it is in the
best interests of VEC and its stockholders that VEC remain involved in the
natural gas and NGL businesses and that, through subsidiaries, it continue to
manage the assets owned by the Partnership. VEC's CEO advised the VEC Board of
the NGC letters; on January 28, 1994, the VEC Board met to discuss the NGC
proposal, unanimously reaffirmed its prior determination that VEC's interest in
the Partnership was not for sale, and authorized the CEO of VEC to reject the
NGC proposal. By letter dated January 28, 1994, the CEO of VEC advised NGC that
VEC's interest in the Partnership was not for sale.
In a letter to the VNGC Board dated February 3, 1994, NGC reiterated its
proposal and requested that the VNGC Board enter into negotiations with it
regarding the proposal. At a meeting held on February 11, 1994, the CEO of VEC
delivered to the VNGC Board a letter stating unequivocally that VEC was
unwilling to sell the Partnership interests controlled by VEC. The VNGC Board
thereupon determined that, without the consent of VEC, it did not appear to be
feasible to effect the transaction proposed by NGC. However, at the request of
the VNGC Board, a letter was sent from Dr. Calgaard, on behalf of the VNGC
Board, to NGC requesting that NGC promptly advise the VNGC Board if it was
contemplating a specific proposal in which NGC would seek to acquire only the
Partnership interests held by persons other than VEC and, if so, the specific
details of such proposal. By letter dated February 15, 1994, NGC responded to
Dr. Calgaard's letter. NGC indicated that it was interested in discussing a
negotiated transaction in which it would acquire, for an unspecified price,
Common Units held by the Public Unitholders upon mutually agreeable terms and
conditions. NGC stated that, in such a transaction, NGC and the Company would be
the two limited partners of VNGP, L.P. NGC further requested a meeting with the
VNGC Board to discuss terms, conditions, timing and structure of such a
transaction.
On the morning of February 23, 1994, the members of the Special Committee, Dr.
Calgaard and Messrs. Escobedo and Wallace, together with their independent legal
counsel, met with representatives of NGC. NGC's representative orally reiterated
its earlier proposal and made additional proposals that were each
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conditioned upon VEC either selling its interest in the Partnership to NGC, or
upon VEC agreeing to permit the Partnership to enter into a joint venture or
other arrangement in which "commercial control" of VNGP, L.P. would be assumed
by NGC. Although NGC did not precisely define what it meant by "commercial
control," NGC's discussions and proposals (described below) led the Special
Committee to conclude that "commercial control" would encompass control over the
commercial operations (including purchasing, marketing and sales) of the
Partnership. Moreover, the NGC representative made clear during the meeting that
the amount of premium over market that NGC was willing to pay for Common Units
was a function of the amount of control NGC acquired over the Partnership in the
transaction and that, if NGC was offered no control, it was unwilling to agree
to pay any premium for Common Units. NGC never suggested to VEC, the VNGC Board
or the Special Committee that it would be willing to enter into a transaction in
which it would acquire the Public Units and not acquire any further interest in
or control over the Partnership. Moreover, at the February 23, 1994 meeting, in
response to a question from Dr. Calgaard, NGC specifically declined to make any
offer for the publicly held Common Units not conditioned upon NGC achieving
"commercial control" of VNGP, L.P. On February 23, 1994, at a regularly
scheduled meeting of the VNGC Board, Dr. Calgaard reported to the VNGC Board
regarding such earlier meeting with NGC. The VNGC Board thereupon adopted a
resolution requesting that the VEC Board state the position of VEC with respect
to a sale, joint venture or other transaction involving NGC. At a special
meeting of the VEC Board held on February 24, 1994, the VEC Board discussed the
NGC proposals and adopted resolutions (i) reconfirming that it is in the best
interests of VEC and its stockholders that VEC continue to engage, through its
subsidiaries, in the natural gas and NGL businesses, and that its subsidiaries
continue to manage the assets owned by VNGP, L.P., and (ii) confirming that VEC
does not desire to participate with NGC, or with any other third party, in any
joint venture or other transaction in which VEC would relinquish, in whole or in
part, its subsidiaries' control of the assets and businesses owned by the
Partnership. The result of the VEC Board meeting was communicated to the VNGC
Board by the CEO of VEC. On March 1, 1994, the Chairman of NGC telephoned Dr.
Calgaard to further explain NGC's interest in the Partnership, and was asked by
Dr. Calgaard to put in writing any proposals he might have. On March 2, 1994,
NGC sent a letter to Dr. Calgaard in which it described various "enhancements"
which NGC believed it could provide if it were able to enter into a negotiated
transaction with VNGP, L.P. In the March 2, 1994 letter, NGC indicated that it
could provide off-system gas sales markets to the Partnership which, according
to NGC, might generate additional transportation revenues, help meet contractual
gas purchase obligations and attract new gas supplies to the Partnership's
system. NGC also indicated that it would be willing to subscribe to gas storage
capacity that, in NGC's opinion, would generate incremental transportation and
storage revenue, that NGC would commit to certain gas transportation volumes at
specified prices, and that it believed it could combine with the Partnership in
establishing "supply hubs" to access gas markets. The letter also stated NGC's
belief that other enhancements could be identified if NGC were allowed to assume
"commercial control" of the Partnership's assets. No mention was made in the
letter of any acquisition of Common Units or other interests in the Partnership.
On March 4, 1994, Dr. Calgaard sent a letter to NGC, formally advising NGC of
VEC's position, indicating that none of NGC's proposals appeared feasible in
light of NGC's desire to obtain "commercial control" and stating that the matter
appeared to be concluded. Subsequently, during the week of March 7, 1993, the
members of the Special Committee conferred by telephone with their legal and
financial advisers and authorized the final response to NGC and, because Dillon
Read had not participated in any of the meetings involving the Special Committee
relating to NGC matters, to apprise Dillon Read formally of those events. The
Special Committee also authorized Dillon Read to contact NGC directly to confirm
NGC's position as previously reported to the Special Committee. A representative
of Dillon Read then so confirmed NGC's position in a telephone conference with
the NGC CEO. No further communications have been received from NGC.
VEC has not made a detailed analysis of NGC's claims and proposals set forth in
the March 2, 1994 letter because it has determined that it has no interest in a
joint venture or other arrangement with NGC or any third party. However, based
upon a preliminary study of the March 2, 1994 letter, VEC believes that the NGC
proposals set forth in the March 2, 1994 letter would provide little, if any,
financial or operational benefit to the Partnership.
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VEC has declined to engage in discussions with NGC in connection with the above
expressions of interest because it has determined it to be in the best interests
of VEC and its stockholders to remain engaged in the natural gas and NGL
businesses and that its subsidiaries continue to manage the assets controlled by
the Partnership. As is more fully discussed in the following paragraph, VEC has
determined that a sale of its interest in the Partnership would have adverse
federal income tax consequences to VEC that would render any such sale
disadvantageous to VEC and its stockholders. Additionally, to the extent that
the Merger were ultimately to prove beneficial to VEC and its stockholders, VEC
did not desire to share that potential with NGC or any other third party. VEC
believes that it has no duty to the Public Unitholders to sell, or to consider
offers to sell, its own interest in the Partnership or its other natural gas
related assets, whether in response to a third party proposal or otherwise.
Neither NGC nor any other third party has expressed an interest in
unconditionally acquiring only the Common Units held by the Public Unitholders
and NGC has not suggested a price that it would pay for only the Public
Unitholders' interests.
As is more fully described under "The Partnership -- History of the
Partnership," in 1987, VEC formed the Partnership and contributed property of
the Company in exchange for an interest in the Partnership and a distribution of
cash from the Partnership. For tax purposes, the transaction was treated as a
contribution of property and a nontaxable partnership distribution, except as
more fully explained below. The Company's tax basis in its assets contributed
carried over and became the Partnership's basis in the assets. At the time, the
assets, by appraisal, had a fair market value in excess of $1 billion but a tax
basis of $440 million due principally to accelerated depreciation and rising
market values of the assets. The distribution of cash from the Partnership to
the Company was treated as a return of capital to the extent of the Company's
interest in the Partnership. This portion of the cash distribution exceeded the
Company's basis by $190 million and therefore created a negative basis in the
Company's investment in the Partnership. Subsequent to formation of the
Partnership, the Company's basis has been increased by its share of Partnership
income and reduced by distributions received. As of December 31, 1993, the
Company's estimated basis in its investment in the Partnership was approximately
a negative $170 million. If this investment were to be sold, gain would be
recognized for federal income tax purposes to the extent of such negative basis,
plus proceeds received from any such sale. As a result, any sale of the
Company's interest in the Partnership would trigger a substantial tax liability
that would necessarily consume a substantial portion of the proceeds of any such
sale. As a result, the sale of its Partnership interest would have undesirable
tax consequences to VEC.
SALOMON BROTHERS' ANALYSIS
March Preliminary Review
As described above, on March 30, 1993, Salomon presented its preliminary review
of strategic alternatives to certain VEC officers and other members of VEC
management. Such preliminary review was conducted with a view to determining the
potential positive and negative implications of various possible transactions to
VEC and its subsidiaries, for further consideration by VEC's management. The
preliminary review was prepared at the request of VEC. No limitations were
placed on, or instructions given to, Salomon in connection with such request.
Such preliminary review (as revised on April 2, 1993 to correct certain errors
and make minor changes (the "March Preliminary Review")) is summarized below.
In the March Preliminary Review, Salomon noted that the key difficulties
regarding continued maintenance of the status quo included the large amount of
financial support which the Partnership would require from VEC (projected to
equal $50 million over the next two years) to achieve its business plan, the
implications that such financial support might have on VEC's credit ratings, the
minimal benefit that ownership of approximately 49% of the Partnership provided
to VEC's valuation in the equity markets, and the conflicts of interest which
might continue to arise between VEC and the Partnership. See "The
Partnership -- Conflicts of Interest." Salomon considered potential VEC
objectives to include: maximizing VEC shareholder value; retaining VEC's
investment grade debt rating; eliminating any need for VEC to continue to
provide capital funding support to the Partnership; allowing the Partnership to
take advantage of opportunities to grow in the natural gas gathering and
processing businesses without VEC support; and eliminating conflicts of interest
between VEC and the Partnership. Salomon then noted that the choice among the
various alternatives would be largely determined by the financial and strategic
objectives of VEC, particularly its long-term strategy with regard to
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whether it wished to continue to participate in the natural gas and NGL
businesses and, thus, maintain the resulting upside opportunities and downside
risks of those businesses, and, therefore, whether it wished to maintain control
of those businesses. In connection with such potential objectives, Salomon noted
its understanding that any transaction would need to be structured so as to be
fair both to the stockholders of VEC and to the Public Unitholders. Salomon was
not requested to recommend, and did not specifically recommend, how a
transaction could be structured to be most fair to both VEC and the Public
Unitholders.
Salomon then described VEC's principal alternatives with respect to the
Partnership: (i) maintenance of the status quo; (ii) repurchase of the publicly
held Common Units; (iii) repurchase of the publicly held Common Units, together
with a contribution of VEC's other gas-related assets to VNGC and a public
equity offering in the combined VNGC-Partnership business (the "equity carve-out
alternative"); (iv) a spin-off of VNGC and VEC's other gas-related assets to
VEC's shareholders (the "spin-off alternative"); and (v) the sale of VNGC and
VEC's other gas-related assets to a strategic buyer which would also acquire the
publicly traded Common Units directly or indirectly following their acquisition
by VNGC (the "sale alternative"). In order to analyze the pro forma effects of
certain of these alternatives, Salomon first performed various preliminary
analyses regarding the value of the Partnership and its businesses, applying
three principal methodologies: (i) an analysis of market trading multiples for
comparable publicly traded companies in the intrastate natural gas processing
and gathering businesses (a "comparable company analysis"), (ii) an analysis of
multiples paid by unaffiliated companies in acquisition transactions (a "third
party acquisition analysis"), and (iii) a discounted cash flow ("DCF") analysis.
In its comparable company analysis, Salomon identified five publicly traded
companies (Western Gas Resources Inc. ("Western"), Associated Natural Gas Corp.
("Associated"), Tejas, American Oil & Gas ("American") and USX-Delhi ("Delhi")),
as having businesses that are somewhat comparable to the business of the
Partnership. Salomon calculated the following ranges of ratios for this
comparable group: (i) market value of equity plus net debt ("firm value") to
analysts' projected 1993 earnings before interest, taxes, depreciation and
amortization ("EBITDA") of 5.2x to 9.4x, (ii) market value to projected 1993
cash flow from operations (net income plus depreciation and amortization, change
in deferred taxes, and other non cash income) per share of between 4.1x and
10.7x, and (iii) market value to adjusted book value (book value less
intangibles and cash) per share of between 1.4x and 3.3x. Applying these ranges
to the Partnership resulted in total equity values (after deducting from firm
value $663 million of debt and capital lease obligations (net of excess cash) of
negative to $474 million (equivalent to approximately (meaningless) to $24.69
per Common Unit based on an assumed 19.2 million Units [including theoretical
Units representing general partner interests] outstanding), $213 million to $556
million ($11.09 to $28.96 per Common Unit), and $221 million to $521 million
($11.51 to $27.14 per Common Unit), respectively.
In its third party acquisition analysis, Salomon identified four recent
acquisition transactions in the natural gas processing and gathering industry
that it viewed as somewhat comparable to the business of the Partnership: (i)
the purchase by Enron Corp. ("Enron") of LRC for a firm value of $170 million
(10.6x last twelve months' ("LTM") EBITDA), (ii) Arkla's acquisition of LIG for
a firm value of $171 million (11.2x LTM EBITDA), (iii) LIG Acquisition Corp.'s
prior acquisition of LIG for an estimated firm value of $125 million (8.2x LTM
EBITDA), and (iv) Koch's acquisition of United for which information was not yet
publicly available. Taking into account the differences between the companies
acquired and the Partnership, Salomon's knowledge as financial advisor to
United, and its experience generally, in its third party acquisition analysis
Salomon utilized a range of firm value to projected 1993 EBITDA for the
Partnership ($121 million, based on VEC's strategic plan prepared in October
1992) of 6.5x to 8.5x, resulting in a total equity value (after deducting from
firm value $659 million of debt and capital lease obligations, net of excess
cash) of $128 million to $370 million (equivalent to approximately $6.67 to
$19.27 per Common Unit based on an assumed 19.2 million Units outstanding).
Salomon's DCF analysis was prepared using both the projections contained in
VEC's strategic plan prepared in October 1992 and revised projections prepared
by Salomon based in part on early 1993 results. Using the Company's projections
and discount rates of 10% to 12% (and subtracting from firm values debt and
capital lease obligations, net of excess cash), implied equity values of $247
million to $493 million (equivalent to approximately $12.86 to $25.68 per Common
Unit based on an assumed 19.2 million Units outstanding).
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Using Salomon's revised projections implied equity values of $101 million to
$306 million (equivalent to approximately $5.26 to $15.94 per Common Unit based
on an assumed 19.2 million Units outstanding).
The foregoing valuation analyses were done by Salomon merely to provide VEC
management with a preliminary indication of the potential range of values
applicable to the Partnership and to highlight key issues which could arise in
the valuation process such as the impact of the substantial debt of the
Partnership. A price of $10.20 per Common Unit was assumed merely to facilitate
pro forma analyses of the impact of the various structuring alternatives on VEC.
Since the focus of the March Preliminary Review was to analyze a broad range of
alternatives, Salomon utilized wide ranges of value for the Partnership and did
not refine its valuation further. Salomon also noted some of the limitations and
uncertainties of the various methodologies, as described below with respect to
the Salomon October Report. Salomon also noted that at the then-current trading
value of $8.50 per Common Unit, the total market value of the Partnership equity
was $163 million (based on an assumed 19.2 million Units outstanding, including
Units owned by the Company). In analyzing and comparing the various
alternatives, Salomon assumed for analytical purposes only that a repurchase by
VEC of the publicly traded Common Units (either alone or as part of the equity
carve-out alternative) would be completed at $10.20 per Unit, which constituted
a 20% premium over the then-market price.
Salomon then analyzed each alternative in detail, including a summary of the
steps necessary to consummate each transaction, the structure of VEC's
investment in the Partnership's business following a transaction, the benefits
and detriments to VEC associated with each transaction, and the pro forma
financial impact of the transaction on VEC. With respect to the status quo
alternative, Salomon noted as benefits to VEC that: VEC would retain control
over the gas gathering and NGL businesses and would avoid transaction costs or
the payment by VEC of any premium to Public Unitholders; VEC would remain an
investment grade company that would be well-followed by equity research analysts
covering the refining business; and VEC would retain a portion of the upside of
the gas gathering and NGL businesses. As negatives with respect to the status
quo alternative, Salomon noted that: it would strain VEC financially; it could
exacerbate existing conflicts of interest (since, in order to expand the
gas-related business, VEC would need to enter into new leases or provide
additional capital funding for the Partnership); and the problems with the
Partnership's financial and operating structure (see "-- Reasons for the
Proposed Merger") would continue.
With respect to the alternative of VEC purchasing the publicly held Common
Units, Salomon assumed that VEC would effect a public offering of VEC Common
Stock, and noted as benefits to VEC that: VEC could invest in the gas gathering
and NGL businesses free of existing structural problems; capital availability
for those businesses would improve; the Public Unitholders' interests in the
Partnership would be eliminated, thereby eliminating conflicts of interest going
forward; and VEC would retain control over the gas gathering and NGL businesses
and increase its participation in any upside of those businesses. As negatives
of that alternative, Salomon noted that: VEC's leverage would increase
significantly; a $300-350 million new equity offering would be needed to
maintain its current capital structure and not risk a ratings downgrade; that an
equity offering might be difficult; equity analysts following VEC might not
fully understand the natural gas businesses and thus might fail to assign full
values thereto; and refining equity is not the optimal capital to fund
acquisition of natural gas assets. Salomon indicated that, on balance, this
alternative might have a slightly negative impact on the VEC stock price.
Although in this analysis Salomon assumed for analytical purposes only that the
publicly traded Common Units would be acquired at $10.20 per Common Unit, a 20%
premium over the market price for the Common Units, Salomon also analyzed the
pro forma impact on VEC resulting from premiums of -20% to +20% to the market
price, and noted that the financial ratios for VEC would not be sensitive to the
premium paid to the Public Unitholders (since changes in such premium would be
relatively small compared to the Partnership's indebtedness which would be
consolidated in VEC's financial statements upon such an acquisition). Salomon
noted its understanding that an acquisition of the publicly traded Common Units
would need to be structured so as to be fair both to the stockholders of VEC and
the Public Unitholders.
With respect to the equity carve-out alternative, Salomon assumed that VEC would
own 49% of the new company's stock following its initial public offering raising
an assumed $250 million. Salomon assumed in this
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analysis that Public Unitholders would have the right to receive $10.20 per
Common Unit either in cash or in the form of stock in the new company. The
positives to VEC resulting from the equity carve-out alternative, as identified
by Salomon, included: the anticipated retention by VEC of its investment grade
debt rating; the new company should be capital self-sufficient, eliminating the
need for VEC financial support; the new company would be close to investment
grade with a capacity for growth; assumed payout ratios for the new company (a
corporation) would be lower than those of the Partnership, thus allowing more
cash to be reinvested in the business; the new company would benefit from
optimal market valuations placed on gas gatherers and NGL companies; and VEC
would have the flexibility in the future to sell or spin-off its shares in the
new company or to acquire the publicly held shares. As negatives of the equity
carve-out alternative, Salomon noted that the transaction would result in some
significant earnings per share and cash flow per share dilution to VEC; that the
new company, unlike the Partnership, would be a taxable entity; that any
subsequent spin-off would not be tax-free to VEC shareholders; and that the
required equity offering might be difficult. Salomon indicated that, on balance,
it anticipated that this alternative would be neutral to the VEC stock price.
With respect to the spin-off alternative, Salomon noted as positives to VEC
that: VEC would remain a "pure-play" refining stock play for investors; VNGC
would be financed independently; the spin-off would be tax-free to VEC
stockholders, who would retain their proportionate ownership in the gas
gathering and NGL businesses and any resulting potential upside (estimated to
have a value of $2-$4 per Unit); that the publicly-traded VNGC stock could
ultimately be an attractive security to be offered in exchange for publicly held
Common Units; and that the VNGC Board could in the future determine whether to
purchase the Common Units owned by the Public Unitholders. As negatives, Salomon
noted that the Partnership's high leverage and constraints on capital
expenditures would continue; perceived conflicts of interest between VNGC and
the Partnership would remain; VEC's equity would be reduced by about $200
million, which would significantly adversely affect leverage ratios; there would
be a negative impact on VEC's coverage ratios resulting from the loss of the
Partnership's cash flow; as a result of such increased leverage and worsened
coverage ratios there would be an anticipated negative impact on VEC's credit
ratings; that the equity markets might have difficulty valuing VNGC and a liquid
market for the VNGC equity security might not develop; and that VNGC would be
vulnerable to a takeover. Salomon anticipated that the spin-off would have a
negative impact on the VEC stock price, in view of the value of the spin-off
received by the VEC stockholders.
With respect to the sale alterative involving all of VEC's and the Partnership's
gas-related assets, Salomon noted as positives to VEC that, Salomon believed an
attractive price might be obtainable because of strong strategic interest in
assets in the gas gathering, processing and marketing industry; it would provide
VEC with capital for refining and other potential expansion; VEC would remain a
"pure play" refining stock; and that VEC's credit would be positively impacted
and positioned for a ratings upgrade. Salomon noted that if VEC wished to exit
the gas gathering/NGL business, the sale alternative might provide maximum value
to VEC shareholders. As negatives to VEC, Salomon noted that the anticipated
gain would result in taxes (some of which might be offset by investment tax
credits), that VEC would lose control of the natural gas business and that there
could be employee and personnel issues. Under the sale alternative, Salomon
assumed that VNGC, the Partnership and VEC's other gas assets could collectively
be sold for an estimated firm value of $950 million to $1,150 million ($390
million to $590 million plus assumption of $560 million of Partnership debt,
with Public Unitholders receiving an assumed $100 million to $120 million
(equivalent to approximately $10.25 to $12.30 per Common Unit based on an
assumed 9.75 million publicly held Common Units outstanding) and VEC receiving
an assumed $290 million to $470 million for its interests in the Partnership,
VNGC and its other gas assets. Salomon estimated the foregoing firm values using
the same third-party acquisition transactions discussed above and applied the
same multiples of EBDIAT (6.5x to 8.5x), but only to a higher EBDIAT ($140
million) estimated for the combined gas-related assets of VNGC, the Partnership
and VEC, to arrive at estimated firm values for such combined assets of $910 to
$1,190 million (narrowed on a range of $950 to $1,150 million). Salomon also
used discounted cash flow analyses using the same discount rates discussed above
(10%, 11% and 12%), but using estimated cash flows only for such combined assets
as provided by VEC and as estimated by Salomon, which resulted in a range of
firm values for such combined gas-related assets of $889 to $1,248 million.
(Salomon did not use public market comparables.) The estimated allocation set
forth above was arbitrary and was done solely in order to calculate estimated
proceeds to VEC in order to analyze the pro forma impact of a third party sale
on VEC.
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Salomon did not make a recommendation with respect to which of these
alternatives VEC should pursue since VEC's management needed to consider each
alternative in light of VEC's primary strategic and financial objectives.
Salomon October Report
As described above, on October 8, 1993, at VEC's request Salomon presented to
certain VEC officers and other members of VEC management Salomon's analysis and
recommendations with respect to the form and amount of consideration that VEC
should propose to pay to the Public Unitholders in connection with a potential
acquisition by VEC of the publicly held Common Units, and the structure of such
an acquisition (the "Salomon October Report"). Except for VEC's request that
such report be limited to consideration of that alternative, no instructions
were given to Salomon and no limitations were placed on Salomon, in connection
with such request. The Salomon October Report considered whether the Public
Unitholders should be offered VEC equity securities through a merger or an
exchange offer or cash to be obtained through a separate offering of VEC equity
securities. Salomon recommended that the latter structure would be preferable
because, among other reasons, it would (i) provide Public Unitholders with cash
to pay taxes generated by the Merger, (ii) avoid the need for the Special
Committee and the Public Unitholders to value the VEC equity securities being
offered, (iii) avoid possible downward pressure on the new VEC stock and the VEC
Common Stock, and (iv) not be subject to the Commission's disclosure rules
governing partnership "roll up" transactions. Countervailing factors were the
expense of underwriting fees in a separate securities offering, the need to
coordinate the timing of the Merger with the timing of the offering of equity
securities, and the applicability of the Commission's disclosure rules governing
"going private" transactions. Salomon recommended that the restructuring of
VNGP, L.P. should be concluded as a merger rather than a tender offer,
regardless of whether the consideration offered to the Public Unitholders was
cash or securities.
The Salomon October Report also contained a valuation analysis of the Common
Units. In connection with its valuation analysis, Salomon reviewed the trading
history of the Common Units in comparison with other publicly-traded limited
partnership ("MLP") units and analyzed the premiums-to-market paid in certain
other comparable MLP buy-in transactions and premiums-to-market paid in
"squeeze-out" transactions by controlling stockholders. Salomon then applied a
comparable company analysis, a third party acquisition analysis and a DCF
analysis. Salomon noted that, given the Partnership's high degree of leverage,
small percentage variations in the value of the Partnership's business would
translate into large percentage variations in the resultant equity value.
Salomon also noted that management anticipated that the Partnership's 1994
income would be significantly less than 1992 and 1993 income due to the positive
effect of certain nonrecurring items in 1992 and 1993 and the restructuring and
expiration of certain favorable sales contracts, and that multiples of projected
1994 results were more relevant than historical results or projected 1993
results in determining an appropriate valuation for the Partnership.
In comparing the Partnership with other publicly-traded MLPs, Salomon stated
that there were no comparable publicly-traded MLPs in the natural gas processing
and gathering business. Salomon then compared the Common Units to selected
pipeline MLPs and calculated a dividend yield of 5.5% on the Common Units versus
a range of 7.0% to 7.9% for the pipeline MLPs, a debt-to-capitalization ratio of
79.6% for the Partnership versus a range of 24.6% to 58.8% for the pipeline
MLPs, and firm value multiples of 6.5x to 8.9x EBITDA for the pipeline MLPs
versus 6.1x EBITDA for the Partnership. Salomon concluded that the Partnership,
especially in light of its limited financial flexibility, appeared to be fairly
valued relative to other MLPs in the public market.
In its analysis of the prices paid in comparable MLP buy-ins, Salomon calculated
premiums to the market price prior to the announcement of the transaction. These
premiums ranged from 7% to 44%, with a median of 28%. In "squeeze out"
transactions by controlling shareholders of corporations, Salomon calculated
average indexed premiums to market of 29.1% for cash transactions, 24.4% for
stock transactions, and 33.0% for cash transactions where the controlling
shareholder owned less than 50% of the target company prior to the transaction.
In comparison, the price of $12.10 offered in the Merger represents a premium of
approximately 36% over the market price of the Common Units of $8.875 one month
prior to the public announcement of the
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Merger and a premium of approximately 18% over the market price of the Common
Units of $10.25 on October 13, 1994, the day prior to such public announcement.
In its comparable company analysis Salomon identified five publicly traded
companies (American, Associated, Tejas, Delhi, and Western, as well as two
initial public offering ("IPO") transactions that were in registration (Aquila
Energy Corp. ("Aquila") and Trident NGL Holdings, Inc. ("Trident")) as having
businesses which are somewhat comparable to the businesses of the Partnership,
and determined that Delhi, Aquila and Trident were the most comparable. Salomon
used the midpoint of the price range on the most recently available Registration
Statements for Aquila and Trident to calculate trading multiples, but was unable
to calculate certain ratios involving estimated 1993 and 1994 results since
there are no publicly available analysts' projections for IPO companies in
registration. Salomon calculated the following trading multiples for the
comparables: (i) firm value to LTM EBITDA of 5.4x to 13.0x for the larger group
and 5.4x to 8.1x for the more comparable group; (ii) firm value to projected
1994 EBITDA of 4.4x to 10.2x for the larger group and 4.4x for Delhi; (iii)
price to LTM cash flow of 5.4x to 14.4x for the larger group and 5.4x to 6.7x
for the more comparable group; (iv) price to projected 1993 earnings of 16.5x to
36.4x for the larger group and 16.5x for Delhi; and (v) price to projected 1994
earnings of 12.4x to 26.0x for the larger group and 13.1x for Delhi. Salomon
determined that in the public market context, the valuation of the Partnership
would be negatively impacted by its high leverage and its low historical and
projected growth rates relative to the comparable companies. Salomon concluded
that the appropriate valuation multiples for the Partnership would be 6.5x to
7.5x LTM EBITDA ($127 million), 6.0x to 7.0x projected 1994 EBITDA ($112
million), 5.5x to 6.5x LTM cash flow ($55 million), 17.0x to 21.0x projected
1993 earnings ($11 million), and 15.0x to 19.0x projected 1994 earnings ($4
million). After computing firm values based on such multiples, and deducting
$639 million of debt and capital lease obligations and adding $28 million in
cash and deducting $18 million in deferred management fees, and assuming 19.05
million Units outstanding (which represented a correction to the previously
assumed 19.2 million Units outstanding), this implied equity values of
approximately $10.33 to $17.00, $2.27 to $8.15, $15.88 to $18.77, $9.82 to
$12.13, and $2.91 to $3.69 per Common Unit, respectively. (As noted above, in
its March Preliminary Report, Salomon used wider ranges of multiples resulting
in wider ranges of valuation in its comparable company analysis.)
Salomon identified four recent merger and acquisition ("M&A") transactions in
the natural gas processing and gathering industry involving businesses that it
viewed as somewhat comparable to the businesses of the Partnership: (i)
Equitable Resources, Inc.'s purchase of LIG for an enterprise value of $185
million, or 8.0x 1993 estimated EBITDA; (ii) Tejas' purchase of EGSI for $380
million or 7.9x EBITDA; (iii) Enron's purchase of LRC for $170 million, or 10.6x
LTM EBITDA; and (iv) Koch's purchase of United for $385 million, or 7.7x 1993
estimated EBITDA. On the basis of these multiples and Salomon's experience
generally, Salomon utilized a range of 7.0x to 8.0x EBITDA, or (using the same
adjustments to firm value and assumptions as described above in the comparable
company analysis) $13.66 to $20.33 and $12.19 to $18.65 per Common Unit based on
LTM ($127 million) and projected 1993 EBITDA ($123 million), respectively, in
its third party acquisition analysis of the Partnership. (As noted above, in
Salomon's March Preliminary Report Salomon utilized a wider range of multiples
of between 6.5x and 8.5x projected 1993 EBITDA.) However, given the
significantly lower outlook for 1994 results for the Partnership, Salomon
pointed out that these values could be overstated. Salomon noted that there is a
limited amount of public information related to these transactions, since the
acquired companies were either private companies or subsidiaries of larger
companies. Moreover, potential buyers in this industry generally utilize a DCF
analysis (based on projections which are not publicly available) rather than
multiples of current results to value natural gas pipeline assets. Therefore,
the aforementioned multiples generally reflect the buyers' view of potential
synergies, tax benefits, and other unquantifiable factors. Salomon also noted
that each of these transactions was significantly smaller in size than the firm
value of the Partnership, resulting in strategic interest from a very broad
group of potential buyers. In view of the foregoing, Salomon did not believe
that using a methodology based upon multiples of LTM EBITDA provided a reliable
indication of value.
Due to the tax-free nature of the Partnership's structure, Salomon utilized a
flow-through entity cash flow approach in its DCF analysis. Salomon therefore
adjusted its discount rates to reflect the absence of a corporate tax "shield"
on interest expense, resulting in discount rates of 11.5% to 12.5% based on the
adjusted
31
<PAGE> 40
weighted-average cost of capital for the five publicly traded comparable
companies. Salomon utilized a DCF which incorporated projected Partnership cash
flows for 1994 through 2003. Cash flows for 1994 through 1998 were estimated by
VEC, and cash flows from 1999 through 2003 were estimated by Salomon in
conjunction with VEC. Salomon's DCF methodology utilized an end-of-year
convention in discounting these cash flows and terminal values based on the
perpetuity growth method assuming 2.5% to 3.5% growth in unlevered free cash
flow after 2003. Salomon utilized VEC management's most recent set of
projections, dated October 5, 1993, in completing its DCF analysis for the
Salomon October Report, which analysis yielded (after computing firm values
based on such methods,and deducting $685.6 million of debt and capital lease
obligations, plus deferred management fees of $18 million, less cash of $3.4
million and assuming Units outstanding of 19.05 million; these amounts differed
from the comparable and M&A analysis by assuming a DCF at January 1, 1994
balance sheet, versus June 30, 1993 for the comparable and M&A analysis) a range
of $4.63 to $11.17 per Common Unit. (Salomon subsequently computed another DCF
analysis using the October 5th projections which assumed the terminal value was
realized at the end of year ten as opposed to year eleven, which yielded a range
of $6.34 to $13.37 per Common Unit. Salomon also computed a DCF analysis
subsequent to the November 10, 1993 projections being finalized which yielded a
valuation of $3.85 to $10.60 per Common Unit based on discount rates of 11.5% to
12.5%, end-of-year discounting and the terminal value realized at the end of
year ten. See "-- Certain Projections.")
Salomon also completed a premium analysis which examined various transaction
multiples at values of $9.00 to $14.00 per Common Unit. A value of $11.00 per
Common Unit would result in premiums of 17.3%, 11.4% and 41.9% to the market
price, the LTM high price and the LTM low price, respectively, for the Common
Units as of October 7, 1993, 11.4x and 56.7x LTM and projected 1994 earnings,
3.8x LTM cash flow, and 6.6x LTM EBITDA.
Based on the foregoing analyses and its experience in other transactions,
Salomon concluded that an offer of $11.00 per Common Unit might reasonably be
expected to be found by a special committee of independent directors of the
General Partner, and its independent financial advisor, to be fair to the Public
Unitholders from a financial point of view and, therefore, that such an offer
might reasonably be expected to lead to a successful acquisition by VEC of the
publicly traded Common Units, although recognizing that such a special committee
would likely seek to negotiate a higher price.
CERTAIN PROJECTIONS
During the period that Salomon was preparing the analysis and recommendations
set forth in Salomon's October Report, VEC and the General Partner were involved
in annual recurring strategic planning and budgeting processes, including
planning and budgeting for the Partnership. VEC and the General Partner utilize
a procedure in which budgeting and forecasting projections and assumptions are
first developed by staff personnel, using general economic assumptions approved
by management. These forecasts are then reviewed by management and refinements
are made as a result of these revisions. VEC's strategic plan and budget,
containing VEC and Partnership forecasts and assumptions for a five-year
planning period, is then ultimately approved by the senior management of VEC and
the General Partner, including Messrs. Greehey, Benninger, McLelland and Heep,
and presented to the Board of Directors of VEC. Beginning on September 10, 1993,
the staff of the Company provided Salomon with numerous successive iterations of
the projections and assumptions for the Partnership being developed in
connection with this strategic planning and budgeting process. The successive
iterations of projections were provided to ensure that Salomon's financial
models were functioning properly and to help reduce the analysis time required
once the approved forecast was available. The review and approval of these
projections were subsequently completed on October 5, 1993, subject to the
resolution of items (5)-(9) described below. The November 10, 1993 projection
was included in Dillon Read's initial opinion which was presented to the Special
Committee and the Board of Directors of the General Partner on December 20,
1993.
As of September 10, 1993, the Company's staff had determined and included in its
projection for the Partnership the maximum amount of new business which could be
expected to be achieved from new sales and transportation customers and
contracts. However, as of such date determinations had not been made with
respect to: (1) the incremental capital expenditures required to increase
throughput capacity to be able to
32
<PAGE> 41
handle certain new business prospects; (2) the operating expenses, primarily
fuel, which would be incurred because of such incremental capital expenditures;
(3) the expected proportions of such new sales business that were expected to be
higher margin term sales and lower margin spot market sales; (4) the effects of
an agreement, completed November 11, 1993, which, in connection with the
settlement of a customer audit, excluded certain costs from the calculation of
the price at which gas will be sold to such customer in the future (described at
Note 6 of Notes to Consolidated Financial Statements included in Annex C); (5)
whether certain potentially favorable measurement, fuel usage, and customer
billing adjustments would be resolved and included in 1993 operating income; (6)
the effects of the reallocation of certain overhead costs following the
September 30, 1993 sale of VEC's natural gas distribution subsidiary; (7) the
results of a detailed study of expected future personnel and other costs which
was completed in late October 1993; (8) a decrease in the projected 1994 market
prices for NGLs of generally $.01 per gallon; and (9) a reclassification of
transportation-related expenses from a reduction of transportation fee revenues
to an increase in operating expenses, with no net effect on 1994 operating
income. Between September 10, 1993 and October 5, 1993, the expected effects of
items (1) through (4) above were estimated and included in the October 5, 1993
projection. Between October 5, 1993 and November 10, 1993, the expected effects
of items (5) through (9) were estimated and included in the November 10, 1993
projection. Salomon did not calculate and provide to VEC any Partnership or Unit
values based upon the September 10, 1993 projections or any of the other
iterations of projections prepared before October 5, 1993.
As discussed in the Form 10-K, the profitability of the Partnership's NGL
operations depends principally on the margin between NGL sales prices and the
cost of the natural gas from which NGLs are extracted ("shrinkage cost").
Beginning in late November 1993, crude oil prices fell significantly resulting
from a decision by the Organization of Petroleum Exporting Countries ("OPEC") at
its November 23, 1993 meeting not to curtail members' production of crude oil,
together with weak worldwide demand for crude oil, increasing production from
the North Sea and other non-OPEC areas and continuing discussions regarding the
possibility of Iraq's re-entry into the world oil markets. In conjunction with
the crude oil price decline, refined product and NGL prices also fell
significantly. VEC revised certain of its projections for the Partnership as of
February 7, 1994, taking into account the effect that such price declines were
then expected to have on the Partnership's 1994 results. VEC did not revise its
projections for 1995 or subsequent years. The revised February 7, 1994
projections were provided to Dillon Read when that firm elected in February 1994
to review its First Opinion (hereafter defined) in connection with the events
described under "-- Background of the Merger -- Certain Contacts." See "Opinion
of Financial Advisor to the Special Committee -- February and March Events." The
revised February 7, 1994 projections provided to Dillon Read are described at
footnote (2) to the table below setting forth certain projections for the
Partnership.
During the first quarter of 1994, NGL prices increased modestly from the levels
in the fourth quarter of 1993 but remained significantly below first quarter
1993 levels. However, natural gas prices and resulting shrinkage costs increased
in the first quarter of 1994 compared with the first quarter of 1993. As a
result of these factors, the Partnership's NGL operations incurred an operating
loss for the fourth quarter of 1993, and the Partnership has subsequently
announced operating results for the first quarter of 1994 which are
substantially below the results for the first quarter of 1993 and also below
both the November 10, 1993 and February 7, 1994 forecasts. In addition, natural
gas pipeline operating income has been adversely affected by an increase in
costs resulting from the settlement of certain contractual disputes, a decrease
in income generated by the Partnership's Market Center Services program and
other decreases in gas sales margins. Operating results reported by the
Partnership for the first quarter of 1994 and for the corresponding period in
1993 were as follows:
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<PAGE> 42
- - - - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
-----------------
1994 1993
<S> <C> <C>
- - - - - ----------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS)($MM):
Natural gas.............................................................. $ 3.0 $ 7.9
Natural gas liquids...................................................... (1.2) 13.8
------ ------
------ ------
Total............................................................ $ 1.8 $ 21.7
------ ------
NET INCOME (LOSS)($MM):.................................................... $(14.4) $ 5.1
OPERATING STATISTICS:
Natural gas:
Gas volumes (MMcf per day):
Sales............................................................... 1,290 1,157
Transportation...................................................... 1,525 1,488
------ ------
Total gas volumes................................................ 2,815 2,645
------ ------
------ ------
Average gas sales margin per Mcf...................................... $ .173 $ .234
Average gas transportation fee per Mcf(1)............................. $ .115 $ .098
Natural gas liquids:
Plant production (MBbls per day)...................................... 68.1 66.5
Average market price per gallon....................................... $ .254 $ .320
Average gas cost per MMBtu............................................ $ 2.05 $ 1.77
</TABLE>
- - - - - --------------------------------------------------------------------------------
(1) The natural gas segment's average transportation fee per Mcf includes
intersegment transportation for NGLs. Average transportation fee per Mcf,
excluding intersegment transportation, is $.110 and $.099, respectively.
VEC does not as a matter of course make public its projections as to future
performance or earnings of the Partnership. However, such projections were
provided to Salomon and Dillon Read and their respective counsel for use in the
portion of their Partnership value calculations that utilize DCF analysis. The
projections were not provided to any other outside parties. The projections were
prepared solely for internal use and not with a view to public disclosure or
compliance with published guidelines of the Commission regarding projections or
the guidelines established by the American Institute of Certified Public
Accountants' Guide for Prospective Financial Information and are included in
this Proxy Statement only because such information was made available to Salomon
and Dillon Read and is required by the Commission to be set forth herein.
Neither VEC nor the General Partner assumes any responsibility for the accuracy
of such projections. Because the estimates and assumptions underlying these
projections are inherently subject to significant economic and competitive
uncertainties and contingencies, which are beyond the control of VEC and the
General Partner, there can be no assurance that the projections will be realized
and it is likely that the Partnership's future financial performance will vary
from that set forth below, possibly by material amounts. Actual results may be
materially lower or higher than those set forth below. VEC does not intend to
update and publicly reissue the projections to reflect circumstances existing or
developments occurring after the preparation of such projections or to reflect
the occurrence of unanticipated events.
34
<PAGE> 43
<TABLE>
<CAPTION>
- - - - - ------------------------------------------------------------------------------------------------------
PROJECTIONS AS OF
(DOLLARS IN MILLIONS)
----------------------------------------------
NOVEMBER 10, OCTOBER 5, SEPTEMBER 10,
1993 1993 1993
- - - - - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Income(1)
1993 -- Natural gas................................... $50.1 $45.7 $45.7
Natural gas liquids.......................... 33.7 37.0 37.0
------ ------ ------
Total..................................... $83.8 $82.7 $82.7
------ ------ ------
------ ------ ------
1994 -- Natural gas................................... $29.4(2) $34.2 $40.9
Natural gas liquids.......................... 38.0(2) 38.9 44.1
------ ------ ------
Total..................................... $67.4(2) $73.1 $85.0
------ ------ ------
------ ------ ------
1995 -- Natural gas................................... $39.6 $40.6 $48.6
Natural gas liquids.......................... 37.9 38.2 38.3
------ ------ ------
Total..................................... $77.5 $78.8 $86.9
------ ------ ------
------ ------ ------
1996 -- Natural gas................................... $43.2 $44.2 $55.2
Natural gas liquids.......................... 39.1 39.5 39.7
------ ------ ------
Total..................................... $82.3 $83.7 $94.9
------ ------- ------
------ ------- ------
1997 -- Natural gas................................... $45.5 $46.6 $60.7
Natural gas liquids.......................... 37.9 38.2 38.8
------ ------ ------
Total..................................... $83.4 $84.8 $99.5
------ ------ ------
------ ------ ------
Net Income (Loss)(3)
1993................................................ $18.6 $17.2 $17.2
1994................................................ $(1.6)(2) $ 5.7 $18.5
1995................................................ $19.2 $21.1 $30.0
1996................................................ $16.9 $19.0 $33.3
1997................................................ $21.6 $23.9 $43.8
Capital Expenditures
1993................................................ $42.4 $44.2 $44.2
1994................................................ $56.2(2) $54.6 $25.4
1995................................................ $31.5 $31.5 $26.5
1996................................................ $28.0 $28.0 $23.0
1997................................................ $29.0 $29.0 $24.0
- - - - - ------------------------------------------------------------------------------------------------------
</TABLE>
35
<PAGE> 44
<TABLE>
<CAPTION>
- - - - - ------------------------------------------------------------------------------------------------------
PROJECTIONS AS OF
(DOLLARS IN MILLIONS)
----------------------------------------------
NOVEMBER 10, OCTOBER 5, SEPTEMBER 10,
1993 1993 1993
- - - - - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1993 OPERATING STATISTICS:
Natural gas:
Gas throughput volumes (MMcf per day):
Gas sales(4)................................... 1,105 1,111 1,111
Gas transportation............................. 1,514 1,525 1,525
------ ------ ------
Total gas throughput........................ 2,619 2,636 2,636
------- ------ ------
------ ------ ------
Average gas sales margin per Mcf................. $ .259 $ .239 $ .239
Average gas transportation fee per Mcf........... $ .108 $ .108 $ .108
Natural gas liquids:
Plant production (MBbls per day)................. 69.3 69.6 69.6
Average market price per gallon(5)............... $ .298 $ .306 $ .306
Average gas cost per MMBtu....................... $ 1.98 $ 2.01 $ 2.01
1994 OPERATING STATISTICS:
Natural gas:
Gas throughput volumes (MMcf per day):
Gas sales(4)................................... 1,170(2) 1,174 1,174
Gas transportation............................. 1,664(2) 1,665 1,737
------ ------ -------
Total gas throughput........................ 2,834(2) 2,839 2,911
------ ------ -------
------ ------ -------
Average gas sales margin per Mcf................. $ .225(2) $ .224 $ .230
Average gas transportation fee per Mcf........... $ .109(2) $ .100 $ .101
Natural gas liquids:
Plant production (MBbls per day)................. 76.0(2) 76.0 76.0
Average market price per gallon(5)............... $ .304(2) $ .313 $ .313
Average gas cost per MMBtu....................... $ 2.06(2) $ 2.06 $ 2.06
1995 OPERATING STATISTICS:
Natural gas:
Gas throughput volumes (MMcf per day):
Gas sales(4)................................... 1,228 1,228 1,227
Gas transportation............................. 1,855 1,856 1,878
------ ------ --------
Total gas throughput........................ 3,083 3,084 3,105
------ ------ ---------
------ ------ ----------
Average gas sales margin per Mcf................. $ .217 $ .217 $ .230
Average gas transportation fee per Mcf........... $ .122 $ .102 $ .103
Natural gas liquids:
Plant production (MBbls per day)................. 76.5 76.5 76.5
Average market price per gallon(5)............... $ .324 $ .324 $ .324
Average gas cost per MMBtu....................... $ 2.16 $ 2.16 $ 2.16
1996 OPERATING STATISTICS:
Natural gas:
Gas throughput volumes (MMcf per day):
Gas sales(4)................................... 1,276 1,276 1,276
Gas transportation............................. 1,856 1,856 1,878
------ ------ -------
Total gas throughput........................ 3,132 3,132 3,154
------ ------ -------
------ ------ -------
Average gas sales margin per Mcf................. $ .219 $ .219 $ .238
Average gas transportation fee per Mcf........... $ .124 $ .104 $ .105
</TABLE>
36
<PAGE> 45
<TABLE>
<CAPTION>
- - - - - ------------------------------------------------------------------------------------------------------
PROJECTIONS AS OF
(DOLLARS IN MILLIONS)
----------------------------------------------
NOVEMBER 10, OCTOBER 5, SEPTEMBER 10,
1993 1993 1993
- - - - - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Natural gas liquids:
Plant production (MBbls per day)................. 76.3 76.3 76.3
Average market price per gallon (5).............. $ .331 $ .331 $ .331
Average gas cost per MMBtu....................... $ 2.20 $ 2.20 $ 2.20
1997 OPERATING STATISTICS:
Natural gas:
Gas throughput volumes (MMcf per day):
Gas sales(4)................................... 1,333 1,333 1,333
Gas transportation............................. 1,875 1,876 1,898
------ ----- -------
Total gas throughput........................ 3,208 3,209 3,231
------ ------ -------
------ ------ -------
Average gas sales margin per Mcf................. $ .221 $ .221 $ .246
Average gas transportation fee per Mcf........... $ .123 $ .104 $ .105
Natural gas liquids:
Plant production (MBbls per day) 76.5 76.5 76.5
Average market price per gallon(5)............... $ .336 $ .336 $ .336
Average gas cost per MMBtu....................... $ 2.24 $ 2.24 $ 2.24
- - - - - ------------------------------------------------------------------------------------------------------
</TABLE>
(1) Projected operating income is based upon the projected operating statistics
reflected herein and projected increases in operating expenses assuming
increases in the Consumer Price Index of 3.1% for 1993, 3.5% for 1994, and
4% per year thereafter.
(2) The 1994 projections for the Partnership were revised by VEC as of February
7, 1994, and provided to Dillon Read in connection with its Revised
Opinion. See "Opinion of Financial Advisor to the Special
Committee -- February and March Events." The revised February 7, 1994
projections for the Partnership's 1994 operating income (loss), net income
(loss), capital expenditures, and operating statistics were as follows:
<TABLE>
<S> <C>
OPERATING INCOME (LOSS) ($MM):
Natural Gas............................................................. $ 32.9
Natural Gas Liquids..................................................... 5.2
------
Total................................................................ $ 38.1
------
------
NET INCOME (LOSS) ($MM)................................................... $(28.7)
CAPITAL EXPENDITURES ($MM)................................................ $ 36.0
OPERATING STATISTICS:
Natural Gas:
Gas volumes (MMcf per day):
Sales.............................................................. 1,172
Transportation..................................................... 1,661
------
Total gas volumes............................................... 2,833
------
------
Average gas sales margin per Mcf..................................... $ .228
Average gas transportation fee per Mcf............................... $ .107
Natural gas liquids:
Plant production (MBbls per day)..................................... 71.4
Average market price per gallon...................................... $ .267
Average gas cost per MMBtu........................................... $ 2.06
</TABLE>
The decrease in operating income and net income between the November 10,
1993 and February 7, 1994 projections resulted from reductions in projected
NGL market prices for 1994, which in turn resulted from weak crude oil and
refined product prices. As with the other projections disclosed herein,
there is no
37
<PAGE> 46
assurance that these projections will be realized, it is likely that the
Partnership's future financial performance will vary from that set forth
herein, possibly by material amounts, and actual results may be materially
lower or higher than those set forth herein. The Partnership's actual
operating results for the first quarter of 1994 are set forth above.
(3) Net income reflects interest expense on the Partnership's short-term bank
lines, assuming such bank lines are renewed on current terms through 1997
and bear interest at the rate of 4.4% for 1993, 4.3% for 1994, 5.9% for
1995, 6.3% for 1996, and 6.2% for 1997. The projections also assume an
additional source of financing is arranged, beginning in 1994, for
financing requirements of up to approximately $75 million in excess of the
maximum $50 million in borrowings which are permitted to be outstanding
under the short-term bank lines. The assumed additional source of financing
was assumed to bear interest at the same rate as the short-term bank lines.
In addition, such additional source of financing was assumed to temporarily
further increase by $50 million to repay all outstanding balances under the
short-term bank lines for a period of 45 consecutive days during each 16
consecutive calendar months (referred to herein as a "clean-up period").
Such clean-up periods are required under the Indenture for the First
Mortgage Notes. Federal income taxes were not included in the projections
above under the assumption that the Partnership will continue to be treated
as a partnership and not be subject to federal income taxes.
(4) In order to make 1993 gas sales volumes comparable with gas sales volumes
projected for the years 1994-1997, the gas sales volumes for 1993 have been
adjusted to include 140 MMcf per day of sales and related purchases made on
pipelines owned by other companies.
(5) Represents the average Houston area market prices for individual NGL
products weighted by relative volumes of each product produced. NGL price
projections are based upon crude oil and refined products forecasts
developed by VEC.
RECOMMENDATION OF THE BOARD OF DIRECTORS OF THE GENERAL PARTNER; FAIRNESS OF THE
MERGER
At a special meeting of the VNGC Board held on December 20, 1993, the VNGC Board
received and reviewed the written report of the Special Committee. The VNGC
Board did not separately analyze the fairness of the proposed transaction. The
VNGC Board reviewed the report of the Special Committee, including the material
factors listed in the report of the Special Committee. The VNGC Board concurred
in and adopted the view of the Special Committee that the material
considerations listed in the Special Committee report were the material
considerations involved in the transaction. The VNGC Board also adopted both the
analysis set forth in the Special Committee report and in the conclusions
contained therein. There were no other material considerations applicable to the
deliberations of the VNGC Board. The VNGC Board thereupon unanimously (i) voted
to approve the Merger, (ii) determined that the Merger is fair to and in the
best interests of the Public Unitholders and (iii) voted to recommend that the
Unitholders vote FOR approval and adoption of the Merger Agreement. VEC also
reviewed the report of the Special Committee, including the material
considerations listed therein, and determined that the material considerations
listed in such report were the material considerations involved in the
transaction. VEC therefore also adopted the analysis set forth in the Special
Committee report and in the conclusions contained therein and, based thereon,
believes that the Merger is fair to and in the best interests of the Public
Unitholders; there were no other material considerations applicable to such
determinations by VEC.
The material factors considered by the VNGC Board and VEC relating in particular
to the procedural fairness of the proposed transaction, as set forth in the
Special Committee report, were the fact that the price of $12.10 and other terms
and conditions of the Revised Proposal were determined through negotiations
between VEC and the Special Committee, the fact that the Special Committee was
assisted by independent financial and legal advisors of its own selection, the
fact that the Merger is subject to the Independent Vote Requirement through
which VEC has neutralized its vote, the fact that the Merger Agreement does not
preclude the Special Committee from taking into consideration other alternatives
to the Merger through the date of closing and does not contain any "bust up" or
termination fee or penalty, and the fact that plaintiffs' counsel in the
lawsuits involving VEC's Initial Proposal had agreed that, subject to
confirmation upon discovery, they would recommend that the Delaware Chancery
Court approve a settlement based upon the Revised Proposal.
38
<PAGE> 47
In reaching the conclusion that the Revised Proposal is fair to and in the best
interests of the Public Unitholders and should be accepted by the Board of
Directors of the General Partner, the Special Committee considered all factors
it deemed to be material, as follows:
- That the price of $12.10 and other terms and conditions of the
Revised Proposal were determined through negotiations between VEC and the
Special Committee, in which the Special Committee was advised by its
financial and legal advisors (although Dillon Read did not participate in
any negotiating sessions between the Special Committee and VEC), and the
Special Committee's belief that such price represents the highest price
that VEC would be prepared to pay. In part, the Special Committee's belief
was based upon the discussions and negotiations between the Special
Committee and its advisors and VEC and its advisors, including the
statement by VEC that, were the Special Committee to determine not to
recommend that the Revised Proposal be accepted, VEC would withdraw the
Revised Proposal and publicly announce that it had determined not to
proceed with the Merger or similar transaction, and the fact that nothing
had come to the Special Committee's attention to indicate that VEC would be
willing to offer a higher price than that contained in the Revised Proposal
in the foreseeable future.
- Dillon Read's oral preliminary opinion delivered to the Special
Committee on December 17, 1993, confirmed in writing on December 20, 1993,
and revised and confirmed in writing on April 27, 1994 (see "-- Opinion of
Financial Advisor to the Special Committee") that the consideration to be
received by the Public Unitholders pursuant to the Revised Proposal is
fair, from a financial point of view, to the Public Unitholders, upon which
opinion the Special Committee placed significant weight and Dillon Read's
financial analysis (see "-- Opinion of Financial Advisor to the Special
Committee") in which the Special Committee concurred.
- That the $12.10 price represents a premium of approximately 36% over
the market price of $8.875 of the Common Units on September 14, 1993, a
date that is one month prior to public announcement on October 14, 1993 of
the Initial Proposal and which was chosen as one of a number of dates on
which the market for Common Units was viewed as likely to have been
unaffected by the Initial Proposal, and materially exceeds the price at
which the Common Units have traded in recent periods (see "Market Prices of
Common Units and Distributions"); that the $12.10 price represents an
increase of $1.10 over the price contained in the Initial Proposal, which,
in light of the current market and business conditions affecting the
Partnership and VEC, the Special Committee believed to be a significant
increase; that, as compared to trading volumes prior to the Initial
Proposal, significant volumes of Common Units have traded subsequent to the
public announcement of the Initial Proposal, and at prices at, above or
near the $11.00 price contained in the Initial Proposal (see "Market Prices
of Common Units and Distributions"); and the likely effect that the
withdrawal of the Revised Proposal or failure to complete the Merger would
have on the trading prices of the Common Units.
- The position of VEC, which, directly or indirectly, controls
approximately 47.5% of the outstanding Common Units, that it has determined
that it is in the best interests of VEC and its stockholders for VEC to
retain its interests in the natural gas and NGL businesses of the
Partnership and that VEC is not interested in selling or spinning off its
interests in the Partnership; that the Partnership Agreement contains no
prohibition on VEC or its subsidiaries acquiring more Units; and that any
merger or sale of substantially all the assets of the Partnership would
effectively require the consent or approval of VEC and its subsidiaries.
The Special Committee also considered that VEC's control over the
Partnership through its indirect ownership of all the outstanding capital
stock of the General Partner makes it questionable whether those Public
Unitholders who are interested in selling their Common Units at this time
would be able to find any other buyer willing to pay more than $12.10 for
each Common Unit not owned by VEC or its subsidiaries.
- The statements made to the Special Committee by management of VEC
and its financial advisor and by the Company, including (i) that none of
such parties has any reason to believe that the conditions to the Merger
(including the condition that VEC have completed a public offering of
convertible preferred stock to finance the Revised Offer and that various
consents be obtained from lenders to VEC and the Partnership or their
subsidiaries) will not be satisfied reasonably promptly and (ii) that the
39
<PAGE> 48
General Partner currently intends and expects to declare and pay quarterly
distributions on the Common Units consistent with past practice in the
amount of $.125 per quarter per Common Unit through the closing of the
Merger and that, if the closing of the Merger occurs more than 30 days
after the last record date for such a quarterly distribution, the Company
intends and expects to declare and pay to holders of Common Units of record
as of the Effective Time a one-time special cash distribution equal to the
product of the quarterly distribution per Common Unit of $.125 and a
fraction the numerator of which is the number of days from and excluding
the record date in respect of which the last quarterly distribution has
been paid to and including the Effective Date and the denominator of which
is 90.
- The terms and conditions of the Merger Agreement, as revised
following discussions between the Special Committee and its advisors and
VEC and its advisors, including:
- that the Merger is subject to the Majority Vote Requirement and
the Independent Vote Requirement and that by its terms the Merger
Agreement will be terminated if the Special Meeting is held but the
Public Unitholders do not so approve the Merger;
- that the Merger Agreement will terminate if the Merger has not
been consummated by June 1, 1994 (it being important to the Special
Committee that the Merger be consummated at an early date) (see "The
Merger -- Effective Time of the Merger");
- the representation and agreement of VEC and the General Partner
that prior to the Effective Time, the General Partner will operate the
Partnership in the ordinary course consistent with past practice, and
the Special Committee will continue in existence without diminution of
its powers or duties and may at any time withdraw or modify its
recommendation if and to the extent that the Special Committee, after
consultation with and based upon advice of outside legal counsel,
determines in good faith that such action is required for the Board of
Directors of the General Partner to comply with any fiduciary duties it
may have to the Public Unitholders under Delaware law as in effect from
time to time;
- the representations of VEC and VNGC contained in Section 2(c) of
the Merger Agreement regarding their intentions to continue the
declaration and payment by the Partnership of regular quarterly
distributions on the Common Units at the established quarterly intervals
through the Effective Date in the amount of $0.125 per quarter per
Common Unit and, under the circumstances referenced therein, to cause
the Partnership to declare and pay a one-time special cash distribution
to holders of Common Units;
- that the Merger is conditioned on, among other things, the
Special Committee not having withdrawn or modified its recommendation in
a manner materially adverse to any party to the Merger Agreement and on
Dillon Read not having withdrawn or modified its opinion to the Special
Committee in a manner materially adverse to any party to the Merger
Agreement; and
- that the Merger Agreement may be terminated by any party prior to
the Effective Time if at any time either the Special Committee's
recommendation or Dillon Read's opinion to the Special Committee is
withdrawn or modified in any manner materially adverse to any party to
the Merger Agreement.
- That the Merger Agreement does not prohibit the Special Committee
from considering any and all information it may receive through the date of
the closing of the Merger, including with respect to alternatives to the
Merger and that the Merger Agreement does not provide for any "bust-up" or
termination fee or penalty to be paid to any party in the event the Merger
Agreement is terminated or otherwise.
- That between October 14, 1993, the date on which the Initial
Proposal was publicly announced, and December 20, 1993, the date of the
Special Committee's recommendation, no proposals, inquiries or indications
of interest had been received from any third party regarding a merger,
business combination or other similar alternative transaction and the
Special Committee's view that the public announcement of the Initial
Proposal would be likely (though not certain) to elicit such proposals,
inquiries or
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indications of interest, whether such were actively solicited, while
recognizing that active solicitation might be more likely to elicit such
proposals, inquiries or indications. Following the events described under
"-- Background of the Merger -- Certain Contacts," the Special Committee
considered such events, including the fact that no proposal, inquiry or
indication of interest has been received from NGC or any other third party
regarding a transaction in which the Public Units would receive higher
value than the Revised Proposal that was not conditioned on NGC achieving
"commercial control" of the Partnership. See "-- Background of the
Merger -- Certain Contacts."
- The expected tax treatment of the consideration to be received by
the Public Unitholders in the Merger (see "Federal Income Tax Consequences
of the Merger"), recognizing that the tax consequences for different Public
Unitholders would differ depending upon the identity and other
characteristics of such holders.
- The Partnership's financial leverage and the constraints on the
Partnership's ability to raise additional capital, including the terms of
the Notes, the terms of the Partnership Agreement and the conditions of the
financial markets; in connection therewith, the Special Committee
considered the views of management of the General Partner and the views of
Dillon Read with respect to the difficulties that the Partnership would
have in raising additional equity or debt capital. The Special Committee
also considered the Partnership's likely need for additional capital in the
future to fund capital expenditures that the management of the Company
believes will be necessary for the Partnership to improve upon or even
maintain its historic operational results, and that, after application of
the capital expenditures included in the General Partner's 1994
projections, the Partnership would continue to be operating at or near
sustainable throughput capacity, limiting the Partnership's growth
prospects without additional capital.
- The possibility that, as a result of the likely need for additional
capital and the constraints on the Partnership's ability to raise
additional capital referred to above, the Partnership could be required in
the longer term to raise capital or enter into other financing arrangements
on terms that would not be favorable to the Partnership or the Public
Unitholders, to reduce the rate of distributions on Common Units below the
current rate, with consequent impact on the market price of the Units, or
to attempt to enter into lease financing or similar arrangements with VEC,
with the possibility that VEC would be unwilling or unable to enter into
such arrangements and that such transactions would represent a conflict of
interest between VEC and the General Partner, with higher attendant
transaction costs.
- The effects of the recent decline in petroleum and NGL prices,
coupled with the lack of a concurrent decline in natural gas prices, on the
Partnership's operations and expected cash flows, and the possibility that
such conditions could continue for an indefinite period of time, and Dillon
Read's views as to the possible future prices for natural gas and NGLs.
- The lawsuits with respect to the Initial Proposal, the allegations
contained therein, discussions between the advisors to the Special
Committee and plaintiffs' counsel and the agreement of such counsel that,
subject to confirmation upon discovery, they would recommend that the
Delaware Chancery Court approve a settlement based upon the Revised
Proposal.
- The Partnership's contingent liabilities, including the pending or
potential litigation involving the City of Houston and the Long Trusts
litigation, and the effect on the Partnership's results of operations and
financial condition if the Partnership were required to record a
significant liability under generally accepted accounting principles as a
result of an adverse ruling in one or more of such lawsuits in the near
term. See "-- Reasons for the Merger -- Considerations Affecting Future
Cash Distributions to Unitholders."
The Special Committee also considered the fact that under Delaware law, the
Public Unitholders would not be entitled to appraisal or dissenters' rights as a
result of the Merger, recognizing that the absence of such rights could be
viewed as an unfavorable fact from the perspective of the Public Unitholders and
that such rights were available in comparable transactions involving
corporations, rather than limited partnerships.
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<PAGE> 50
The Special Committee also considered, together with Dillon Read's opinion and
the other matters considered in reaching its conclusion that the Revised
Proposal is fair to and in the best interests of the Public Unitholders, Dillon
Read's statement that Dillon Read was not prepared to render an opinion that the
Initial Proposal (which contemplated an $11.00 per Unit price) was fair to the
Public Unitholders from a financial point of view; Dillon Read's statement that
a price of $15.00 per Unit was at or near the top of the range of values for the
Public Units; the fact that $12.10 was closer to $11.00 than $15.00; and that
Dillon Read had not rendered an opinion as to a range of fair values for the
Public Units. The Special Committee recognized that a $12.10 per Unit price was
less advantageous to the Public Unitholders than a price at or nearer to the
$15.00 per Unit price suggested by Dillon Read as being at or near the top of
the range of values for the Public Units. However, having started negotiations
with VEC by requesting a price of $15.00 per Unit, and having received a revised
proposal from VEC of $12.10 per Unit, which VEC on several occasions represented
to be the highest price that VEC would be prepared to pay per Unit, the members
of the Special Committee were satisfied that, based upon their consideration of
all the factors described herein, such price of $12.10 per Unit was fair to and
in the best interests of the Public Unitholders. See "-- Opinion of Financial
Advisor to the Special Committee."
The foregoing discussion of the information and factors considered by the
Special Committee is not intended to be exhaustive but is believed to include
all material factors considered by the Special Committee. In reaching the
conclusion that the Revised Proposal is fair to and in the best interests of the
Public Unitholders and should be accepted by the Board of Directors of the
General Partner, the Special Committee did not assign any specific or relative
weights to the foregoing factors, and individual directors may have given
differing weights to different factors.
In view of the wide variety of factors considered in connection with its
evaluation of the Merger, the VNGC Board and the Special Committee did not find
it practical to, and did not, quantify or otherwise assign relative weights to
the individual factors considered in reaching their determinations, except that
significant weight was placed on the opinion of Dillon Read.
As described above under "-- Background of the Merger -- Certain Contacts," each
of the Special Committee, the VNGC Board and VEC was fully aware of the
proposals made by NGC described therein. The VNGC Board directed the members of
the Special Committee to meet with NGC to discuss NGC's proposals, and they did
so. In addition, the financial advisor to the Special Committee reviewed NGC's
proposals and, having taken such proposals into account, determined that the
consideration to be received by the Public Unitholders in the Merger was
nonetheless fair, from a financial point of view, to the Public Unitholders. See
"-- Opinion of Financial Advisor to the Special Committee -- February and March
Events." Each of the Special Committee, the VNGC Board and VEC recognized that
the proposals made by NGC were conditioned upon, and could not be implemented
without the agreement of, VEC, and that VEC had rejected such proposals. The
Special Committee did not formally reaffirm its view that the Merger was fair
to, and in the best interests of, the Public Unitholders, but having been fully
informed regarding the NGC proposals, engaged in direct discussions with NGC and
reviewed the April 27, 1994 opinion of Dillon Read reaffirming that the
consideration to be received in the Merger is fair to the Public Unitholders,
from a financial point of view, upon which opinion the Special Committee
continued to place significant weight, the Special Committee did not withdraw or
amend in any way its prior determination. The VNGC Board and VEC were also fully
informed regarding the NGC proposals, the rejection of such proposals by VEC,
the discussions between the Special Committee and NGC, and the other events
described under "-- Background of the Merger -- Certain Contacts." The VNGC
Board and VEC were also aware that the Special Committee had received the April
27, 1994 opinion of Dillon Read and that, having done so, it had not withdrawn
or modified in any respect its prior report as to the fairness of the proposed
transaction to the Public Unitholders. The VNGC Board and VEC did not formally
reaffirm their prior determinations that the Merger was fair to, and in the best
interests of, the Public Unitholders, but having been fully informed regarding
the foregoing matters, did not withdraw or amend in any way their prior
determinations. In the event the settlement of the litigation described under
"The Merger -- Certain Rights of Public Unitholders; Litigation Related to the
Merger" cannot be approved by the Delaware Chancery Court, or the Merger can not
otherwise be completed, by June 1, 1994, the General Partner anticipates that
the parties will be requested to approve an amendment
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<PAGE> 51
or waiver to the Merger Agreement extending the date for completing the Merger,
as permitted under the Merger Agreement.
OPINION OF FINANCIAL ADVISOR TO THE SPECIAL COMMITTEE
On December 17, 1993, Dillon Read gave the Special Committee its preliminary
oral advice that the proposed cash consideration of $12.10 per Common Unit to be
received by the Public Unitholders pursuant to the Merger was fair to such
Public Unitholders from a financial point of view. Dillon Read delivered its
written opinion confirming such preliminary oral advice on December 20, 1993
(the "First Opinion"). On April 27, 1994, Dillon Read delivered its revised
opinion (the "Current Opinion") to the Special Committee. In the Current
Opinion, Dillon Read takes into account the events described under "--
Background of the Merger -- Certain Contacts" above; nonetheless, in the Current
Opinion, Dillon Read confirmed the opinion set forth in the First Opinion. A
copy of Dillon Read's Current Opinion, setting forth certain of the assumptions
made, matters considered and limitations regarding the review undertaken is
included herein as Annex B. Public Unitholders are urged to read the opinion in
its entirety.
For purposes of its opinions, Dillon Read, without independent verification,
assumed and relied upon the accuracy and completeness of the financial and other
information obtained by Dillon Read from public sources and from the
Partnership, the General Partner, VEC and its affiliates and advisors. Dillon
Read did not make an independent evaluation or appraisal of any assets or
liabilities (contingent or otherwise) of the Partnership, nor was it furnished
with any such appraisal.
Dillon Read was requested not to approach and it did not approach any
unaffiliated persons or entities with respect to the acquisition of the
Partnership or any of its assets. Except to that extent and for its limited
participation in the NGC deliberations, no limitations were imposed by the
Special Committee or the VNGC Board upon Dillon Read with respect to the
investigations made or the procedures followed by Dillon Read in rendering its
opinion, and the management of the General Partner and VEC cooperated fully with
Dillon Read in its analysis of the Partnership.
December Events
At a meeting of the Special Committee on December 3, 1993, Dillon Read reviewed,
on a preliminary basis, the following methodologies it was employing in the
evaluation of the Partnership: (i) DCF analysis, (ii) an analysis of comparable
publicly-traded companies, (iii) an analysis of premiums paid in noncontrol
position buyouts and (iv) an analysis of comparable company acquisitions.
Dillon Read's purpose in using each methodology was to produce ranges of values
for the Partnership predicated on objective data from which a range of fair
values for the Common Units could be synthesized. Each methodology differed as
to the objective data utilized. In Dillon Read's view, absent an arm's length
transaction between a willing buyer and seller, the process of evaluation of an
enterprise requires experience, judgment and expertise. Thus, Dillon Read did
not accept all values produced by its calculations; it excluded any that, in
Dillon Read's judgment, were aberrational for one reason or another or were
regarded by Dillon Read as unrealistic in light of the results of its analysis
as a whole. Accordingly, while the methodologies themselves may have been
predicated on objective data, the use of the analytical results of such
methodologies to synthesize a range of fair values for the Common Units was very
much a matter of Dillon Read's experience, judgment and expertise. Indeed,
Dillon Read's selection of the methodologies to be used for that purpose was
itself a matter of Dillon Read's experience and judgment in valuing enterprises
and its knowledge of the Partnership's industry.
At that meeting on December 3, 1993, no conclusions were offered by Dillon Read.
During the following week, Dillon Read performed various sensitivity analyses
with respect to, among other things, NGL margins, conducted comparative reviews
of general and administrative expenses and operating and maintenance expenses
and, in general, refined the information on which it would predicate its
conclusions.
On December 10, 1993, representatives of Dillon Read presented the results of
their final analyses to the members of the Special Committee. The
representatives of Dillon Read did not present a specific range of
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<PAGE> 52
values that was represented to be Dillon Read's opinion of the range of fair
values for the Common Units. Rather, they discussed with the members of the
Special Committee the nature of their methodologies, the results thereof and
their judgments as to the more relevant results of their analyses. The following
is a summary of such analyses:
1. Discounted Cash Flow Analysis. Dillon Read performed a DCF analysis for the
purpose of determining the value per Common Unit based in part upon certain
projections and assumptions regarding future Partnership operations prepared and
provided by the General Partner and described above under "-- Background of the
Merger". The projections and assumptions were the same as those described above
as the "November 10th projections" and are here called the "Forecast". Dillon
Read utilized certain information set forth in the Forecast and assumed that
such information was reasonably prepared on bases reflecting the best currently
available estimates and judgments of the managements of the Partnership and VEC
as to the future financial performance of the Partnership. With the assistance
of the General Partner, Dillon Read extended the Forecast from 1997 to 1999. In
preparing its DCF analysis, Dillon Read derived from the Forecast the unlevered
free cash flow (defined as the cash flow from operating activities less
projected capital expenditures) for the Partnership for the six years ending
December 31, 1999 on three bases: (i) the base case from the Forecast ("Base
Case"); (ii) the Base Case adjusted for certain assumptions made by Dillon Read
as to declines in NGL prices in recognition of a decline in NGL prices
experienced during the fourth quarter of 1993 and potential annual savings in
general and administrative expenses and operating and maintenance expenses ("G&A
and O&M Expenses") totaling $5 million ("First Adjusted Base Case"); and (iii)
the Base Case adjusted for assumptions made by Dillon Read as to potential
annual G&A and O&M Expense savings totaling $10 million ("Second Adjusted Base
Case"). The Forecast included maintenance capital expenditures averaging
approximately $28 million annually during the period and other capital
expenditures in 1994 of approximately $29 million. Dillon Read then prepared a
weighted average cost of capital analysis using a group of five publicly owned
gas gathering and transmission companies. Based on a range of 10.27% to 12.36%
for the implied weighted average cost of capital to the Partnership, Dillon Read
selected discount rates of 10.0%, 10.5%, 11.0%, 11.5% and 12.0%. Dillon Read
also selected assumed terminal EBITDA multiples of 7.5, 8.0, 8.5 and 9.0. In
deriving the Partnership's unlevered free cash flow and estimating its weighted
average cost of capital, Dillon Read disregarded the effect of federal income
taxes because of the tax-free nature of the Partnership's structure. Utilizing
these unlevered cash flows, discount rates and terminal EBITDA multiples, Dillon
Read prepared ranges of total enterprise values for the Base Case and the First
and Second Adjusted Base Cases. After deducting net debt (total indebtedness
less cash and cash equivalents) to derive the indicated value ranges for total
partners' capital represented by the Partnership, Dillon Read then calculated
the ranges of estimated values per Common Unit held by the Public Unitholders in
the Base Case and each of the Adjusted Base Cases.
These ranges of estimated values were as follows: Base Case -- $7.98 per Common
Unit (based on an assumed terminal EBITDA multiple of 7.5 and a discount rate of
12.0%) to $16.48 (based on an assumed terminal EBITDA multiple of 9.0 and a
discount rate of 10.0%); First Adjusted Base Case -- $8.00 per Common Unit (7.5;
12.0%) to $16.83 per Common Unit (9.0; 10.0%); Second Adjusted Base
Case -- $12.50 per Common Unit (7.5; 12.0%) to $21.81 per Common Unit (9.0;
10.0%).
On December 10, 1993, representatives of Dillon Read expressed the view to the
members of the Special Committee that the Second Adjusted Base Case was too
optimistic in that it assumed the most optimistic level of potential savings in
G&A and O&M Expenses ($10 million) but did not reflect the then declining prices
in the NGL markets that Dillon Read expected to continue during the next year.
As a consequence, the representatives of Dillon Read advised the Special
Committee that, in their view, the Special Committee members should focus on the
Base Case and the First Adjusted Base Case. In addition, the Dillon Read
representatives expressed the view that, in their judgment and based on the
Partnership's low historical growth rates and its highly leveraged capital
structure, the most realistic value ranges produced by this methodology were
those bracketed by the discount rates of 11.0% and 11.5% and the terminal
multiples of 8.0 and 8.5. In the Base Case, this produced a range of indicated
values for the Common Units of $10.37 to $12.86, while, in the First Adjusted
Base Case, this produced a range of indicated values of $10.48 to $13.07 per
Common Unit.
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<PAGE> 53
2. Analysis of Comparable Publicly-Traded Companies. In its market comparison
analysis, Dillon Read selected eight companies engaged in lines of business
somewhat similar to that of the Partnership (the "Industry Group"). The Industry
Group consisted of: American, Aquila, Associated, Tejas, Tejas Power
Corporation, Trident, Delhi and Western. Dillon Read reduced this group to the
four that maintain NGL processing businesses similar in relative size to that of
the Partnership: Aquila, Associated, Trident and Western (the "Peer Group").
Dillon Read noted that it was difficult to select publicly-traded companies that
could be used to establish meaningful comparisons with the Partnership for at
least four reasons: the historical growth rates and prospects for future growth
of such companies in comparison with the Partnership; the Partnership's ratio of
debt-to-capitalization in comparison with other members of the industry; the
relative mix of the intrastate natural gas transmission business and the NGL
production, transmission and sale business; and the corporate rather than
partnership organizational structure of the comparable companies. Dillon Read
then prepared implied valuation ranges based on (i) Peer Group trading multiples
and (ii) Industry Group trading multiples. In each case, Dillon Read determined
the comparable company's trading multiples with respect to its net income for
(i) the LTM ended September 30, 1993, (ii) 1993 (estimated) and (iii) 1994
(estimated); its cash flow from operations for the LTM ended September 30, 1993
and for 1994 (estimated) and its EBITDA for the LTM ended September 30, 1993.
Dillon Read then determined implied equity market value ranges for the
Partnership by applying the means and medians of such multiples to the
Partnership's net income for the same periods, its cash flow from operations for
the same periods and its EBITDA for the LTM ended September 30, 1993 (and, in
the latter case, by deducting the Partnership's net debt therefrom). Partnership
net income for 1993 and 1994 was estimated as reported by Institutional Brokers
Estimate System, which estimates were higher than those contained in the
Forecast.
The Partnership is not a taxable entity for federal income tax purposes.
Accordingly, the Partnership's net income and its cash flow from operations
were, for purposes of this analysis, reduced to reflect a federal income tax
provision at the rate of 35% to make trading comparisons with the Peer Group and
the Industry Group comparable because the entities that comprise the Groups are
tax-paying entities.
This analysis produced a matrix of implied equity market values for the Common
Units:
(A) For the Peer Group, (i) using the mean of the Peer Group trading
multiples, the implied values ranged from $10.04 per Unit (a net income
multiple of 15.7 times the Partnership's net income for the LTM, as of
September 30, 1993) to $17.60 (an EBITDA multiple of 8.3 times the
Partnership's LTM EBITDA as of the same date), and (ii) using the median of
the Peer Group trading multiples, the implied values ranged from $10.30 per
Common Unit (a net income multiple of 16.1 times the Partnership's net
income for the LTM as of the same date) to $16.52 (a cash flow multiple of
6.8 times the Partnership's cash flow from operations for the LTM as of the
same date).
(B) For the Industry Group, (i) using the mean of the Industry Group
trading multiples, the implied values ranged from $13.30 per Common Unit (a
cash flow multiple of 6.4 times the Partnership's 1994 estimated cash flow
from operations) to $17.87 (a cash flow multiple of 7.4 times the
Partnership's cash flow from operations for the LTM as of September 30,
1993), and (ii) using the median of the Industry Group trading multiples,
the implied values ranged from $13.80 per Common Unit (a net income
multiple of 21.6 times the Partnership's net income for the LTM as of the
same date) to $20.18 (a cash flow multiple of 8.3 times the Partnership's
cash flow from operations for the LTM as of the same date).
In the case of both the Peer Group and the Industry Group, Dillon Read prepared
various ancillary analyses. Such analyses were prepared using the Partnership's
actual net income for the LTM ended September 30, 1993 and for 1993 (estimated)
and cash flow from operations and EBITDA for the LTM ended as of the same date
and, alternatively, using such LTM results after excluding the benefits of
certain nonrecurring items realized in 1993 ("Adjusted Results").
After adjustment of the Partnership's results, the Peer Group analysis produced
a range of implied values per Common Unit of $9.16 (a median EBITDA multiple of
7.7 times the Partnership's EBITDA for the LTM as of September 30, 1993) to
$14.82 (a median cash flow multiple of 6.8 times the Partnership's cash flow
from operations for the LTM as of the same date), and the Industry Group
analysis produced a range of implied
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<PAGE> 54
values per Common Unit of $11.61 (a mean EBITDA multiple of 8.2 times the
Partnership's EBITDA for the LTM as of the same date) to $18.10 (a median cash
flow multiple of 8.3 times the Partnership's cash flow from operations for the
LTM as of the same date).
In discussions with the members of the Special Committee on December 10, 1993,
the representatives of Dillon Read emphasized the Peer Group trading multiples
as being more relevant in the evaluation of the Common Units than those of the
Industry Group because of the importance of the NGL business to the Partnership.
On this basis, the ranges of indicated values per Common Unit were $10.04 to
$17.60 (actual results) and $9.16 to $14.82 (Adjusted Results).
3. Analysis of Premiums Paid In Noncontrol Position Buyouts. Dillon Read
reviewed 137 buyouts of noncontrol equity positions in publicly owned entities
by controlling persons effected during the eight year period commencing January
1, 1986. These 137 buyouts represent, according to an unaffiliated statistical
source Securities Data Corporation, all noncontrol acquisition transactions that
were effected subsequent to December 31, 1985 and prior to December 10, 1993.
Dillon Read did not attempt to categorize or subdivide these transactions into
subgroups by industry or otherwise. In analyzing the premiums paid in these
transactions, Dillon Read considered the "premium" to be equivalent to the
percentage price change in the market price of the relevant stock between the
"undisturbed" price on a date one month prior to the date of public announcement
of the transaction and the price on the latter announcement date. Dillon Read
selected one month earlier prices from a choice of three alternatives published
by Securities Data Corporation: one month; one week; and one day. It was Dillon
Read's intention to determine the price of the security without any market
influence with respect to the prospective transaction. Dillon Read's review of
the 137 transactions revealed a wide range of premiums, as illustrated by the
fact that, in 72% of the transactions, the premiums ranged from 0% to 70%.
Dillon Read found that the mean of the premiums for all 137 transactions was
35.2% and the median was 33.0%. Based on the closing price for the Common Units
on the Exchange on September 14, 1993 of $8.875, the mean premium would suggest
a value of $12.00 per Common Unit and the median premium would suggest a value
of $11.80 per Common Unit.
4. Analysis of Comparable Company Acquisitions. In this methodology, Dillon Read
examined 24 selected mergers and other acquisitions in the gas gathering and
processing industry effected since August 1, 1987. Of these, 18 were effected
since January 1, 1991. Dillon Read noted that it was difficult to select
transactions that could be used to establish meaningful comparisons. Useful data
regarding the transactions is publicly available only with respect to 13 of the
24 transactions. Moreover, many of those for which data is available were not of
the same order of magnitude as the current transaction. These 13 transactions
produced a range of EBITDA multiples from 3.5x to 11.2x. The mean and median of
such multiples were 6.8x and 6.9x, respectively. Applying the latter multiples
to the Partnership's EBITDA for the LTM ended as of September 30, 1993 would
produce implied values per Common Unit of $8.43 and $9.04, respectively. In
discussions with the Special Committee at their meeting on December 10, 1993,
however, Dillon Read concentrated on the seven out of the 13 transactions that
Dillon Read considered to resemble the Partnership assets more closely. Of
these, the more significant transactions were the acquisition by Tejas from EGSI
of substantially all of EGSI's Texas and Louisiana intrastate gathering systems
and the West Clear Lake storage facility and the acquisition by Western from
Union Texas Petroleum Company of 12 gas processing plants and 5,200 miles of gas
gathering systems in Texas, Oklahoma and Louisiana. These transactions produced
a mean EBITDA multiple of 7.7x which, when applied to the Partnership's EBITDA
for the LTM ended as of September 30, 1993, resulted in indicated values per
Common Unit of $13.91 (actual EBITDA) and $9.10 (EBITDA adjusted, as referenced
above, for certain nonrecurring items).
While Dillon Read did not consider it to be a valuation methodology, Dillon Read
performed an analysis of the effect of the proposed Merger on VEC to determine
the price at which the acquisition became dilutive to the earnings per share of
common stock of VEC. Such analysis was prepared using pro forma combined results
of operations of VEC and the Partnership for the nine months ended September 30,
1993, and, on that basis, the transaction was determined to be dilutive at
$14.75 per Common Unit. The consideration given by Dillon Read to the results
for valuation purposes was limited to assurance that VEC could pay more than
$11.00 per Common Unit without dilution of earnings.
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On December 10, 1993, in addition to noting the results produced by each
methodology, the representatives of Dillon Read pointed out the weaknesses, as
indicated above, of the comparable company acquisition analysis and the
comparable publicly-traded company analysis and the fact that the premiums paid
in noncontrol position buyouts analysis was, in large measure, simply a
statistical compilation. The representatives of Dillon Read did not, however,
assign any specific weight or priority to any of the methodologies used.
Moreover, they did not render an opinion as to a range of fair values for the
Common Units. They did, however, observe that Dillon Read was not then prepared
to render an opinion that the then pending offer of $11.00 per Common Unit was
fair to the Public Unitholders from a financial point of view. Moreover, they
advised the members of the Special Committee on December 10, 1993 that the
Special Committee should consider negotiating with VEC for a higher price per
Unit; that the members of the Special Committee should consider opening those
negotiations by asking for $15.00 per Unit; and that the Special Committee might
infer from Dillon Read's advice that $15.00 was at or near the top of the range
of values for the Common Units held by the Public Unitholders that Dillon Read
considered to be fair.
When the Special Committee concluded its negotiations with VEC and tentatively
agreed upon a price of $12.10 per Common Unit, Dillon Read rendered the First
Opinion on December 20, 1993 that such price was fair to the Public Unitholders
from a financial point of view. In rendering the First Opinion, Dillon Read
considered (i) the fact that, given Valero's ownership of an approximate 49%
interest in the Partnership, the role of its wholly owned subsidiary as the
General Partner and VEC's stated unwillingness to sell its interest in the
Partnership, a sale of the Common Units held by the Public Unitholders to a
third party was unlikely, (ii) the probability of a return of Common Unit market
prices to pre-October 1993 levels if negotiations regarding the Merger were
terminated without agreement and (iii) the prospects for the Partnership given
its current structure and ownership in the current environment if such
negotiations were terminated. Dillon Read also considered the representations
contained in the Merger Agreement regarding the continuation of distributions by
VNGP, L.P. during the pendency of the Merger Agreement and the payment, subject
to the conditions therein specified, of an interim distribution by VNGP, L.P.
through the date of consummation of the Merger. Moreover, although Dillon Read
did not attempt to place a value on the contingent liabilities represented by
the claim and litigation discussed under "-- Reasons for the Proposed
Merger -- Considerations Affecting Future Cash Distributions to Unitholders", it
did, in arriving at its opinion, consider the consequences an adverse ruling
related thereto could have on the Partnership's results of operations and
financial condition.
February and March Events
As indicated above, in connection with its First Opinion, Dillon Read was
requested not to approach and did not approach any unaffiliated persons or
entities with respect to the acquisition of the Partnership, any of its
affiliates or any of its assets. In early February 1994, however, Dillon Read
was advised that first VEC and then the General Partner received an unsolicited
offer from NGC to acquire all the Units owned by subsidiaries of VEC for $16.00
per Unit in cash and, if the offer were accepted by VEC, to offer to acquire
Common Units from the Public Unitholders on the same basis (the "Unsolicited
Offer"). Moreover, Dillon Read was apprised of, or to the extent so indicated
participated in, the related subsequent events, all as described under
"-- Background of the Merger -- Certain Contacts."
In light of those events and having been advised that the Partnership was likely
soon to be soliciting proxies in connection with the Special Meeting, Dillon
Read elected to review and, if appropriate, to update its opinion. In connection
with such review, Dillon Read requested, received and reviewed more recent
business and financial information relating to the Partnership, including the
revision to the Forecast effected in February 1994, as indicated below, as well
as information contained in the Partnership's reports filed with the Commission
since the First Opinion.
In addition to the matters described under "-- Background of the
Merger -- Certain Contacts", the most notable events that transpired subsequent
to the First Opinion with respect to valuation of the Common Units were that (i)
the Partnership revised its Forecast as of February 7, 1994 to reflect the
current NGL price environment, resulting in a reduction of the Partnership's
estimated 1994 EBITDA by $29 million and (ii) the index of stock market prices
for the Peer Group remained about flat (a decline of approximately 1%), while
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their financial results for the last three months of the LTM ended December 31,
1993 were lower, circumstances that generally resulted in increased multiples
for the group. (The index of stock market prices for the Industry Group
increased by about 9% during the same period, and the financial results for the
group during the period also declined, resulting in higher multiples. As
indicated elsewhere, however, Dillon Read believes that the Peer Group multiples
are more relevant to a valuation of the Common Units.)
In assessing the effect of the Unsolicited Offer, Dillon Read (i) was apprised
of and evaluated the various communications between or among VEC, the General
Partner, the Special Committee and NGC, as described under " -- Background of
the Merger -- Certain Contacts", (ii) as so described, met with the members of
Special Committee regarding the development of events and (iii) as indicated
under "-- Background of the Merger -- Certain Contacts," communicated directly
with NGC regarding NGC's desires and intentions with respect to the Partnership.
At the conclusion of these events, Dillon Read concluded that, whatever the
value of the Unsolicited Offer to VEC, it was not indicative of the value of the
Common Units in the hands of the public because, as a practical matter, the
public could not deliver that which NGC desired, that is, control of the
Partnership.
In assessing the effect of the other events, Dillon Read determined that the
application of the discounted cash flow analysis to the revised Forecast
resulted in uniformly reduced implied values when compared with those described
above under "December Events". For example, the current analysis yields an
implied value per Unit of $8.61 (Base Case, using an 8.0 terminal value and a
12% discount factor) as compared with $9.49 in the December analysis using the
same factors; the current analysis yields an implied value of $11.97 per Common
Unit (Base Case, using a terminal value of 8.5 and a discount factor of 11%) as
compared with $12.86 in the December analysis using the same factors.
With respect to the comparable company analysis, Dillon Read continues to
believe that Peer Group comparisons are more relevant in valuation of Common
Units than Industry Group comparisons because of the importance of the NGL
business to the Partnership. In this regard, the combined effect of flat stock
prices and lower financial results during the last three months of the LTM ended
December 31, 1993 was to increase the trading multiples of the Peer Group as
compared with the trading multiples for the LTM ended on September 30, 1993.
Although applied to lower financial results for the Partnership for the LTM
ended on the same date, the higher trading multiples resulted in generally
higher implied values for the Common Units for the LTM ended December 31, 1993
when compared with those for the LTM ended September 30, 1993. For example, the
mean and the median trading multiples produced implied values of $14.48 and
$14.82 based on cash flow from operations for the LTM ended September 30, 1993
(adjusted as described above); the current analysis produced comparable implied
values per Common Unit of $15.15 and $16.36 for the LTM ended December 31, 1993.
When the analysis is applied to estimated 1994 cash flow from operations,
however, the result is reversed. NGL prices began to decline in the fourth
quarter of 1993, and this trend was recognized in the Partnership's changes in
the Forecast as described above. As a result largely of the impact on the
Forecast of a full year of reduced NGL prices, the implied values for the Common
Units based on estimated 1994 cash flow from operations were lower in the
current analysis than in the analysis utilized for the First Opinion. The
implied median value per Common Unit utilized for the First Opinion was $13.38,
while the comparable median value under the current analysis was $9.95.
On April 27, 1994, Dillon Read delivered the Current Opinion to the Special
Committee. In rendering the Current Opinion, Dillon Read took into account all
of the matters indicated above with respect to its First Opinion, the matters
discussed under this caption "February and March Events" (which in general for
the reasons given above under this caption support the conclusions reached by
Dillon Read in its First Opinion) and, in addition, the agreement of VEC, as
more fully described under "The Merger -- Conditions to the Obligations of the
Parties to the Merger Agreement", to pay or cause to be paid to those persons
who were Public Unitholders on the Effective Date an amount in cash equal to the
difference, if any, between $12.10 per Common Unit and the fair value of any
greater amount of consideration per Unit realized by VEC as a result of any sale
of its interest in VNGP, L.P. during the two years following the Effective Date
(reduced by the amount of any capital contributions made by VEC to VNGP, L.P.
after the Effective Date).
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<PAGE> 57
The summary of Dillon Read's procedures set forth above is by no means all
inclusive; Dillon Read performed other analyses and procedures not described
above. The summary does, however, describe the material points of the most
important analyses performed by Dillon Read in arriving at its fairness opinion.
Dillon Read believes that its analyses must be considered as a whole; the
selection of only a portion of its analyses and the factors considered by it
would create an incomplete view of the processes underlying its opinion. The
preparation of a fairness opinion is a complex process involving subjective
judgments and is not necessarily susceptible to partial analysis or summary
description. In its analysis, Dillon Read made a number of assumptions, which
include the assumption that the Partnership's gas transmission system, after
application of the capital expenditures included in the Forecast for 1994, would
be at or near maximum sustainable throughput. Any estimates contained in such
assumptions are not necessarily indicative of actual values, which may be
significantly more or less favorable than those set forth herein. Estimates of
values of companies do not purport to be appraisals or necessarily reflect the
prices at which companies may actually be sold. Because such estimates are
inherently subject to uncertainty, none of VNGP, L.P., the General Partner, VEC,
Dillon Read, or any other person assumes any responsibility for their accuracy.
Dillon Read was selected as financial advisor to the Special Committee because
it is a nationally recognized investment banking firm and engages in providing
financial advisory services in connection with mergers and acquisitions,
leveraged buyouts, business valuations, recapitalizations and private
placements. To the best of its knowledge, Dillon Read has not had any material
relationship with the Partnership, the General Partner, VEC or their respective
officers or directors during the past three years. A managing director and an
associate of Dillon Read, who were involved in this engagement, were, however,
previously employed in similar capacities by another investment banking firm.
While with the latter firm, both individuals were involved on behalf of such
firm in an underwritten public offering of securities by VEC effected in early
1992, and the associate participated on such firm's behalf in a proposed
offering of securities by VEC in mid-1993.
As compensation for Dillon Read's services as financial advisor to the Special
Committee, the General Partner has paid Dillon Read, pursuant to the terms of an
engagement letter dated November 9, 1993, a fee of $250,000 that was payable
upon execution of the engagement letter and an additional fee of $250,000 that
was payable on submission of Dillon Read's written opinion to the Special
Committee. These fees were not contingent upon the successful completion of the
Merger. The Partnership has also agreed to indemnify Dillon Read against certain
liabilities, including liabilities arising under the federal securities laws,
and agreed to reimburse Dillon Read for its expenses.
PRINCIPAL EFFECTS OF THE MERGER
If the Merger is effected, (i) the Common Units held by the Public Unitholders
will be converted into the right to receive $12.10 in cash per Common Unit from
VNGC, (ii) the Common Units held by subsidiaries of VEC will remain outstanding,
(iii) the 1% general partner interest in VNGP, L.P. held by VNGC will remain
outstanding, (iv) VNGC will acquire additional Common Units from VNGP, L.P. in
consideration of the cash payment to the Public Unitholders, (v) the general and
limited partner interests in Newco will be converted into the right to receive,
on a pro rata basis, a cash amount equal to the capital account of the partners,
estimated to aggregate $1,000, (vi) VNGP, L.P. and its consolidated subsidiaries
will become wholly owned subsidiaries of VEC, and (vii) the Public Unitholders
(including Public Unitholders who vote against, or do not exercise their voting
rights with respect to, the proposed Merger) will cease to be limited partners
of VNGP, L.P.
As a result of the Merger, the proportionate interest of the Company in the net
book value and net earnings of the Partnership applicable to the Common Units
will increase from approximately 49 percent to 100 percent.
The Merger is expected to facilitate financing arrangements, including capital
contributions and distributions, between the Company and the Partnership because
the interest of Public Unitholders will not be required to be considered in any
such transactions. The Merger will also benefit the Company by eliminating the
management time and out-of-pocket costs associated with the preparation and
filing of reports under the Exchange Act, transfer agent costs, tax compliance
costs and other miscellaneous costs. However, such
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savings are expected to be offset by other incremental costs and expenses. See
"Special Considerations -- Reasons for the Proposed Merger" and "-- Background
of the Merger."
The Merger will be a taxable transaction to the Public Unitholders, but will not
be a taxable transaction to the Company. See "Federal Income Tax Consequences of
the Merger."
Under Section 12(g)(4) of the Exchange Act, registration of any class of
security registered pursuant to Section 12(g) of the Exchange Act (as are the
Common Units) may be terminated within 90 days, or such shorter period as the
Commission may determine, after the issuer files a certification with the
Commission that the number of record holders of its securities is less than 300.
The Partnership intends to file with the Commission its certificate and notice
of termination of registration of the Common Units as soon as practicable after
the consummation of the Merger. As a result of the filing of its certificate and
notice of termination of registration of the Common Units, VNGP, L.P. will no
longer be required to file annual and quarterly reports with the Commission or
to send annual reports to its Public Unitholders. Upon the effectiveness of the
termination of registration, the Company, its officers and directors and certain
of its stockholders will no longer be required to make any other filings with
the Commission with respect to the Common Units. It is anticipated that, after
the Effective Time, the Common Units will cease to be traded on the Exchange.
As is mentioned above, VEC is principally involved, through subsidiaries, in the
oil refining and marketing, natural gas and NGL businesses. VEC has
substantially completed a major capital expansion at its refinery in Corpus
Christi, Texas (the "Refinery"), and does not currently intend to undertake any
further substantial additions to the Refinery. Following the Merger, VEC
anticipates that its principal business focus will be on maintaining the
operations of the Refinery and improving and expanding the operations of the
Partnership through capital additions and by taking advantage of business
opportunities that may arise over the next several years, as described under
"Special Considerations -- Reasons for the Proposed Merger -- Industry
Opportunities and Need for Additional Financing." Additionally, VEC anticipates
that it will take action to simplify the Partnership's organizational structure,
such as by merging or consolidating several of the Subsidiary Operating
Partnerships and Subsidiary General Partners so as to reduce the overall number
of separate entities. However, except as described above, neither VEC nor its
affiliates has any specific plans or proposals regarding activities or
transactions that relate to or would result in an extraordinary partnership
transaction, including any merger, reorganization or liquidation, involving the
Partnership, a sale or transfer of a material amount of assets of the
Partnership, any change in the present board of directors or management of the
General Partner, any material change in the indebtedness or capitalization of
the Partnership or any other material change in the Partnership's corporate
structure or business. However, the Board of Directors of the General Partner
currently includes three members who are not otherwise affiliated with the
Company principally because of an Exchange requirement that entities whose
securities are traded on the Exchange have an independent audit committee. As a
wholly owned subsidiary of VEC following the merger, VNGP, L.P. would no longer
be subject to this requirement.
In the event that the Merger is not approved, VEC intends to continue to manage
and operate the Partnership, through the General Partner, subject to the capital
expenditure restrictions and limitations described under "The
Partnership -- History of the Partnership". The management of VEC has not
formulated any other plan, proposal or intent with respect to the Partnership or
the Common Units if the Merger is not approved.
For additional information related to the duties of VEC and the General Partner,
the rights of the Public Unitholders and certain litigation related to the
Merger, see "The Merger -- Certain Rights of Public Unitholders; Litigation
Related to the Merger."
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THE MERGER
BASIC TERMS OF THE MERGER
VNGP, L.P., VNGC, Newco and VEC have entered into the Merger Agreement, a copy
of which is attached to this Proxy Statement as Annex A. A summary of certain
basic provisions of the Merger Agreement is set forth in this section. The
summary, which is not a complete explanation or description of the terms of the
Merger Agreement, is qualified in its entirety by reference to Annex A.
The Merger Agreement provides that, subject to certain conditions (see "The
Merger -- Conditions to the Obligations of the Parties to the Merger
Agreement"), Newco will be merged with and into VNGP, L.P., the surviving
entity, which shall continue to exist under the terms of its present Partnership
Agreement. Upon the filing of the Certificate of Merger pursuant to Delaware
law, all rights, powers, liabilities and obligations of VNGP, L.P. shall
continue in effect unimpaired by the Merger, and all rights, powers, liabilities
and obligations of Newco will become the rights, powers, liabilities and
obligations of VNGP, L.P. Also on the Effective Date, each of the Common Units
outstanding at the close of business on the Effective Date and held of record by
a Public Unitholder will, by virtue of the Merger and without any action on the
part of the holder thereof, be converted into and represent the right to receive
$12.10 in cash from VNGC. The present Public Unitholders will not be partners of
VNGP, L.P. (the surviving entity) following the Merger and will be entitled only
to receive cash. Upon execution of the Merger Agreement, VNGP, L.P. and VNGC
also entered into a separate agreement (the "Purchase Agreement") pursuant to
which VNGC will acquire 9,711,919 newly issued Common Units immediately
following completion of the Merger, in consideration of the cash payment to be
made by VNGC.
In the Merger Agreement, VEC and VNGC each represented that, with respect to the
regular quarterly distribution on the Common Units, they intended that such
distributions continue to be declared and paid at the then-established quarterly
intervals and rate through the Effective Date of the Merger, and that they knew
of no reason why the regular quarterly distribution scheduled to be paid on or
about March 1, 1994 could not be declared and paid. Such March 1, 1994
distribution was subsequently declared and paid. In addition, VEC and VNGC each
represented that, if the closing of the Merger occurred more than 30 days after
the last record date for a regular quarterly distribution, VNGP, L.P. intends
and expects to declare and pay to the holders of the Common Units of record as
of the Effective Date (as hereinafter defined) of the Merger a one-time special
cash distribution equal to the product of the regular quarterly distribution per
Common Unit of $.125 and a fraction the numerator of which is the number of days
from and excluding the record date in respect of which the last regular
distribution has been paid to and including the Effective Date, and the
denominator of which is 90. Such representations were based upon the facts and
circumstances in existence at December 20, 1993, the date of the Merger
Agreement, and as such were necessarily subject to the possible effect of
subsequent developments upon the ability of VNGP, L.P. to declare and pay
distributions. Cash distributions on the Common Units can be declared only by
the Board of Directors of VNGC, acting pursuant to the provisions of the
Partnership Agreement, and can be declared only from the Distributable Cash Flow
of VNGP, L.P. See "The Partnership -- History of the Partnership." The
Partnership is subject to a requirement, more fully described under "The
Partnership -- History of the Partnership", that short-term borrowings be
reduced to zero for a period of 45 consecutive days during each period of 16
consecutive calendar months. Under this requirement, the Partnership must
complete such a "clean-up" period in September 1994. Additionally, during the
period since execution of the Merger Agreement, the Partnership's results of
operations have continued to deteriorate and the Partnership has reported
substantially reduced operating income and a net loss for the first quarter of
1994. On April 27, 1994, the VNGC Board declared a regular quarterly cash
distribution of $0.125 per Common Unit, such distribution to be paid on May 31,
1994, to holders of record of the Common Units on May 16, 1994. However, in
light of the Partnership's deteriorating operating results and the
above-described clean-up requirement, neither VEC nor VNGC can provide assurance
that future quarterly cash distributions can be so declared and paid, or that,
if applicable, the one-time special cash distribution described above can be
declared and paid. The General Partner anticipates that the Effective Date
should occur within 30 days following the record date for the May 31, 1994,
distribution
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and that, accordingly, the one-time special cash distribution mentioned above
would not be payable under the terms of the Merger Agreement.
For a discussion of the background, fairness and purpose of the Merger and other
matters concerning the Merger, see "Special Considerations -- Reasons for the
Proposed Merger," "-- Background of the Merger," and "-- Opinion of Financial
Advisor to the Special Committee."
FEES AND EXPENSES
The Company will pay all expenses of the Merger. It is estimated that if the
Merger is consummated, the fees and expenses incurred in connection therewith
will be as set forth below:
<TABLE>
<S> <C>
Filing Fees (Securities and Exchange Commission)................................. $ 23,503
Legal Fees and Expenses.......................................................... 2,100,000
Accounting Fees and Expenses..................................................... 50,000
Printing Costs................................................................... 50,000
Fees and Expenses of Investment Advisors......................................... 2,000,000
Fees and Expenses of Information Agent........................................... 15,000
Miscellaneous.................................................................... 11,497
---------
Total............................................................................ $4,250,000
---------
---------
</TABLE>
In addition, in connection with the Public Offering to fund the Merger, the
Company has incurred additional expenses of approximately $310,000, in addition
to usual and customary underwriters' discounts and commissions.
EFFECTIVE TIME OF THE MERGER
Under the Merger Agreement, the Merger will become effective at the time that a
Certificate of Merger is filed pursuant to Delaware law. It is anticipated that,
if all conditions have been met or waived, the Effective Date will occur on or
about May 31, 1994, although there can be no assurance in that regard. The
Common Unit transfer books of the Partnership will be closed as of the close of
business on the day of such filing, and no registration of transfer of
certificates representing Common Units will be made thereafter other than
registrations of transfers occurring before the close of business on the
Effective Date. If the Merger cannot be concluded by June 1, 1994 (see
"-- Termination or Amendment of the Agreement of Merger"), the Special Committee
and the parties to the Merger Agreement may consider whether or not to extend
the time for consummation of the Merger by amendment or waiver of the applicable
condition in the Merger Agreement to provide additional time to conclude the
settlement of litigation or for any other appropriate reason. See "-- Certain
Rights of Public Unitholders; Litigation Related to the Merger." In such event,
no further approval of the Unitholders would be required.
SOURCE OF CASH CONSIDERATION
VEC intends to fund the cash payment to the Public Unitholders contemplated by
the Merger Agreement with a portion of the proceeds of the Public Offering of
VEC's $3.125 Convertible Preferred Stock. The Public Offering was completed in
March 1994, and VEC received net proceeds from the Public Offering (after
underwriters' discounts and commissions, but before expenses and underwriters'
over-allotment options) of $168.2 million. VEC will advance or contribute
proceeds from the Public Offering to VNGC, and VNGC will make the cash payment
to the Public Unitholders.
CONDITIONS TO THE OBLIGATIONS OF THE PARTIES TO THE MERGER AGREEMENT
In order to address the separate concerns of the Public Unitholders, although
not required by the Partnership Agreement, the General Partner has conditioned
approval of the Merger upon satisfaction of the Independent Vote Requirement.
Accordingly, the effectiveness of the Merger must be preceded by, and is
expressly subject to, the adoption of the Merger Agreement through satisfaction
of both the Majority Vote Requirement and
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the Independent Vote Requirement. The Majority Vote Requirement and Independent
Vote Requirement cannot be waived. See "The Proxy Solicitation -- Voting and
Proxy Procedures."
On the Record Date, there were outstanding 18,486,538 Common Units, which are
entitled to vote as a single class. The General Partner and its subsidiaries
have informed the Partnership that they intend to vote the Common Units that
they own, representing approximately 47.5% of the outstanding Common Units,
"FOR" approval of the Merger.
Under the Merger Agreement, the obligations of VNGP, L.P., VNGC, Newco and VEC
are subject to various conditions, including that before the Effective Time, (i)
the Merger Agreement shall have been approved by both the Majority Vote
Requirement and the Independent Vote Requirement; (ii) there shall not have been
any governmental or judicial action, law or regulation prohibiting, restraining
(whether by imposing additional conditions or covenants or otherwise) or making
unlawful the Merger or prohibiting, restraining or making unlawful the payment
or receipt of cash for Common Units as contemplated by the Merger Agreement;
(iii) the Internal Revenue Service ("IRS") shall have issued a response (the
"Private Letter Ruling") with respect to the private letter ruling request of
VNGP, L.P. dated December 6, 1993, ruling that the proposed Merger, if effected
in the manner described in such private letter ruling request, will not result
in any technical termination of VNGP, L.P.; and (iv) neither the opinion of
Dillon Read set forth at Annex B, nor the recommendation of the Special
Committee referred to above shall have been withdrawn or modified in any manner
materially adverse to VEC, VNGC, VNGP, L.P. or Newco. The conditions described
in clauses (iii) and (iv) may be waived by VNGP, L.P., VNGC, VEC and Newco,
while the conditions described in clauses (i) and (ii) cannot be waived. See
"Federal Income Tax Consequences of the Merger." A satisfactory Private Letter
Ruling, dated February 7, 1994, has been received by the General Partner and the
condition specified in clause (iii) has been satisfied. See "Federal Income Tax
Consequences of the Merger -- IRS Private Ruling Letter Ruling."
In addition, the obligations of Newco to effect the Merger shall also be subject
to the fulfillment of various conditions, any or all of which may be waived by
Newco in its sole discretion; including that (i) any consent, waiver or
amendment necessary or desirable in the opinion of Newco under certain financial
agreements of VEC shall have been obtained, in form and substance reasonably
satisfactory to Newco; (ii) VEC shall have completed the Public Offering and
shall have received proceeds therefrom, net of all underwriters' discounts and
commissions, equal to not less than the aggregate amount payable to the Public
Unitholders; (iii) except for changes in the business or condition of the
Partnership, financial or otherwise, or in the results of operations of the
Partnership, occurring prior to the date of the Merger Agreement, or expected by
the management of the General Partner to occur based on events occurring prior
to the date of the Merger Agreement, there shall not have occurred any material
adverse change in the business or condition of the Partnership, financial or
otherwise, or in the results of operations of the Partnership from that set
forth in or contemplated by the financial statements of the Partnership for the
nine months ended September 30, 1993; (iv) with certain exceptions there shall
not be pending or threatened against VNGP, L.P., or any subsidiary of VNGP,
L.P., any action, suit or proceeding involving a claim at law or in equity or
before or by any federal, state, or municipal or other governmental department,
commission, board, business, agency or instrumentality, domestic or foreign,
that would be reasonably likely to have a material adverse effect on the
condition, financial or otherwise, of VNGP, L.P.; and (v) there shall not be
pending or threatened against VEC, VNGC, VNGP, L.P., Newco, or any affiliate of
VEC, VNGC, VNGP, L.P., or Newco or the property or business of VEC, VNGC, VNGP,
L.P. or Newco, any other action, suit or proceeding involving a claim at law or
in equity or before or by any federal, state, or municipal or other government
department, commission, board, bureau, agency or instrumentality, domestic or
foreign, relating to the Merger or the Merger Agreement that would be reasonably
likely to have a material adverse effect on the condition, financial or
otherwise, of VEC, VNGC or VNGP, L.P. With respect to the condition in clause
(i) above that certain consents, waivers and amendments to financing agreements
be obtained, VEC has obtained satisfactory amendments to its various long-term
agreements related to funded indebtedness and has negotiated a $250 million
unsecured bank credit agreement which is intended to replace VEC's existing $30
million credit agreement, a secured $160 million letter of credit and revolving
credit facility of Valero Refining Company and the existing short-term committed
and uncommitted revolving credit facilities of the Management Partnership. The
new $250 million
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bank credit agreement has been executed but would not actually become effective
until completion of the Merger. It is a condition to the effectiveness of the
new credit agreement that certain lawsuits, pending in Delaware Chancery Court
(and any other lawsuits that contest or seek to prevent the consummation of the
Merger), have been settled. A hearing to consider approval of a settlement of
such lawsuits has been scheduled for May 31, 1994. See "The Merger -- Certain
Rights of Public Unitholders; Litigation Related to the Merger." Unless such
condition is waived, the Merger could not be completed until such settlement
actually occurs. As is noted above under "-- Source of Cash Consideration," the
Public Offering has been completed and the condition in clause (ii) above has
been satisfied.
The Memorandum of Understanding, as amended, provides that for a period
beginning on the Effective Date, and ending on the second anniversary of the
Effective Date, VEC will not dispose of its interest in VNGP, L.P. except in a
transaction (the "Second Transaction") in which the Public Unitholders who hold
the Common Units at the Effective Date would receive a payment such that upon
the consummation of the Second Transaction each such Public Unitholder would
receive a payment in an amount per Unit equal to the difference between (a) an
amount equal to (i)(A) the product of the percentage of the Units held by the
Public Unitholders immediately prior to consummation of the Merger
(approximately 51%) and (B) the value of the total consideration received by VEC
in such second transaction, reduced by the amount of any capital contributions
made by VEC to VNGP, L.P. between the closing dates of the Merger and such
second transaction, divided by (ii) the number of Units held by Public
Unitholders immediately prior to consummation of the Merger, and (b) $12.10.
Such right is nontransferable. Additionally, VEC has no obligation to attempt to
sell its interest in VNGP, L.P., and has no intention of doing so.
TERMINATION OR AMENDMENT OF THE AGREEMENT OF MERGER
The Merger Agreement may be terminated and the Merger abandoned at any time
before the Effective Time, notwithstanding the prior approval of the holders of
Common Units or the partners of Newco, by the consent of the Board of Directors
of VNGC (with the prior written consent of a majority of the members of the
Special Committee) and the Board of Directors of the general partner of Newco.
The Merger Agreement shall be terminated by any party and the Merger abandoned
if (a) the Closing Date and consummation of the Merger shall not have occurred
by June 1, 1994 unless such date is extended by the parties (see "-- Effective
Time of the Merger"), or (b) any governmental or judicial action, law or
regulation shall be enacted or become effective which prohibits, restrains or
renders unlawful the Merger or prohibits, restrains, or renders unlawful the
payment or receipt of cash as contemplated by the Merger Agreement, or (c) if
the Special Meeting is held but the Independent Vote Requirement is not met, and
shall also be terminated (unless such condition is waived, as provided above) if
the Special Committee withdraws, or materially modifies in a manner materially
adverse to VEC, its recommendation regarding the Merger, or the opinion of
Dillon Read is withdrawn or modified in a manner materially adverse to any party
to the Merger Agreement. The Merger Agreement may be terminated by the Board of
Directors of VNGC if VEC or Newco breaches in any material respect any of its
covenants or agreements contained herein, and by VEC or the Board of Directors
of the general partner of Newco if VNGC or VNGP, L.P. breaches in any material
respect any of its covenants or agreements contained herein. Additionally, the
Merger Agreement may be terminated by VEC or by the Board of Directors of the
general partner of Newco if (i) all necessary governmental consents and
approvals have not been obtained, and the Hart-Scott-Rodino waiting period has
not expired, all on or before March 31, 1994; (ii) the IRS shall issue a private
letter ruling to the effect that the Merger will result in a technical
termination of VNGP, L.P. or which is otherwise materially adverse to VEC or
Newco; (iii) appropriate consents, waivers and amendments to VEC's various
financing agreements have not been obtained on or before March 31, 1994, and VEC
reasonably determines that such consents, waivers and amendments cannot be
obtained upon terms and conditions reasonably satisfactory to VEC; (iv) the
Public Offering has not been completed on or before March 31, 1994, and VEC
reasonably determines that the Public Offering cannot be completed upon terms
and conditions reasonably satisfactory to VEC; or (v) in the reasonable opinion
of VEC, certain events have occurred, or there has occurred the filing of, or a
development in, any action, suit or proceeding which, unless waived by VEC and
Newco, would result in the failure of a condition to closing the Merger. In the
event of termination of this Agreement and abandonment of the Merger as provided
herein, this Agreement shall become wholly void and of no effect and there shall
be no liability pursuant to this
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Agreement on the part of any party hereto or its respective officers, directors,
stockholders, or general or limited partners. As of the date of this Proxy
Statement, the Hart-Scott-Rodino waiting period mentioned in clause (i) above
has expired, the Private Letter Ruling has been issued, satisfying the condition
in clause (ii), and the Public Offering has been completed, satisfying the
condition in clause (iv). In addition, certain of the consents, waivers and
amendments referred to in clause (iii) have been obtained. See "-- Conditions to
the Obligations of the Parties to the Merger Agreement."
The Merger Agreement may be amended, modified or supplemented upon the consent
of the Board of Directors of VNGC (with the prior written consent of a majority
of the members of the Special Committee) and the Board of Directors of the
general partner of Newco, provided that the approval of a majority of the Common
Units entitled to vote thereon held by Public Unitholders and voted at a special
meeting of Unitholders called to vote upon such amendment shall first be
obtained for any amendment which under applicable law requires such approval, if
the consideration to be received by the Public Unitholders pursuant to Section
1(b)(i) of the Merger Agreement is changed or if the Merger Agreement is
modified in a manner materially adverse to the Public Unitholders.
CERTAIN RIGHTS OF PUBLIC UNITHOLDERS; LITIGATION RELATED TO THE MERGER
In accordance with the DRULPA, the Public Unitholders will have no dissenters
rights of appraisal in connection with the Merger. However, in lieu of appraisal
rights, Unitholders may have other rights and remedies available to them in
connection with the Merger. Under Delaware law (subject to modification by
agreement), the fiduciary duty of a general partner to a Delaware limited
partnership and its limited partners is at least as great as the fiduciary duty
owed by a director of a Delaware corporation to the corporation and its
shareholders. Thus, it can be anticipated that a Delaware court would apply
corporate precedent in determining the obligations of a general partner.
Several decisions by Delaware courts have held that, in certain instances, a
controlling stockholder of a corporation that uses its control to establish the
terms of and effectuate a merger has a fiduciary duty to the other stockholders
that requires the merger to be fair to such stockholders. Such precedent may
apply by analogy where a corporate parent controls the general partner of a
limited partnership and the general partner in turn controls the affairs of the
limited partnership. That conclusion is supported by existing Delaware
partnership case law holding that fiduciary obligations may be owed directly by
a controlling stockholder of a corporate general partner to the limited
partnership and its limited partners. In determining whether a merger is fair to
stockholders, the Delaware courts have considered, among other things, the type
and amount of consideration to be received by the stockholders and whether there
were fair dealings among the parties. In some Delaware cases, the remedy granted
to former stockholders in a merger transaction found not to be "fair" has been a
damages remedy based on the fair value of their interests acquired in the
merger. However, under the entire fairness standard, a Delaware court may
fashion any form of equitable and monetary relief as may be appropriate,
including rescissory damages.
Seven lawsuits were filed in Chancery Court in Delaware in response to the
announcement by VEC on October 14, 1993 of its proposal to acquire the publicly
traded Common Units pursuant to the proposed Merger. The suits, which were
consolidated into a single proceeding, requested the court to certify the
litigation as a class action. The plaintiffs sought to enjoin or rescind the
proposed Merger, alleging that the corporate defendants and the individual
defendants, as officers or directors of the corporate defendants, engaged in
actions in breach of the defendants' fiduciary duties to the Public Unitholders
by proposing the Merger. The plaintiffs alternatively sought an increase in the
proposed merger consideration, compensatory damages and attorneys' fees.
Attorneys representing the plaintiffs communicated with counsel for the Special
Committee in the course of the Special Committee's deliberations, and reviewed
Dillon Read's analysis referred to under "Special Considerations -- Opinion of
Financial Advisor to the Special Committee." Prior to the approval of the
Revised Proposal by the Special Committee, such attorneys advised the General
Partner that they were satisfied with the agreement reached with the Special
Committee and had entered into a Memorandum of Understanding with VEC and VNGP,
L.P. in which they have agreed in principle to recommend that the Chancery Court
approve a settlement based upon the terms of the Merger as described herein.
Notice of the proposed settlement of such litigation upon the basis described in
the Memorandum of
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Understanding has been given to the Public Unitholders. A hearing to consider
approval of such settlement has been scheduled in Delaware Chancery Court for
May 31, 1994, and it is expected that, subject to the approval of the Chancery
Court, and to the satisfaction of all other preconditions to the Merger, the
Merger would become effective on or about such date.
Public Unitholders who vote in favor of the Merger or who accept the benefits of
the Merger by surrendering their Common Units for payment of the Merger
consideration may thereafter be estopped from challenging the Merger. Further,
if the settlement contemplated by the Memorandum of Understanding is finalized
and approved by the Court, it would release all claims by Public Unitholders in
connection with or that arise out of the Merger. Under Delaware law, Public
Unitholders would not be permitted to opt out of the settlement and would have
no further rights under Delaware law.
METHOD OF SURRENDERING UNIT CERTIFICATES FOR PAYMENT
Promptly following the Special Meeting, if the Merger is approved and completed,
the General Partner will mail or cause to be mailed to each registered holder of
the Common Units at the Effective Time of the Merger, a transmittal form and
appropriate instructions regarding the transmittal of certificates representing
the Common Units to VEC (in such capacity, the "Disbursing Agent") for payment.
No certificates should be sent until such transmittal letter and instructions
are received. During the twelve-month period following the Effective Time, the
Disbursing Agent will pay to the Public Unitholders upon surrender of their
certificates for Common Units (together with a validly completed and duly
executed transmittal letter in the form furnished) the amount of cash into which
the Common Units represented by such certificates shall have been converted,
without interest. After such twelve-month period, any holders of Common Units
that have not so surrendered their certificates representing Common Units must
obtain such payment from VEC or any successor thereof.
If any payment for Common Units is to be made in a name other than that in which
the certificate for such Common Units is registered on the Common Units transfer
books of the Partnership at the Effective Time, the certificate must be endorsed
properly or otherwise be in proper form for transfer and the person requesting
such payment must either (i) pay to the Disbursing Agent any transfer or other
taxes required by reason of the payment to a person other than the registered
holder of the certificate or (ii) establish to the satisfaction of VNGC (as the
General Partner of the surviving entity in the Merger) that such tax has been
paid. If satisfactory evidence of the payment of such tax (or applicable
exemption therefrom) is not submitted, the Disbursing Agent will deduct the
amount of any such tax (whether imposed on the registered holder or transferee)
from the amount otherwise payable.
Each certificate that, before the Effective Time, represented outstanding Common
Units held by Public Unitholders will, after the Effective Time, be deemed for
all purposes to evidence only the right to receive, without interest, the amount
of cash into which the Common Units represented thereby shall have been
converted. Interest or other income on funds held by the Disbursing Agent for
the benefit of the holders of Common Units will be paid to VEC or any person
designated by VEC and will not be paid to the Public Unitholders or any person
claiming by, through or under a Public Unitholder.
ACCOUNTING TREATMENT OF THE MERGER
The Merger will be accounted for using the "purchase" method of accounting for
accounting and financial reporting purposes.
THE PARTNERSHIP
HISTORY OF THE PARTNERSHIP
The Partnership was formed on January 28, 1987 and commenced operations on March
25, 1987. The Partnership was created to succeed to substantially all of the
natural gas and NGL businesses previously conducted by subsidiaries of VEC and
VNGC. The operations of the Partnership are conducted pursuant to the
Partnership Agreement. The Partnership was expected to continue the natural gas
and NGL businesses
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previously conducted by the Company and to make distributions to partners of the
Distributable Cash Flow (as defined in the Partnership Agreement) resulting from
such operations. The Partnership Agreement provided that such distributions
would be made in a particular order of priority, with holders of the Preference
Units being entitled during a specified period (the "Preference Period") to a
preferential distribution of such Distributable Cash Flow (pari passu with
distribution to the general partners) to the extent of $0.625 per Unit per
quarter prior to any distribution to the Company, as holder of the Common Units.
The Preference Period would terminate and the Preference Units would
automatically convert into Common Units when the Preference Unitholders had
received cumulative cash distributions of $12.50 per Unit at a rate not to
exceed $1.875 in 1987 and $2.50 in subsequent years.
On March 25, 1987, substantially all of the natural gas and NGL assets of the
principal subsidiaries of VNGC, including a transmission division formerly owned
by Rio Grande Valley Gas Company ("Rio"), were transferred through VNGP, L.P.
and the Management Partnership to certain Subsidiary Operating Partnerships. To
fund the acquisition of these assets, VNGP, L.P. sold in an underwritten public
offering 9,500,000 Preference Units representing an approximately 52% limited
partner interest in VNGP, L.P. The Preference Units were sold at a price of
$22.75 per Unit, or an aggregate of $216,125,000, and the Partnership realized
approximately $201,020,000 after underwriting discounts and commissions, but
before expenses. At the same time, the Management Partnership issued in a
private placement transaction $550 million principal amount of Notes pursuant to
the Indenture. Substantially all of the proceeds from the sale of the Preference
Units and the Notes were transferred to the selling VNGC subsidiaries in return
for the transferred assets. At the same time, the subsidiaries of VNGC
transferring assets to the Partnership received Common Units representing an
approximately 47% limited partner interest in VNGP, L.P.; VNGC also received a
1% general partner interest in each of VNGP, L.P. and Management Partnership,
and various corporate subsidiaries of VNGC received 1% general partner interests
in the various Subsidiary Operating Partnerships. Throughout the existence of
the Partnership, VNGC has served as general partner of VNGP, L.P. and Management
Partnership, while subsidiaries of VNGC have served as general partners of the
various Subsidiary Operating Partnerships. Management Partnership holds a 99%
limited partner interest in the principal Subsidiary Operating Partnerships,
while VNGP, L.P. holds a 99% limited partner interest in certain Subsidiary
Operating Partnerships formed after the original creation of the Partnership. At
March 25, 1987, 250,000 Common Units were also sold by VNGP, L.P. to Valero
Management Company, a wholly owned subsidiary of VEC, for use in connection with
an employee benefit plan. These Common Units were subsequently converted into
Preference Units and granted to key employees of the Company pursuant to a
Preference Unit Award Plan. The proceeds received by the Company from the
Partnership attributable to the offering of the Preference Units and Notes, as
described above, were utilized by the Company to retire indebtedness.
As noted above, upon formation of the Partnership in 1987, $550 million
aggregate principal amount of Notes were issued. Subsequently, Management
Partnership issued $40 and $35 million of additional Notes in June 1988 and
December 1988, respectively, pursuant to the Indenture. The Notes, which are due
serially through 2009, are secured by a mortgage on and security interest in
substantially all of the currently existing and after-acquired property, plant
and equipment of Management Partnership and each of its Subsidiary Operating
Partnerships and by Management Partnership's limited partner interest in its
Subsidiary Operating Partnerships, but are non-recourse to VEC and its corporate
subsidiaries. The Indenture contains covenants prohibiting the Management
Partnership and its Subsidiary Operating Partnerships from incurring additional
indebtedness, including issuing any additional Notes, other than (i) the
aggregate of $625 million of Notes heretofore issued, (ii) up to $50 million of
indebtedness for working capital purposes (subject to a requirement that, for a
period of 45 consecutive calendar days during each period of 16 consecutive
calendar months, no such indebtedness will be permitted to be outstanding) and
(iii) up to the amount of any future capital improvements financed through the
issuance of debt or equity by VNGP, L.P. and the contribution of such amounts as
additional equity to Management Partnership. The Management Partnership will be
required to complete another such "clean-up" period by September 1994. The
Indenture also prohibits the Management Partnership and its Subsidiary Operating
Partnerships from, among other things, creating any new funded indebtedness
unless certain cash-flow-to-debt-service ratios are met.
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Under the provisions of the Partnership Agreement, quarterly cash distributions
are paid by VNGP, L.P. from the Partnership's Distributable Cash Flow after
working capital and other operating requirements, capital expenditures, debt
service on the Notes and other debt service obligations are funded. Under the
Partnership structure, the general partners of VNGP, L.P., the Management
Partnership and each Subsidiary Operating Partnership each receive quarterly
distributions equal to 1% of the Distributable Cash Flow from the respective
partnership, which is an amount aggregating approximately 3% of the
Partnership's Distributable Cash Flow. Concurrently, the limited partners share
pro rata in the remaining Distributable Cash Flow. As noted above, during the
Preference Period, the holders of the Preference Units were entitled to a
preferential call on the Distributable Cash Flow of the Partnership. The
Preference Period terminated May 30, 1992, with the distribution of an aggregate
of $12.50 per Preference Unit for the period April 1, 1987 through March 31,
1992. Upon the termination of the Preference Period, the preferential
distribution rights of the Preference Unit holders terminated and the Preference
Units were automatically converted into Common Units. As a result of the
termination of the Preference Period and the conversion of the Preference Units
into Common Units, VNGP, L.P. now has only one class of limited partner
interest, the Common Units. At April 1, 1994, 18,486,538 Common Units were
issued and outstanding, including 8,774,619 Common Units held by the Company,
88,713 Common Units held by persons who are currently officers or directors of
VEC or VNGC or employees of the Company and 9,623,206 Common Units that are
publicly held (other than by such officers and employees).
In offering Preference Units to the public in March 1987, the Partnership stated
its intent to distribute $0.625 per Preference Unit (the "Indicated
Distribution") on a quarterly basis and indicated that it expected to distribute
at least such amount quarterly with respect to each quarter in calendar year
1987, but that the ability to make such distributions would depend on the future
operating performance of the Partnership, among other factors. The Partnership
further stated that the Partnership's Distributable Cash Flow would depend upon
the Partnership's future performance and would be subject to prevailing economic
conditions and to financial, business and other factors, many of which were
beyond its control, including the possible adverse determination of certain
take-or-pay claims in litigation. For a further discussion of such take-or-pay
claims, see "Special Considerations -- Reasons for the Proposed
Merger -- Background of the Merger." As a result, increases in working capital,
debt service or other operating requirements, or decreases in the Partnership's
earnings or cash flow, can adversely affect the Partnership's ability to make
cash distributions. For the past several years, the Partnership's operating
income from natural gas operations has been adversely affected by industry-wide
excess pipeline deliverability capacity, which has caused extreme competition in
both the sales and transportation segments of the Partnership's natural gas
business. These and other events have reduced the cash flow and operating income
levels of the Partnership. At the same time, the provisions of the Partnership
Agreement requiring the distribution to the Unitholders of all Distributable
Cash Flow of the Partnership have had the effect of channeling available cash to
Partnership distributions, rather than to capital projects. However, the General
Partner believed that it would be advisable to expand the Partnership's pipeline
system so as to diversify supply sources and to increase the Partnership's
access to gas markets, and that the Partnership should undertake an expansion of
its NGL operations in order to remain competitive in the NGL business. Also, the
Partnership's principal and interest payments on the Notes and payments under
capital leases with VEC subsidiaries have continued to increase. Taken together,
capital investment and debt service requirements have imposed significant and
increasing funding requirements on the Partnership. Beginning in April 1991, the
Company publicly advised the Preference Unitholders that, principally as a
result of the foregoing factors, cash distributions on the Common Units were
likely to be substantially reduced following the end of the Preference Period to
an annualized rate of approximately $0.50 to $0.75 per Unit. In August 1992, the
quarterly cash distribution rate on the Units was reduced from $0.625 to $0.125
per Unit per quarter, and subsequent quarterly cash distributions have been made
on the Units at this lower rate. To date, aggregate distributions of $13.424
have been paid per Common Unit, which distributions have generally not been
subject to current federal income taxation.
The Partnership Agreement contains provisions that limit the Partnership's
consolidated capital expenditures during any calendar year to the greater of (i)
$35 million, or (ii) 30% of the Partnership's Operating Cash Flow (as defined in
the Partnership Agreement) unless in the good faith opinion of the General
Partner capital expenditures in excess of such limit are required to sustain,
improve or expand the natural gas
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operations of the Partnership. In 1989, the General Partner determined that it
would be desirable to undertake the East Texas Expansion Project to extend the
Partnership's North Texas pipeline system, extending the then-existing pipeline
by approximately 105 miles to Carthage, in east Texas, at a cost of
approximately $60 million. As a result of the capital limitations then facing
the Partnership, the General Partner recommended that the pipeline extension be
constructed and owned by a subsidiary of VEC and leased to the Partnership (the
"East Texas Pipeline Lease"). See "The Partnership -- Conflicts of Interest." At
a meeting of the VNGC Board held on December 18, 1989, the VNGC Board determined
that the Partnership could not participate directly in the East Texas Expansion
Project due to capital limitations, that the leasing arrangement proposed to the
VNGC Board was in the best interests of the Partnership and that the terms and
conditions of the East Texas Pipeline Lease were fair and reasonable to the
Partnership. The East Texas Expansion Project was subsequently completed and the
facilities were leased by a subsidiary of VEC to the Partnership under the East
Texas Pipeline Lease, which commenced February 1, 1991 and has a term of 25
years.
In July 1990, the General Partner recommended that the Partnership's
fractionation and related pipeline facilities in the Corpus Christi, Texas, area
be expanded in order to improve the Partnership's ability to fractionate NGLs.
The fractionation facilities expansion cost approximately $15 million and the
General Partner again recommended that the project (the "Fractionator Expansion
Project") be funded through a leasing arrangement similar to the East Texas
Pipeline Lease. On July 25, 1990, the VNGC Board determined that the Partnership
could not participate directly in the Fractionator Expansion Project, that the
proposed lease (the "Fractionator Expansion Lease") was in the best interests of
the Partnership, and that the terms of the Fractionator Expansion Lease were
fair and reasonable to the Partnership. The Fractionator Expansion Lease
commenced December 1, 1991 and has a term of 15 years.
In April 1991, the General Partner publicly announced that VNGP, L.P.'s cash
distribution per Unit was likely to be reduced following the end of the
Preference Period in May 1992, from the then current rate of $2.50 per Unit
annually, to an estimated annual range of $0.50 to 0.75 per Unit. Following this
announcement, the market price of the Preference Units declined. See "Market
Price of Common Units and Distributions."
In November 1991, the General Partner proposed that an approximately 200MMcf/d
natural gas processing plant be built near Thompsonville, Texas (the
"Thompsonville Plant"), and that certain related pipeline and fractionator
facilities improvements be undertaken, all at a cost of approximately $26
million. At a meeting of the VNGC Board held December 6, 1991, the VNGC Board
determined that the Partnership was itself unable to pursue most of such capital
expenditures, and approved the terms of a lease (the "Thompsonville Plant
Lease") under which the Thompsonville Plant and related pipelines would be
constructed by subsidiaries of VEC and leased to the Partnership. The
Thompsonville Plant Lease commenced December 1, 1992 and has a term of 15 years.
In late 1992, VEC was advised that certain assets owned by Oryx, consisting
principally of a natural gas processing plant in Starr County, Texas, a second
plant located in Dimmit County, Texas, and a 59-mile NGL pipeline located in
Starr County, Texas, were being offered for sale. Under the terms of the
Partnership Agreement, certain proposed investments in the natural gas business
within the State of Texas are designated as "Natural Gas Business Opportunities"
which may not be acquired by the Company unless, in the good faith determination
of the General Partner, the Partnership is unable to pursue such investments due
to capital limitations of the Partnership on a consolidated basis or because the
proposed investment is determined by the General Partner to involve a degree of
risk (including consideration of potential impairment of the ability to make the
Indicated Distribution) unsuitable for investments by the Partnership.
Additionally, if the General Partner determines that the investment is
appropriate for the Partnership except for capital limitations of the
Partnership, then the Partnership will be permitted to participate in the
Natural Gas Business Opportunity on a fair and reasonable basis if such
participation is reasonably practicable. In its capacity as General Partner,
VNGC determined that the Partnership would be unable to undertake the
acquisition of the Oryx assets due to capital limitations. VEC then submitted a
bid for the Oryx assets on behalf of the Company. On January 29, 1992, at the
next regularly scheduled VNGC Board meeting, the General Partner presented the
proposed transaction involving the Oryx assets to the VNGC Board for
consideration. At such meeting, the VNGC Board determined that the Partnership
was unable due to capital limitations to pursue the Oryx asset
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purchase. The VNGC Board also considered and approved an arrangement, proposed
by VEC, whereby the Partnership would participate in the Oryx transaction by
entering into contractual arrangements to manage and operate the Oryx assets on
behalf of the Company, acquire processing rights to residue gas from the Dimmit
County processing plant, enter into certain gas transportation agreements with
Oryx and pay $3 million to Oryx for such contractual commitments. A subsidiary
of VEC was determined by Oryx to be the successful bidder, subsequently acquired
the Oryx assets effective May 1992 for approximately $80 million and entered
into operating agreements with the Partnership for operation of the Oryx assets
by the Partnership and a residue gas processing agreement.
In August 1991, a lawsuit was filed in 57th Judicial District Court, Bexar
County, Texas, against VEC, VNGC and certain officers and directors of VEC and
VNGC, alleging that the corporate defendants and the individual defendants, as
officers or directors of one or both of the corporate defendants, engaged in
actions constituting self-dealing, lack of due care and breach of fiduciary duty
to the holders of the Preference Units and the Partnership. The plaintiffs
further alleged that, in exercising dominance and control over the Partnership,
such defendants, among other things, diverted assets, reduced capital
expenditures, incurred unnecessary debt and caused the Partnership to enter into
the East Texas Pipeline Lease and other transactions on terms unfavorable to the
Partnership. The plaintiffs sought to have the East Texas Pipeline Lease set
aside and to have the defendants account for the alleged damages suffered. In
October 1992, this litigation was certified by the court as a class action and,
at the same time, the court preliminarily approved a settlement of all claims in
the lawsuit. The settlement provided for an adjustment in the terms of the East
Texas Pipeline Lease, which had the effect of reducing lease payments under the
lease by approximately $2.5 million annually. In addition, the settlement
provided for the terms of the Fractionator Expansion Lease to be conformed to
those of the East Texas Pipeline Lease, for the payment of $3 million to a
settlement fund (the "Settlement Fund") established for the benefit of members
of a class consisting of certain selling Unitholders and for the dismissal and
full release of all claims that were brought, or which could have been brought,
in the litigation. The settlement was approved by the court on November 23,
1992, and the lawsuit was dismissed. Final distribution of amounts payable to
the class of selling Unitholders out of the Settlement Fund occurred on October
18, 1993.
CONFLICTS OF INTEREST
The directors and officers of VEC owe a fiduciary duty to VEC to manage VEC and
its investments for the benefit of VEC and its shareholders. Similarly, VNGC, as
the General Partner of the Partnership, and the VNGC Board of Directors have
fiduciary duties to the Partnership and to the Public Unitholders while at the
same time the Board of Directors of VNGC has a fiduciary duty to manage VNGC for
the benefit of VEC. At the same time, VEC, as the sole stockholder of the
General Partner of the Partnership, may, under the DRULPA, be accountable to the
Partnership as a fiduciary and, accordingly, be required to exercise good faith
and integrity in relation to the assets and affairs of the Partnership. These
obligations give rise to certain conflicts of interest.
Through subsidiaries, including the Subsidiary General Partners, VEC holds
approximately 47.5% of the issued and outstanding Common Units, while the
remaining 52.5% of the Common Units are publicly held. As a result of its
subsidiaries' holdings of Common Units and their general partner interests in
VNGP, L.P., the Management Partnership and the Subsidiary Operating
Partnerships, VEC holds an effective equity interest in the Partnership of
approximately 49%. Under terms of the Partnership Agreement, VNGC has exclusive
authority to manage the business and operations of VNGP, L.P. As sole
stockholder of VNGC, VEC has the power to elect the Board of Directors, and
therefore may be deemed to effectively control the management of, VNGC. Because
VNGC is wholly-owned by VEC, the interests of VEC and VNGC may be deemed to be
substantially aligned and VNGC may be deemed to be unable, as a practical
matter, to act independently of VEC. For this reason, the Special Committee,
consisting of three independent directors of VNGC, was created to separately
evaluate the fairness of the proposed Merger. See "Special
Considerations -- Background of the Merger." Under Delaware law, VNGC could not
merge or dispose of its interest in the Partnership without the consent of its
sole stockholder, VEC. In addition, VEC, through its ability to elect the
directors of VNGC, controls the membership of the VNGC Board, and there is a
substantial similarity
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between the management of VEC and the management of VNGC. As a result, for legal
and practical reasons, VNGC could not act independently of VEC in considering
alternative transactions available to the Partnership, and did not do so. See
"Special Considerations -- Reasons for the Proposed Merger -- Alternative
Transactions Considered."
Various management personnel are common to both VEC and VNGC. Mr. William E.
Greehey serves as CEO and as a director of both VEC and VNGC. Mr. Edward C.
Benninger serves as Executive Vice President and a director of VEC and as
Executive Vice President and Chief Operating Officer and as a director of VNGC.
Mr. Stan L. McLelland serves as Executive Vice President and General Counsel of
VEC and as Executive Vice President and General Counsel and as a director of
VNGC. Mr. Don M. Heep serves as Senior Vice President and Chief Financial
Officer of both VEC and VNGC. Mr. Steven E. Fry serves as Vice President
Administration of both VEC and VNGC. Mr. John H. Krueger serves as Controller of
both VEC and VNGC. Mr. John D. Gibbons serves as Treasurer of both VEC and VNGC.
Mr. Rand C. Schmidt serves as Corporate Secretary of both VEC and VNGC.
Subsidiaries of VEC have entered into several transactions in which natural gas
and NGL-related assets have been constructed and owned by subsidiaries of VEC
and leased to the Partnership. For a description of these leasing transactions
between the Company and the Partnership, see "-- History of the Partnership."
The various leasing transactions have been approved by the VNGC Board and also
by the VEC Board. Nonetheless, such transactions inevitably give rise to
conflicts of interest. From the point of view of VEC and its stockholders, an
investment in assets leased to the Partnership is a use of VEC's capital
resources that must be measured against other possible uses of such resources,
such as capital investments in VEC's other businesses or increased returns to
stockholders through increased dividends or repurchases of VEC common stock. To
date, VEC has determined that such transactions are nonetheless in the best
interest of the Company because of the substantial investment of the Company in
the Partnership and the Company's desire to maintain and enhance the value of
this investment. Nonetheless, VEC must still weigh the alternatives of investing
in assets leased to the Partnership at a fixed rate and investing in other
capital assets that may produce a higher rate of return. To the extent that
higher rates of return could be obtained on assets leased to the Partnership,
the financial return to the Company and its stockholders would be enhanced. From
the point of view of the Partnership and the Public Unitholders, leases of
assets from the Company provide an important source of capital because of the
financial limitations of the Partnership. See "Special Considerations -- Reasons
for the Proposed Merger -- Limitations on Additional Financing." However,
financial returns to the Partnership and the Public Unitholders are enhanced to
the extent that the Company's return on its investment in leased assets, and
therefore the Partnership's lease payments, are reduced. In 1991, certain Public
Unitholders brought suit against VEC, the General Partner and certain of their
respective officers and directors alleging, among other things, that the terms
of the East Texas Pipeline Lease were unfavorable to the Partnership. In 1992,
this lawsuit was settled and, among other things, the Company agreed to reduce
the lease payments, and its rate of return, under this lease. Because the
Company and the VEC stockholders generally benefit to the extent that the rate
of return and lease payments under leases with the Partnership are higher, and
the Partnership and Public Unitholders generally benefit to the extent that
lease payments and the Company's rate of return are lower, there is an
inevitable conflict of interest between the Company and the Partnership with
respect to this type of transaction. Additionally, further leasing transactions
would inevitably invite the possibility of either litigation by Public
Unitholders if lease terms are perceived to be too favorable to the Company, or
complaints and possible litigation by VEC stockholders if lease terms are
perceived to be too favorable to the Partnership. For these reasons, and because
of concerns expressed by certain debt rating agencies with respect to this type
of transaction, VEC does not intend to enter into any further significant
leasing transactions with the Partnership.
Certain proposed capital investments in the natural gas and NGL businesses
within the State of Texas are classified under the Partnership Agreement as
"Natural Gas Business Opportunities" and must generally be offered first to the
Partnership before the Company can make such investments. See "-- History of the
Partnership." For example, each of the leasing transactions between the Company
and the Partnership described herein, because it involves a capital investment
in such businesses in the State of Texas, constituted such a "Natural Gas
Business Opportunity" and was offered to the Partnership. In each case, the VNGC
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<PAGE> 70
Board determined that the Partnership was unable to directly undertake such
investment due to capital limitations. Additionally, in 1992, VEC became aware
of an opportunity to acquire certain NGL-related assets from Oryx. The VNGC
Board again determined that the Partnership was unable to make the substantial
capital investment involved in this acquisition and the acquisition was made by
the Company, with the Partnership participating through operating agreements,
gas processing and gas transportation arrangements. See "-- History of the
Partnership." The General Partner expects that similar situations will arise in
the future involving possible acquisitions of natural gas or NGL-related assets
by either the Company or the Partnership. Determinations by the VNGC Board as to
whether or not to participate in a particular Natural Gas Business Opportunity
necessarily involve an inherent conflict of interest because the VNGC Board owes
a fiduciary duty both to VEC, as the sole stockholder of VNGC, and to the Public
Unitholders.
Significant capital transactions by the Partnership, involving an expenditure of
$2 million or more, are reviewed by the VNGC Board. The VNGC Board also reviews
significant transactions between the Partnership and the Company, such as the
East Texas Pipeline Lease, Fractionator Expansion Lease and Thompsonville Lease,
and also reviews situations constituting a Natural Gas Business Opportunity,
such as the acquisition by the Company of the assets from Oryx, to determine
that the Partnership is unable to itself undertake or participate in the
particular opportunity due to capital limitations or because the transaction is
otherwise unsuitable for the Partnership. Notwithstanding the conflicting
fiduciary duties that the members of the VNGC Board have to VEC and to the
Public Unitholders of the Partnership, the members of the VNGC Board balance
their respective duties and review transactions and conflicts between the
Company and the Partnership with a view to determining in their judgment that
the transactions are fair to the Partnership. Although the VNGC Board considered
the terms of such transactions to be fair to the Partnership, there can be no
assurance that more favorable terms could not have been obtained by the
Partnership in substantially similar transactions with independent third
parties.
VNGC, as General Partner of the Partnership, is responsible for all management
and operational decisions of the Partnership. All of the members of the VNGC
Board are elected by VEC, acting as sole stockholder of VNGC. Three of the six
members of the VNGC Board of Directors are also officers of VEC. Because the
Partnership has no employees of its own, employees of the General Partner and
its subsidiaries, acting on behalf of the Partnership, conduct all of the
operations of the Partnership; evaluate and make decisions and recommendations
regarding capital investments and similar transactions, including leasing
transactions involving VEC and its subsidiaries; evaluate and make decisions
regarding all natural gas and NGL purchase, sale, transportation, processing and
other contractual arrangements involving the Partnership, including such
arrangements between the Partnership and subsidiaries of VEC; and evaluate and
make decisions regarding financing for the Partnership's operations. In the
normal course of business, subsidiaries of VEC and the Subsidiary Operating
Partnerships engage in many transactions with one another, and in connection
therewith, the officers and employees of the General Partner and its
subsidiaries owe a fiduciary duty to the Partnership and the Public Unitholders
and at the same time owe a duty to the General Partner and VEC. Additionally,
under the terms of the Partnership Agreement, all transactions between the
Company and the Partnership, including those that are not specifically reviewed
by the VNGC Board, are required to be fair and reasonable to the Partnership
and, under the terms of VEC's own credit agreements, must be entered into on an
arm's length basis. However, these transactions are generally negotiated between
employees of the General Partner and employees of other VEC subsidiaries, and no
independent third party reviews such transactions for compliance with such
requirements.
Under the terms of the Partnership Agreement, the Partnership is required to
indemnify the General Partner and its officers and directors against all losses,
claims, damages, liabilities, costs and expenses incurred by them if the
indemnitee acted in good faith and in a manner the indemnitee reasonably
considered to be in, or not opposed to, the best interests of the Partnership,
and the indemnitee's conduct did not constitute gross negligence or willful
misconduct. Unless ordered by a court, such indemnification shall be made only
upon a determination by the General Partner, if not a named defendant or
respondent in the proceeding, by a majority in interest of the Unitholders or by
an opinion of counsel that such indemnification is proper in the circumstances
because the indemnitee has met the applicable standard of conduct.
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<PAGE> 71
Additionally, under the Partnership Agreement, the Company is authorized to
obtain, at the expense of the Partnership, insurance on behalf of the General
Partner, its officers, directors, employees and agents against any liability
that may be asserted against or expense that may be incurred by such persons in
connection with the activities of the Partnership.
OWNERSHIP OF COMMON UNITS
On April 1, 1994, there were 18,486,538 Common Units outstanding, of which
approximately 8,863,332 Common Units (47.9%) were owned by the Company,
executive officers or directors of VEC or VNGC, or employees of the Company, as
shown in the following table:
- - - - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON UNITS PERCENT
BENEFICIALLY OWNED(1) OF CLASS
<S> <C> <C>
------------------------------------------------------------------------------------------------
Subsidiaries of VEC:
VT Company............................................... 7,374,282 39.89%
VM Company............................................... 510,970 2.76
VH Company............................................... 412,626 2.23
Rio Pipeline Company..................................... 214,051 1.16
Val Gas Company.......................................... 117,965 (2)
Reata Industrial Gas Company............................. 42,552 (2)
Valero Management Company................................ 38,081 (2)
Valero Gathering Company................................. 25,210 (2)
VLDC Company............................................. 15,126 (2)
V.H.C. Pipeline Company.................................. 14,476 (2)
Valero Industrial Gas Company............................ 9,280 (2)
--------- ----
8,774,619 47.5%
--------- ----
Executive Officers and Directors:(3)
Edward C. Benninger(4)(5)(6)............................. 15,774 (2)
Ronald K. Calgaard(4).................................... -- --
Ruben M. Escobedo(4)..................................... -- --
Steven E. Fry(6)......................................... -- --
William E. Greehey(4)(5)(6).............................. 33,595 (2)
Don M. Heep(6)........................................... 552 (2)
Stan McLelland(4)(6)..................................... 20,260 (2)
Mack Wallace(4).......................................... -- --
--------- ----
70,181 (2)
--------- ----
Other Company employees.................................... 18,532 (2)
--------- ----
All current officers, directors and employees of the
Company as a group, including the persons named above.... 88,713 0.5%
--------- ----
</TABLE>
- - - - - --------------------------------------------------------------------------------
(1) Each individual named in the table has sole power to vote or direct the vote
of all such Common Units beneficially owned by him. Each individual named
in the table has sole power to dispose or direct the disposition of Common
Units beneficially owned by him. The executive officers and directors of
the General Partner identified herein as owning Common Units have advised
the General Partner that they intend to vote such Common Units "FOR" the
Merger. Messrs. Benninger, Greehey and McLelland are directors of the
General Partner and, in such capacity, have voted in favor of approving the
Merger. See "Special Considerations -- Recommendation of the Board of
Directors of the General Partner; Fairness of the Merger." No such person
has made a separate recommendation with respect to the Merger.
(2) Less than 1%.
(3) The business address of each beneficial owner listed above is 530 McCullough
Avenue, San Antonio, Texas 78215.
(4) Director of VNGC.
(5) Director of VEC.
(6) Executive officer of VEC and VNGC.
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<PAGE> 72
THE PROXY SOLICITATION
VOTING AND PROXY PROCEDURES
A proxy enables a Unitholder to be represented at a meeting at which he would
otherwise be unable to participate. The proxy card accompanying this Proxy
Statement is solicited because each Unitholder is entitled, as a limited partner
of VNGP, L.P., to vote on matters scheduled to come before the Special Meeting.
Common Units eligible to be voted and for which a proxy card in the accompanying
form is properly signed, dated and returned in sufficient time to permit the
necessary examination and tabulation of the proxy before a vote is taken will be
voted in accordance with any choice specified. The proxy card permits a
specification of approval, disapproval or abstention as to the proposal
described in this Proxy Statement. Unitholders are urged to specify their choice
by marking an (x) or other mark in the appropriate box on the proxy card, but
where no choice is specified, eligible Common Units will be voted as indicated
on the proxy card.
If any matters not specified in this Proxy Statement come before the Special
Meeting, eligible Common Units will be voted in accordance with the best
judgment of the persons named therein as proxies. At the time this Proxy
Statement was printed, the management of the General Partner was not aware of
any other matters to be voted upon. Only procedural matters may come before the
Special Meeting since the only substantive matters which may be considered are
those with respect to which prior notice is given.
The proxy may be revoked at any time before it is exercised by submitting a
written revocation or a later-dated proxy or proxy card to Rand C. Schmidt,
Corporate Secretary, Valero Natural Gas Company, P.O. Box 500, San Antonio,
Texas 78292, or by attending the Special Meeting in person and so notifying the
meeting inspectors.
The presence in person, or by properly executed proxy, of the holders of more
than 50 percent of the issued and outstanding Common Units is necessary to
constitute a quorum at the Special Meeting. Each holder of record of Common
Units on the Record Date is entitled to cast one vote per Common Unit on each
proposal properly submitted for the vote of the holders of the Common Units.
Pursuant to the DRULPA, approval of the Merger requires satisfaction of the
Majority Vote Requirement. Additionally, in order to address the separate
interests of the Public Unitholders, although not required by the Partnership
Agreement or the DRULPA, the General Partner has conditioned approval of the
Merger upon satisfaction of the Independent Vote Requirement. Abstentions and
any unvoted positions in brokerage accounts will be counted toward the
calculation of a quorum, but are not treated as either a vote for or against the
proposal. Abstentions and unvoted Common Units will have the same effect as a
vote against the proposal with respect to satisfaction of the Majority Vote
Requirement but will not have any effect on satisfaction of the Independent Vote
Requirement.
SOLICITATION OF PROXIES
Solicitation of proxies from VNGP, L.P.'s Unitholders will be made by the
General Partner and will be undertaken principally by use of the United States
Postal Service. However, such solicitation may also be undertaken, without
additional remuneration, by the directors, officers and employees of the
Company, and the General Partner may also utilize the services of the firm of
Kissel-Blake Inc. ("Kissel-Blake"), New York, New York. Such solicitation could
be undertaken either by telephone, telegraph or personal interview. The cost of
any such solicitation, including the cost of preparing and mailing proxy
materials, returning the proxies and reimbursing brokerage houses and nominees
for forwarding proxy materials to beneficial owners, will be borne by the
Company. The General Partner's arrangement with Kissel-Blake provides for
payments to Kissel-Blake for compensation and reimbursement of expenses, all of
which are estimated not to exceed $15,000.
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<PAGE> 73
NO DISSENTERS' RIGHTS OF APPRAISAL
In accordance with the DRULPA, the Public Unitholders will have no dissenters'
rights of appraisal in connection with the Merger. For additional information
related to the duties of VEC and the General Partner, the rights of the Public
Unitholders and certain litigation related to the Merger, see "The
Merger -- Certain Rights of Public Unitholders; Litigation Related to the
Merger."
CONDUCT OF THE SPECIAL MEETING
An agenda will be distributed at the Special Meeting, and the meeting will be
conducted in accordance with the agenda. The presiding officer's rules will
govern the meeting.
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<PAGE> 74
SUMMARY FINANCIAL DATA
The following summary consolidated financial information relating to the
Partnership has been taken or derived from the audited financial statements
contained in the VNGP, L.P. 1993 Form 10-K and other public documents of VNGP,
L.P. More comprehensive financial information is included in the VNGP, L.P. 1993
Form 10-K and the other documents filed by VNGP, L.P. with the Commission, and
the financial information below is qualified by reference to such reports and
other documents including the financial statements and related notes contained
therein. VNGP, L.P.'s audited financial statements included in its 1993 Form
10-K as filed with the Commission are set forth in Annex C hereto. The VNGP,
L.P. 1993 Form 10-K and other VNGP, L.P. public documents may be examined and
copies may be obtained from the offices of the Commission as described under
"Available Information."
VALERO NATURAL GAS PARTNERS, L.P.
SUMMARY FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
- - - - - ----------------------------------------------------------------------------------------------
AS OF OR FOR THE YEAR ENDED
DECEMBER 31,
------------------------------------
1993 1992 1991
- - - - - ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME STATEMENT DATA:
Operating revenues..................................... $1,326,458 $1,197,129 $1,144,001
Depreciation and amortization.......................... 38,905 37,924 42,306
Operating income....................................... 79,478 89,841 99,834
Net income............................................. 14,447 24,986 37,036
General partners' interest............................. 1,217 1,596 1,973
Net income allocable to limited partners............... 13,230 23,390 35,063
Net income per limited partner unit.................... .72 1.27 1.90
Ratio of earnings to fixed charges(1).................. 1.20x 1.36x 1.53x
STATEMENT OF CASH FLOWS DATA:
Net cash provided by operating activities.............. $ 70,481 $ 77,886 $ 84,281
Capital expenditures................................... 36,061 35,893 33,074
Cash distributions paid per limited partner unit....... .50 1.50 2.50
BALANCE SHEET DATA:
Total assets........................................... $1,045,082 $1,084,481 $1,061,490
Total debt:
Long-term debt obligations(2)....................... 534,286 559,643 582,500
Long-term capital lease obligations(2).............. 104,838 104,839 77,542
Total debt..................................... 639,124 664,482 660,042
Partners' capital:
Limited partners' capital........................... 158,448 154,461 158,801
General partners' capital........................... 1,598 1,558 1,764
Total partners' capital........................ 160,046 156,019 160,565
Total debt as a percentage of total
capitalization(3)................................... 80.0% 81.0% 80.4%
</TABLE>
- - - - - --------------------------------------------------------------------------------
(1) The ratio of earnings to fixed charges is computed by dividing (i) the sum
of pre-tax income (equivalent to net income as the Partnership is not
subject to federal income taxes), amortization of previously capitalized
interest and fixed charges (excluding capitalized interest) by (ii) fixed
charges. Fixed charges consist of total interest, whether expensed or
capitalized, amortization of debt expense and one-third of rents, which is
deemed representative of the interest portion of rental expense.
(2) Includes current maturities.
(3) Total capitalization represents the sum of total debt and total partners'
capital.
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<PAGE> 75
MARKET PRICES OF COMMON UNITS AND DISTRIBUTIONS
The Common Units are traded on the New York Stock Exchange (symbol: VLP), which
is the principal trading market for such securities. On April 1, 1994, there
were 2,254 holders of record of the Common Units and an estimated 13,200
beneficial holders of the Common Units. The following table sets forth, on a per
Unit basis, for the periods indicated the high and low sales prices of the
Common Units in the New York Stock Exchange-Composite Transactions listing, as
reported by The Wall Street Journal, and the amount of distributions per Common
Unit declared.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
COMMON
UNITS(1)(2)
--------------
HIGH LOW DISTRIBUTIONS
DECLARED
PER COMMON
UNIT(1)
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
1992:
First Quarter........................................ $11 3/4 $7 3/4 $.625
Second Quarter....................................... 9 1/2 7 3/4 .125
Third Quarter........................................ 8 7/8 7 7/8 .125
Fourth Quarter....................................... 9 7/8 7 7/8 .125
1993:
First Quarter........................................ 8 5/8 8 .125
Second Quarter....................................... 8 1/2 7 3/4 .125
Third Quarter........................................ 9 3/8 8 1/8 .125
Fourth Quarter....................................... 12 9 .125
1994:
First Quarter........................................ 12 1/4 11 1/2 (3)
Second Quarter (through April 28, 1994).............. 12 1/4 12
-------------------------------------------------------------------------------------
</TABLE>
(1) Distributions declared per Common Unit represent distributions attributable
to the periods indicated. For example, the $0.625 distribution indicated
for the First Quarter of 1992 was based upon Distributable Cash Flow for
the quarter ended March 31, 1992, was declared on May 5, 1992 and paid on
May 30, 1992 to holders of record on May 15, 1992.
(2) Prior to May 30, 1992, the limited partner interests in VNGP, L.P. not held
by subsidiaries of VEC were represented by Preference Units. On May 30,
1992, the Preference Units were automatically converted into Common Units
in accordance with the terms of the Partnership Agreement. See "The
Partnership -- Background of the Partnership." The Common Units have been
traded on the Exchange since June 1, 1992. As reported by the Exchange,
during the third quarter of 1993, the closing prices of the Common Units on
the Exchange ranged from $8.25 to $9.375 per Common Unit, and the average
trading volume for such period was approximately 19,200 Common Units per
day. During the two trading days ended October 13, 1993, average daily
trading volume in the Common Units increased to approximately 114,000 Units
and the closing price per Common Unit on the Exchange increased from a
closing price of $9.25 on October 11, 1993 to a closing price of $10.00 on
October 13, 1993. Heavy trading activity continued and the price of the
Common Units further increased on the morning of October 14, 1993. In
response to such activity, on October 14, 1993, VEC issued a public
announcement that the VEC Board would meet on October 16, 1993 for the
purpose of considering management's recommendation that the Merger be
proposed to the Board of Directors of the General Partner. On October 14,
1993, the day of such public announcement, the closing price of the Common
Units on the Exchange was $11.00 per Common Unit.
(3) The General Partner has generally declared quarterly distributions
approximately 20 to 25 days following the end of each quarter and paid such
distributions approximately 60 days following the end of each quarter. On
April 27, 1994, the VNGC Board declared a regular quarterly distribution of
$0.125 per Common Unit. Such distribution is payable May 31, 1994. There
can be no assurance that a quarterly distribution will be declared for
subsequent periods. See "The Merger -- Basic Terms of the Merger."
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<PAGE> 76
On April 28, 1994, the last sales price of the Common Units in the New York
Stock Exchange -- Composite Transactions listing was $12.
FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER
INTRODUCTION
The following discussion is intended to provide Public Unitholders with a
summary of certain federal income tax matters that should be considered in
connection with the Merger. Although the principal federal income tax aspects of
general application to Public Unitholders regarding the Merger are discussed
herein, no attempt has been made to comment on all tax matters affecting the
Public Unitholders. Moreover, the tax consequences to a particular Public
Unitholder will depend, in part, on the Public Unitholder's own tax
circumstances. The following discussion is not applicable to nonresident aliens
or foreign corporations and has limited application to domestic corporations.
Accordingly, each Public Unitholder should consult his own tax advisor about the
federal, state, local, foreign and other tax consequences of the Merger in
respect of his particular circumstances.
IRS PRIVATE LETTER RULING
VNGC requested and on February 7, 1994 received, a Private Letter Ruling from
the IRS confirming the following federal income tax consequences of the Merger
to the Public Unitholders, VNGC, the Partnership and Newco:
1. Newco's formation and subsequent Merger with and into VNGP, L.P.
will be disregarded for federal income tax purposes. The Merger will be
treated as a purchase by VNGC of the Common Units from the holders of those
units in exchange for cash. No gain or loss will be realized by Newco or
the Partnership as a result of the Merger;
2. Gain or loss will be realized and recognized by the holders of the
Common Units upon the exchange of those units for cash in the Merger. The
amount of the gain or loss will be equal to the difference, if any, between
(a) the amount of cash received and (b) the adjusted tax basis of the
Common Units exchanged. Except as provided in section 751(a) of the
Internal Revenue Code of 1986, as amended (the "Code"), if a person holds
Common Units as a asset, any gain recognized will be from the sale or
exchange of a capital asset, within the meaning of section 1222. Except as
provided in section 751(a), if a person holds Common Units as a capital
asset, any loss so recognized will be loss from the sale or exchange of a
capital asset, within the meaning of section 1222;
3. The amount of cash received by the holders of the Common Units
attributable to VNGP, L.P.'s unrealized receivables (as defined in section
751(c) of the Code) or inventory items that have appreciated substantially
in value (within the meaning of section 751(d)) shall be considered as an
amount realized from the sale or exchange of property other than a capital
asset;
4. The holders of the Common Units will be allocated their respective
distributive shares of the items listed in section 702(a) of the Code, with
respect to the Partnership, for the period beginning on the first day of
the taxable year in which the Merger occurs and ending on the day of the
Merger;
5. Provided that a holder of Common Units disposes of that
Unitholder's entire interest in VNGP, L.P., the exchange of Common Units
for cash will be a disposition by the Unitholder of an entire interest in a
passive activity in a fully taxable transaction. Unless a holder of Common
Units has a relationship to VNGC described in sections 267(b) or 707(b)(1)
of the Code, the excess of (i) the sum of (I) any VNGP, L.P. loss allocated
to that Unitholder with respect to the period beginning with that
Unitholder's entry into VNGP, L.P. and ending on the date of the Merger
(including any previously disallowed loss determined under section 469(b))
and (II) any loss realized on the exchange, over (ii) any net income or
gain for the taxable year of the Merger (determined without regard to the
losses described in clause (i)) will be treated as a loss that is not from
a passive activity;
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<PAGE> 77
6. As a result of the Merger, VNGP, L.P. will not terminate under
section 708(b)(1)(B) of the Code, provided that immediately prior to the
Merger, the Public Unitholders own a less than 50 percent interest in
either the capital or the profits of VNGP, L.P;
7. Provided that VNGP, L.P. interests cease to be traded on an
established securities market or cease to be readily tradable on a
secondary market (or the substantial equivalent of a secondary market), for
its first taxable year beginning after the Merger and for later years,
VNGP, L.P. will cease to be a publicly traded partnership within the
meaning of section 7704 of the Code.
As a result of obtaining the Private Letter Ruling, VNGC has not obtained an
opinion of independent tax counsel with respect to the federal income tax
consequences of the Merger to Public Unitholders because the IRS Private Letter
Ruling addresses such tax consequences.
Prior to receiving the Private Letter Ruling, VEC and VNGP, L.P. entered into
the Memorandum of Understanding with certain plaintiffs' counsel as described in
"The Merger -- Conditions of the Obligation of the Parties to the Merger
Agreement." In connection with the Memorandum of Understanding, VEC has agreed
to pay fees of plaintiffs' counsel. VNGC's tax advisors have advised VNGC that
the per-Unit amount of such fees (equal to approximately $0.12 per Common Unit
held by the Public Unitholders) should be included in both the Public
Unitholders' consideration received in the Merger (increasing the nominal amount
of such consideration from $12.10 per Common Unit to approximately $12.22 per
Common Unit) and in the Public Unitholders' basis for calculating gain or loss.
In order to avoid delay in obtaining the Private Letter Ruling, VNGC did not
amend its ruling request to address the treatment of attorneys' fees but did
informally advise the IRS examiner handling such ruling request of such facts
and requested that, if appropriate, he consider such facts in responding to the
ruling request. The Private Letter Ruling therefore does not formally address
the treatment of such attorneys' fees. However, based upon the advice provided
by its tax advisors and the fact that the IRS was aware of such information but
did not alter the Private Letter Ruling in response thereto, VEC and VNGC
believe that the tax treatment of such attorneys' fees will be substantially as
described above and did not consider a further private letter ruling or formal
tax opinion to be necessary.
BACKUP WITHHOLDING
A Public Unitholder may be subject to backup withholding at the rate of 31
percent with respect to the cash to be received in the Merger unless such holder
(i) is a corporation or is otherwise exempt from backup withholding and, when
required, demonstrates this fact to the Disbursing Agent, or (ii) provides a
taxpayer identification number to the Disbursing Agent, certifies as to no loss
of exemption from backup withholding and otherwise complies with applicable
requirements of the Treasury Regulations.
FORECAST OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES TO PUBLIC UNITHOLDERS
The General Partner is unable to project the exact amount of gain or loss that
will be realized by each individual Public Unitholder as a result of the Merger;
however, Annex D summarizes certain estimated gain or loss tax information on a
per-Unit basis applicable to Common Units held as of January 1, 1994, based upon
an acquisition of the Units during each month from March 1987 to December 1993.
Annex D-1 provides estimated information regarding Units purchased at an assumed
acquisition price equal to the highest reported trade price of the Units during
each such month. Annex D-2 provides estimated information based upon an assumed
acquisition of Units at a price equal to the unweighted average of the reported
"high" and "low" trade prices of the Units during each such month. Annex D-3
provides estimated information regarding Units purchased at an assumed price
equal to the lowest reported trade price of the Units during each such month. In
each case, Unit prices are the "high" or "low" trade prices for the Units, as
reported in the NYSE-Composite Transactions listing in The Wall Street Journal.
For each acquisition month and assumed acquisition price, the Annexes provide
estimated information regarding the per-Unit cumulative net income or loss that
a Public Unitholder would experience if the Merger is consummated; the
cumulative per-Unit cash distributions that the Public Unitholder has received;
the per-Unit suspended passive ordinary and capital losses; the Public
Unitholder's basis for calculating gain or loss; the per-Unit gain or loss
expected to be realized by a Public Unitholder; and the per-Unit ordinary and
capital gain or loss components included within
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<PAGE> 78
such per-Unit gain or loss. In each case, both the Public Unitholder's
consideration received in the Merger and the Public Unitholder's basis for
calculating gain or loss have been increased by a pro-rata share of the
attorneys' fees described above. Therefore, each Public Unitholder's overall
gain or loss should not be affected by such payment of attorneys' fees. As
indicated in the Annex D-1 through D-3, the Merger may result in a Unitholder
recognizing both ordinary income and capital loss; while ordinary income
realized from the Merger would generally be subject to current federal income
taxation, any such capital loss could generally be utilized only to offset
capital gains otherwise realized by the Unitholder, or to the extent otherwise
permitted under the Code.
The Merger Agreement provides that, immediately prior to the consummation of the
Merger, VNGC will make, or cause one or more of its subsidiaries to make,
certain capital contributions to VNGP, L.P. Such capital contributions are being
made in order to prevent a technical termination of VNGP, L.P. for federal
income tax purposes and have no effect upon the Public Unitholders or the
federal income tax treatment of the transaction to such Public Unitholders.
UNITHOLDERS ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS REGARDING THE SPECIFIC
TAX CONSEQUENCES TO THEM RESULTING FROM THE TRANSACTION, INCLUDING THE
CONSEQUENCES UNDER FEDERAL, STATE, LOCAL AND FOREIGN TAX LAWS.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
VNGP, L.P. hereby incorporates into this Proxy Statement by reference its Annual
Report on Form 10-K for the year ended December 31, 1993.
All documents subsequently filed by VNGP, L.P. pursuant to Section 13(a), 13(c),
14, or 15(d) of the Exchange Act, subsequent to the date of this Proxy Statement
and prior to the date of the Special Meeting, shall be deemed to be incorporated
by reference in this Proxy Statement and to be a part of this Proxy Statement
from the date of the filing of such documents.
Any statement contained in a document incorporated or deemed to be incorporated
by reference herein shall be deemed to be modified or superseded for purposes of
this Prospectus to the extent that a statement contained herein or in any
subsequently filed document that also is or is deemed to be incorporated by
reference herein modifies or supersedes such statement. Any statement so
modified or superseded shall not be deemed, except as so modified or superseded,
to constitute a part of this Proxy Statement.
Any person receiving a copy of this Proxy Statement may obtain, without charge,
upon written or oral request, a copy of any of the documents incorporated by
reference herein, except for the exhibits to such documents (other than the
exhibits expressly incorporated by reference into the information that this
Proxy Statement incorporates). Written requests should be directed to: Investor
Relations, Valero Energy Corporation, P.O. Box 500, San Antonio, Texas
78292-0500 (telephone 210-246-2099).
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ANNEX A
AGREEMENT OF MERGER
This AGREEMENT OF MERGER dated this 20th day of December, 1993 (this
"Agreement"), is made and entered into by and between Valero Natural Gas
Partners, L.P., a Delaware limited partnership ("VNGP, L.P." and, together with
its consolidated subsidiaries, the "Partnership"), Valero Merger Partnership,
L.P., a Delaware limited partnership ("Newco"), and Valero Natural Gas Company,
a Delaware corporation ("VNGC" or the "General Partner"), the general partner of
VNGP, L.P. and a wholly owned subsidiary of Valero Energy Corporation, a
Delaware corporation ("VEC"), and VEC.
WITNESSETH
WHEREAS, the limited partner interest of VNGP, L.P. is represented by 18,486,538
Common Units of limited partner interests ("Common Units"); and
WHEREAS, of such Common Units, 8,774,619 Common Units are held by direct or
indirect subsidiaries of VEC ("Subsidiary Unitholders") as shown on Schedule 1
hereto, and the balance of such Common Units is held by persons ("Public
Unitholders") other than subsidiaries of VEC ("Subsidiary Unitholders"); and
WHEREAS, the Board of Directors of VNGC has established a special committee of
directors (the "Special Committee") to review a proposed merger involving VNGP,
L.P., and to determine the fairness of this Agreement and such transactions to
the Public Unitholders; and
WHEREAS, the Special Committee has (i) considered the fairness of this Agreement
and the transactions contemplated hereby to the Public Unitholders, (ii)
determined that the transactions contemplated hereby are fair to and in the best
interests of the Public Unitholders, (iii) recommended that VNGC approve this
Agreement and (iv) subject to the conditions hereof, recommended that the
transactions contemplated hereby be consummated in accordance with the terms
hereof; and
WHEREAS, VNGC, as the sole general partner of VNGP, L.P., upon the
recommendation of the Special Committee, has approved the adoption and
authorization of this Agreement, the transactions contemplated hereby and the
plan of merger set forth herein and has recommended that this Agreement be
submitted to the holders of the Common Units for their approval pursuant to
Section 17-211 of the Delaware Revised Uniform Limited Partnership Act (the
"Act") at a Special Meeting to be held pursuant to Section 16.4 of the Second
Amended and Restated Agreement of Limited Partnership of VNGP, L.P., effective
March 25, 1987 (the "Partnership Agreement"); and
WHEREAS, on October 18, 1993, VEC filed with the Securities and Exchange
Commission (the "Commission") a Registration Statement on Form S-3, Commission
File No. 33-70454 (as amended, the "Registration Statement"), registering under
the Securities Act of 1933, as amended, 2,875,000 shares of VEC's Preferred
Stock, $1.00 par value, for issuance and sale in a proposed underwritten public
offering, all as more fully described in the Registration Statement (the "Public
Offering"); and
WHEREAS, VEC has advised VNGC that, subject to satisfaction of the various
conditions set forth in Section 2(a) below, and the satisfaction or waiver of
the various conditions set forth in Section 2(b) below, VEC intends to advance
or contribute proceeds from such Public Offering to VNGC to fund the cash
payment to Public Unitholders specified herein; and
WHEREAS, VEC and certain of its subsidiaries are parties to certain bank credit
and other financing arrangements, including without implied limitation (a) the
Amended and Restated Credit Agreement, dated as of December 4, 1992, as amended,
among VEC, certain subsidiaries of VEC, Bankers Trust Company, as Agent, and
Bank of Montreal, as Co-Agent, (b) the Credit Agreement, dated as of December 4,
1992, as amended, among VEC, Bankers Trust Company, as Agent, and Bank of
Montreal, as Co-Agent, (c) the Note Purchase Agreements, dated as of December
19, 1990, among VEC and the Note Purchasers named therein,
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relating to VEC's 10.58% Series A Senior Notes due December 30, 2000 and its
10.58% Series B Senior Notes due December 30, 2000, (d) the Note Purchase
Agreements, dated as of October 15, 1987, among VEC and the Note Purchasers
named therein, relating to VEC's 12.00% Series A Senior Subordinated Notes due
September 30, 1993 and its 12.25% Series B Senior Subordinated Notes due
September 30, 1994, (e) the Note Purchase Agreement, dated as of March 17, 1989,
among VEC, Frost National Bank of San Antonio, N.A., as trustee, and the Note
Purchasers named therein, relating to the 9.14% Senior ESOP Notes due 1999
(collectively, together with all other promissory notes, bank credit agreements,
note purchase agreements, indentures related to debt securities, guarantee
agreements and other financial agreements and instruments to which VEC or any of
its consolidated subsidiaries is a party or by which any of them or their assets
is bound, and which is material to VEC and its subsidiaries, the "Financial
Agreements"), some or all of which contain provisions which must be waived or
amended in order to permit the consummation of the Merger contemplated hereby;
NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency
and reasonably equivalent value of which are hereby acknowledged, the parties
hereto hereby agree as follows:
1. Merger.
(a) Subject to the terms and conditions of this Agreement, at the
Effective Time (as defined hereafter), Newco shall be merged with and into
VNGP, L.P. and the separate existence of Newco shall thereupon cease (the
"Merger"). VNGP, L.P. shall be the surviving entity in the Merger and shall
continue to be governed by the laws of the State of Delaware, and the
separate existence of VNGP, L.P. shall continue unaffected by the Merger.
The Merger shall be governed by and have the effects specified in the Act.
VNGP, L.P. shall file with the Secretary of State of the State of Delaware
(the "Secretary of State"), a Certificate of Merger in accordance with the
Act. The Merger shall become effective at the time of the filing of the
Certificate of Merger, which shall be filed not earlier than, and not later
than the first business day following, the Closing Date described in
Section 8 herein (such time and date of filing shall be referred to as the
"Effective Time" and the "Effective Date," respectively).
(b) At the Effective Time, VNGP, L.P. shall succeed to all of the
assets and shall assume all of the liabilities of Newco, and, in connection
therewith:
(i) each Common Unit of VNGP, L.P. held of record as of the
Effective Date by a Public Unitholder shall become and be converted into
and exchanged for the right to payment from VNGC of the amount of $12.10
cash;
(ii) each Common Unit of VNGP, L.P. held of record as of the
Effective Date by a Subsidiary Unitholder shall remain outstanding and
shall not be affected by the Merger;
(iii) VNGC's general partner's partnership interest in VNGP, L.P.
shall remain outstanding;
(iv) The general partner's and each limited partner's partnership
interest in Newco shall become and be converted into and exchanged for
the right to payment from VNGC of an amount in cash equal to the capital
account of such partner as shown on the books and records of Newco as of
the Effective Date;
(v) Common Units, if any, held in VNGP, L.P.'s treasury shall be
canceled, no consideration shall be paid and issued therefor, and
certificates representing any such treasury units shall be canceled.
2. Representations, Warranties and Certain Covenants.
(a) VEC and Newco each jointly and severally represent and warrant to
each of VNGC and VNGP, L.P. that:
(i) such company is duly organized, validly existing and in good
standing under the laws of the jurisdiction of its organization and has
the requisite power and authority to carry on its respective business as
now conducted. VEC owns, directly or indirectly, all the outstanding
partnership
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interests in Newco. True and complete copies of the organization
documents of VEC, Newco, VNGC and VNGP, L.P. have been delivered to the
Special Committee or their representatives.
(ii) such company has the requisite power and authority to enter
into this Agreement and to perform its obligations hereunder. The
execution, delivery and performance of this Agreement by such company
and the consummation of the transactions contemplated hereby have been
duly authorized by all requisite organizational action and no other
organizational proceeding is necessary therefor. This Agreement has been
duly executed and delivered by such company and constitutes the valid
and binding obligation of such company, enforceable against each such
company in accordance with its terms.
(iii) Neither the execution and delivery hereof by such company,
nor the consummation of the transactions contemplated hereby, nor
compliance with the provisions hereof will (A) violate or conflict with
or result in the breach of or default under (whether following lapse of
time or notice of both), or terminate or accelerate any right or
obligation under, or create any lien upon any property or assets of such
company or any of its subsidiaries, under any of the terms of (x) the
organization documents of such company or its subsidiaries or (y)
subject to the matters described in the eighth recital to this
Agreement, any material debt or other agreement to which such company or
its subsidiaries or the assets or properties thereof may be subject; or
(B) violate any judgment, ruling, order, writ, injunction, statute, rule
or regulation applicable to such company; except in the case of clauses
(A) and (B) above, for such violations, conflicts, breaches, defaults,
terminations, accelerations or liens which, in the aggregate, would not
have a material adverse effect on the transactions contemplated hereby
or on the condition (financial or other), business or operations of such
company and its subsidiaries, taken as a whole. Other than under the
Act, the federal securities laws, the "blue sky" regulations of various
states, and the Hart-Scott-Rodino Antitrust Improvements Act of 1976, to
the knowledge of such company no notice to, filing with, or
authorization of any domestic or foreign public body or authority is
required for the consummation of the transactions contemplated hereby.
(iv) Any documents prepared and filed pursuant to the federal
securities laws or any other law or regulation by such company in
connection herewith shall comply in all material respects with such
laws.
(v) VEC and Newco have disclosed to the Special Committee all
material facts (including publicly-available information relating to VEC
and its subsidiaries), known to VEC or Newco related to the satisfaction
of the conditions specified in Sections 3(a) and 3(b).
(b) VNGC and VNGP, L.P. each severally represent and warrant to VEC
and Newco that:
(i) Such company is duly organized, validly existing and in good
standing under the laws of the jurisdiction of its organization and has
the requisite power and authority to carry on its respective business as
now conducted.
(ii) Such company has the requisite power and authority to enter
into this Agreement and to perform its obligations hereunder. The
execution, delivery and performance of this Agreement by such company
and the consummation of the transactions contemplated hereby have been
duly authorized by all requisite organizational action and no other
organizational proceeding is necessary therefor. This Agreement has been
duly executed and delivered by such company and constitutes the valid
and binding obligation of such company, enforceable against each such
company in accordance with its terms.
(iii) Neither the execution and delivery hereof by such company,
nor the consummation of the transactions contemplated hereby, nor
compliance with the provisions hereof will (A) violate or conflict with
or result in the breach of or default under (whether following lapse of
time or notice of both), or terminate or accelerate any right or
obligation under, or create any lien upon any property or assets of such
company or any of its subsidiaries, under any of the terms of (x) the
organization documents of such company or its subsidiaries or (y)
subject to the matters described in the eighth
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recital to this Agreement, any material debt or other agreement to which
such company or its subsidiaries or the assets or properties thereof may
be subject; or (B) violate any judgment, ruling, order, writ,
injunction, statute, rule or regulation applicable to such company;
except in the case of clauses (A) and (B) above, for such violations,
conflicts, breaches, defaults, terminations, accelerations or liens
which, in the aggregate, would not have a material adverse effect on the
transactions contemplated hereby or on the condition (financial or
other), business or operations of such company and is subsidiaries,
taken as a whole. Other than under the Act, the federal securities laws,
the "blue sky" regulations of various states, and the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, to the knowledge of such company no
notice to, filing with, or authorization of any domestic or foreign
public body or authority is required for the consummation of the
transactions contemplated hereby.
(iv) Any documents prepared and filed pursuant to the federal
securities laws or any other law or regulation by such company in
connection herewith shall comply in all material respects with such
laws.
(c) VEC and VNGC each represent and warrant to the other than:
(i) With respect to the payment of regular quarterly distributions
on the Common Units, each such party intends that such distributions
continue to be declared and paid at the established quarterly intervals
through the Effective Date in the amount of $0.125 per quarter per
Common Unit, and, except as is disclosed in the preliminary proxy
statement furnished to the Special Committee, knows of no reason why the
regular distribution expected to be considered at a meeting of the Board
of Directors of VNGC scheduled to be held on January 25, 1994 and paid
on or about March 1, 1994 cannot be so declared and paid;
(ii) During the period from the date of this Agreement to the
Effective Time of the Merger, the business of VNGP, L.P. shall continue
to be operated in the ordinary course and in a manner generally
consistent with past practice; and
(iii) If the closing of the Merger occurs more than 30 days after
the last record date for such regular quarterly distribution, VNGP, L.P.
intends and expects to declare and pay to holders of Common Units of
record as of the Effective Date of the Merger a one-time special cash
distribution equal to the product of the regular quarterly distribution
per Common Unit of $.125 and a fraction the numerator of which is the
number of days from and excluding the record date in respect of which
the last regular distribution has been paid to and including the
Effective Date and the denominator of which is 90.
(d) Subject to the terms and conditions hereof, each of the parties
hereto will use all reasonable efforts to take, or cause to be taken, all
actions necessary to consummate the transactions contemplated by this
Agreement. VEC, on behalf of itself and Newco, and VNGC, on behalf of
itself and VNGP, L.P., shall give prompt notice to the other and to the
Special Committee of the occurrence, or failure to occur, of any event
which is, or is reasonably likely to cause, a failure of a representation
or warranty of any party hereunder or the breach of any agreement hereunder
or the failure of the satisfaction of any condition to the Closing
(including the condition that the Public Offering be completed), provided,
however, that no such notification shall affect any party's obligations
hereunder. Each party shall cooperate to correct any information contained
in any document filed in connection herewith or mailed to the Public
Unitholders to the extent any such document shall have become false or
misleading in any material respect. Each party shall, and shall cause its
subsidiaries, officers, directors, employees and agents to, afford each
other party and its officers, directors, employees and agents access at all
reasonable times to its relevant books, records, assets and properties, and
shall furnish all financial, business, operating and other data as such
persons may reasonably request, provided that, subject to the requirements
of law, each such person shall, and shall use reasonable efforts to cause,
all such information to be kept confidential until such time as such
information is otherwise publicly available, provided that no investigation
pursuant hereto shall affect any party's obligations hereunder.
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(e) During the term of this Agreement, VEC and VNGC shall take all
actions necessary such that the Special Committee shall continue in
existence without diminution of its powers or duties and its members shall
consist solely of the members thereof on the date hereof, or any
successors, selected (with the written consent of a majority of the members
of the Special Committee) by the Board of Directors and/or sole stockholder
of VNGC, who are not otherwise employed by or affiliated with VEC or its
affiliates. Any amendment, waiver or extension of time by VNGC or VNGP,
L.P. hereunder, and any action to be taken by VNGC or the Board of
Directors thereof in connection herewith, shall require the concurrence or
consent of a majority of the members of the Special Committee.
(f) Notwithstanding anything herein to the contrary, the Special
Committee may at any time withdraw or modify its recommendation regarding
the transactions contemplated hereby if, and only to the extent that, the
Special Committee, after consultation with and based upon the advice of
outside legal counsel, determines in good faith that such action is
required for the Board of Directors of VNGC to comply with any fiduciary
duties it may have to the Public Unitholders under Delaware law as in
effect from time to time.
3. Conditions to Closing.
(a) The obligations of all the parties to this Agreement to effect the
Merger shall be subject to the fulfillment of the following conditions:
(i) the Merger Agreement shall have been approved by (A) the
affirmative vote of the holders of a majority of the outstanding Common
Units entitled to vote thereon, including Common Units held by
Subsidiary Unitholders, and (B) a majority of the Common Units held by
Public Unitholders and voted at a special meeting of Unitholders (the
"Special Meeting") called to vote upon the Merger;
(ii) there shall not have been any governmental or judicial action,
law or regulation prohibiting, restraining (whether by imposing
additional conditions or covenants or otherwise) or making unlawful the
Merger or prohibiting, restraining or making unlawful the payment or
receipt of cash for Common Units as contemplated by the Merger Agreement
or the Purchase Agreement (defined in Section 4 hereof);
(iii) the parties shall have received any necessary governmental
consents or approvals (including the expiration of all waiting periods
required under the Hart-Scott-Rodino Antitrust Improvements Act of
1976);
(iv) the Internal Revenue Service ("IRS") shall have issued a
response with respect to the private letter ruling request of VNGP, L.P.
dated December 6, 1993, ruling that the proposed Merger, if effected in
the manner described in such private letter ruling request, will not
result in any technical termination of VNGP, L.P.;
(v) the receipt by the Special Committee, VNGC and Newco of a true
and correct copy of the opinion of Dillon, Read & Co, Inc., dated
December 20, 1993, that the consideration to be paid to the Public
Unitholders in connection with the Merger is fair to the Public
Unitholders from a financial point of view (the "Fairness Opinion"); and
(vi) neither the Fairness Opinion, nor the recommendation of the
Special Committee referred to in the recitals of this Agreement, shall
have been withdrawn or modified in any manner materially adverse to VEC,
VNGC, VNGP, L.P. or Newco.
(b) The obligations of Newco to effect the Merger shall also be
subject to the fulfillment of the following conditions, any or all of which
may be waived by Newco in its sole discretion:
(i) any consent, waiver or amendment necessary or desirable in the
opinion of Newco under any Financial Agreement shall have been obtained,
in form and substance reasonably satisfactory to Newco;
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(ii) VEC shall have completed the Public Offering and shall have
received proceeds therefrom, net of all underwriters' discounts and
commissions, equal to not less than the aggregate amount payable to the
Public Unitholders pursuant to Section 1(b)(i); provided, however, that
VEC shall not be obligated by this Agreement to complete the Public
Offering;
(iii) except for changes in the business or condition of the
Partnership, financial or otherwise, or in the results of operations of
the Partnership, occurring prior to the date of this Agreement, or
expected by the management of the General Partner to occur based on
events occurring prior to the date of this Agreement, there shall not
have occurred any material adverse change in the business or condition
of the Partnership, financial or otherwise, or in the results of
operations of the Partnership from that set forth in or contemplated by
the financial statements of the Partnership for the nine months ended
September 30, 1993;
(iv) with the exception of actions, suits, proceedings or claims
described in the draft preliminary proxy statement in the form provided
to the Special Committee (including documents incorporated by reference
therein), there shall not be pending or threatened against VNGP, L.P.,
or any subsidiary of VNGP, L.P., any action, suit or proceeding
involving a claim at law or in equity or before or by any federal,
state, or municipal or other governmental department, commission, board,
business, agency or instrumentality, domestic or foreign, that would be
reasonably likely to have a material adverse effect on the condition,
financial or otherwise, of VNGP, L.P. and, except for developments
occurring prior to the date of this Agreement or expected by the
management of the General Partner to occur based on events occurring
prior to the date of this Agreement in the case of actions, suits or
proceedings described in such preliminary proxy statement, there shall
be no subsequent developments therein adverse to VNGP, L.P. or its
subsidiaries, property or business which, would be reasonably likely to
have a material adverse effect on the condition, financial or otherwise,
of VNGP, L.P.; and
(v) there shall not be pending or threatened against VEC, VNGC,
VNGP, L.P., Newco, or any affiliate of VEC, VNGC, VNGP, L.P., or Newco
or the property or business of VEC, VNGC, VNGP, L.P. or Newco, any other
action, suit or proceeding involving a claim at law or in equity or
before or by any federal, state, or municipal or other government
department, commission, board, bureau, agency or instrumentality,
domestic or foreign, relating to the Merger or the Merger Agreement that
would be reasonably likely to have a material adverse effect on the
condition, financial or otherwise, of VEC, VNGC or VNGP, L.P.
(c) The parties hereto agree that in exercising its discretion to
waive or require the fulfillment of the conditions prescribed in Section
2(b) above, Newco shall not be required to consider the interests of any
person or entity that may be affected by the Merger other than Newco, and
that Newco shall have no obligation, fiduciary or otherwise, to the limited
partners of VNGP, L.P. in exercising its discretion under Section 2(b).
4. Purchase Agreement. Upon the execution of this Agreement by the
parties hereto, VNGC and VNGP, L.P. shall enter into a Purchase Agreement,
in the form attached hereto as Exhibit M-1 and by this reference made a
part hereof for all purposes (the "Purchase Agreement"), pursuant to which
VNGC shall agree to purchase directly from VNGP, L.P., 9,711,919 Common
Units, such Common Units to be acquired on the Effective Date.
5. Valuation of VNGC Obligations. The parties hereto agree and
stipulate that the value of the obligations and undertakings of VNGC under
this Agreement is equal to $117,514,210, representing the purchase of
9,711,919 Common Units from VNGP, L.P. at a purchase price of $12.10 per
Common Unit.
6. Capital Contributions. In connection with the transactions
contemplated by this Agreement and in order to prevent any technical
termination of VNGP, L.P. caused thereby, VNGC, as general partner of VNGP,
L.P., agrees to contribute cash in the amount of not less than $95,542 to
VNGP, L.P. prior to the Effective Time of the Merger. In addition, VNGC
shall cause one or more of its wholly owned subsidiaries that is presently
a limited partner of VNGP, L.P. to contribute cash in the aggregate amount
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of not less than $9,457,335 to VNGP, L.P. prior to the Effective Time of
the Merger; provided however, that if the Merger is for any reason not
consummated, such capital contributions may be withdrawn and shall be
repaid by VNGP, L.P. promptly upon notice from VNGC or such subsidiary.
7. Surrender of Certificates. After the Effective Time, each holder of an
outstanding certificate theretofore representing Common Units (other than VNGC
and the Subsidiary Unitholders) shall surrender such certificate together with
the letter of transmittal furnished to unitholders to VEC, as Transfer Agent for
the Common Units, or any bank designated by VNGP, L.P. pursuant to an agreement
to act as an Exchange Agent (hereinafter so called) under this Agreement. As
soon as practicable after the Effective Time and after surrender to VEC or an
Exchange Agent of any certificate which prior to the Effective Time represented
Common Units, VEC or such Exchange Agent shall deliver, for and on behalf of
VNGC to the person in whose name such certificate has been issued, the amount of
cash the right to which any Common Units previously represented by the
surrendered certificate shall have been converted hereunder. Until surrendered
as contemplated by the preceding sentence, each certificate that immediately
prior to the Effective Time represented any Common Units (other than Common
Units held by VNGC or the Subsidiary Unitholders) shall be deemed at and after
the Effective Time to represent only the right to receive from VNGC upon such
surrender the amount of cash contemplated by the preceding sentence. No service
charges, brokerage commissions or transfer taxes shall be payable by any holder
of any certificate which prior to the Effective Time represented any Common
Units, except that, if any payment is to be made to a person other than the
person in whose name the certificates for Common Units surrendered are
registered, it shall be a condition of such issuance that (i) the person
requesting such issuance shall pay to VEC (or, if appointed, the Exchange Agent)
any transfer taxes payable by reason thereof (or of any prior transfer of such
surrendered certificate) or establish to the satisfaction of VNGC, as general
partner of the surviving entity, that such taxes have been paid or are not
payable, and (ii) such surrendered certificate shall be properly endorsed and
otherwise be in proper form for transfer. VNGP, L.P., VEC or any Exchange Agent
may impose such other reasonable conditions upon the exchange of certificates as
it may deem to be necessary or desirable and as are consistent with the
provisions of this Agreement. No interest shall be accrued or paid upon any cash
payable upon the surrender of certificates.
8. Closing.
(a) The Closing Date shall be the later of the date on which:
(i) All conditions precedent to the obligations of VNGP, L.P., VNGC
and Newco to consummate and effect the Merger contemplated by this
Agreement shall have been satisfied or waived; and
(ii) Such later date as the Chairman of the Board or President of
VNGC and the Chairman of the Board or President of the general partner
of Newco may agree upon in writing.
(b) The closing and consummation of the Merger shall take place at the
offices of VNGC at 530 McCullough Avenue, San Antonio, Texas, or at such
other place as the parties hereto may agree.
9. Further Assurances. If, at any time after the Effective Time, VNGP, L.P.
shall consider or be advised that any deeds, bills of sales, assignments,
assurances or any other actions or things are necessary or desirable to vest,
perfect or confirm of record or otherwise in VNGP, L.P. its right, title or
interest in, to or under any of the rights, properties or assets of Newco as a
result of, or in connection with, the foregoing provisions of this Agreement or
otherwise to carry out the purposes or intent of this Agreement, the general
partner of VNGP, L.P., and any of its officers or directors, shall be authorized
to execute and deliver, in the name and on behalf of Newco, all such deeds,
bills of sale, assignments and assurances, and to take and do, in the name and
on behalf of Newco, all such other actions and things as may be necessary or
desirable to vest, perfect or confirm any and all right, title and interest in,
to and under such rights, properties or assets in VNGP, L.P. or otherwise to
carry out this Agreement. To the extent permitted by applicable law, Newco
hereby makes, constitutes and appoints the general partner of VNGP, L.P., or any
of its officers or directors, with full power of substitution, as the true and
lawful agent and attorney-in-fact for Newco in its name, place and stead to
execute and deliver, in the name and on behalf of Newco, all such deeds, bills
of sale, assignments and assurances, and this
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appointment shall be irrevocable and deemed a special power of attorney coupled
with an interest and shall not terminate but shall survive the dissolution,
winding up and termination or cessation of existence of Newco pursuant to the
Merger.
10. Termination. This Agreement may be terminated and the Merger abandoned at
any time before the Effective Time, notwithstanding the prior approval of the
holders of Common Units or the partners of Newco, by the consent of the Board of
Directors of VNGC (with the prior written consent of a majority of the members
of the Special Committee) and the Board of Directors of the general partner of
Newco. This Agreement shall be terminated by any party and the Merger abandoned
if (a) the Closing Date and consummation of the Merger shall not have occurred
by June 1, 1994, or (b) any governmental or judicial action, law or regulation
shall be enacted or become effective which prohibits, restrains or renders
unlawful the Merger or prohibits, restrains, or renders unlawful the payment or
receipt of cash as contemplated by this Agreement or the Purchase Agreement, or
(c) if the Special Meeting is held but the Public Unitholders do not approve the
Merger as set forth in Section 3(a)(i)(B). Unless such condition is waived by
VEC, the Board of Directors of VNGC (with the written approval of the Special
Committee) and the Board of Directors of the general partner of Newco, this
Agreement shall also be terminated by any party and the Merger abandoned if
either the Fairness Opinion, or the recommendation of the Special Committee
referred to in the recitals to this Agreement, shall have been withdrawn or
modified in any manner materially adverse to VEC, VNGC, VNGP, L.P. or Newco.
This Agreement may be terminated by the Board of Directors of VNGC if VEC or
Newco breaches in any material respect any of its covenants or agreements
contained herein, and by VEC or the Board of Directors of the general partner of
Newco if VNGC or VNGP, L.P. breaches in any material respect any of its
covenants or agreements contained herein. Additionally, this Agreement may be
terminated by VEC or by the Board of Directors of the general partner of Newco
if (i) the governmental consents and approvals referred to in Section 3(a)(iv)
have not been obtained, and the waiting period referred to therein has not
expired, all on or before March 31, 1994; (ii) the IRS shall issue a private
letter ruling to the effect that the Merger will result in a technical
termination of the Partnership or which is otherwise materially adverse to VEC
or Newco; (iii) appropriate consents, waivers and amendments to the Financing
Agreements have not been obtained on or before March 31, 1994, and VEC
reasonably determines that such consents, waivers and amendments cannot be
obtained upon terms and conditions reasonably satisfactory to VEC; (iv) the
Public Offering has not been completed on or before March 31, 1994, and VEC
reasonably determines that the Public Offering cannot be completed upon terms
and conditions reasonably satisfactory to VEC; or (v) in the reasonable opinion
of VEC, an event specified in Section 3(b)(iii) or 3(b)(v) has occurred, or
there has occurred the filing of, or a development in, any action, suit or
proceeding which, unless waived by VEC and Newco, would result in the failure of
a condition to closing the Merger pursuant to Section 3(b)(iv) or (v). In the
event of termination of this Agreement and abandonment of the Merger as provided
herein, this Agreement shall become wholly void and of no effect and there shall
be no liability pursuant to this Agreement on the part of any party hereto or
its respective officers, directors, stockholders, or general or limited
partners.
11. Miscellaneous.
(a) This Agreement may be amended, modified or supplemented upon the
consent of the Board of Directors of VNGC (with the prior written consent
of a majority of the members of the Special Committee) and the Board of
Directors of the general partner of Newco, provided that the approval of a
majority of the Common Units entitled to vote thereon held by Public
Unitholders and voted at a special meeting of Unitholders called to vote
upon such amendment shall first be obtained for any amendment which under
applicable law requires such approval, if the consideration to be received
by the Public Unitholders pursuant to Section 1(b)(i) of this Agreement is
changed or if this Agreement is modified in a manner materially adverse to
the Public Unitholders.
(b) This Agreement may be executed in one or more counterparts, all
of which shall be considered one and the same agreement and shall become
effective when one or more counterparts have been signed by each of the
parties and delivered to the other parties, it being understood that all
parties need not sign the same counterpart.
A-8
<PAGE> 87
(c) It is the intent of the parties that the provisions of this
Agreement shall be enforced to the fullest extent permissible under law. In
the event that any provision would be held invalid or unenforceable in any
jurisdiction for any reason, such provision, as to such jurisdiction, shall
be ineffective without invalidating the remaining provisions hereof,
provided that if such provision could be more narrowly drawn so as not to
be invalid, it shall, as to such jurisdiction, be so narrowly drawn without
affecting the remaining provisions hereof.
(d) All notices and communications hereunder shall be in writing and
shall be deemed to have been duly delivered if delivered personally,
telecopied, by overnight courier or mailed by registered mail, postage
prepaid, to the parties at the following addresses (or such other notices
as the parties may notify the others in writing):
If to VNGC, VNGP, L.P. or the Special Committee:
VALERO NATURAL GAS COMPANY
530 McCullough Avenue
San Antonio, Texas 78215
Attention: Corporate Secretary
with a copy to:
Special Committee of Directors
VALERO NATURAL GAS COMPANY
c/o Dr. Ronald K. Calgaard
President
Trinity University
715 Stadium Drive
San Antonio, Texas 78212-7200
and:
Wachtell, Lipton, Rosen & Katz
299 Park Avenue
New York, New York 10171
Attention: Edward D. Herlihy, Esq.
If to Newco or VEC:
VALERO MERGER PARTNERSHIP, L.P.
c/o Valero Management Company
530 McCullough Avenue
San Antonio, Texas 78215
Attention: Corporate Secretary
(e) No waiver or modification of the terms of this Agreement shall be
valid unless in writing signed by the party to be charged and only to the
extent therein set forth. Any waiver or modification hereunder by VNGC or
VNGP, L.P. must be approved in writing by a majority of the members of the
Special Committee.
(f) This Agreement shall be binding upon and inure to the benefit of
the parties hereto, their respective successors and assigns.
(g) The captions appearing in this Agreement are inserted only as a
matter of convenience and for reference and in no way define, limit or
describe the scope and intent of this Agreement or any of the provisions
hereof.
(h) This Agreement shall be governed by, and construed in accordance
with, the laws of the State of Delaware.
A-9
<PAGE> 88
IN WITNESS WHEREOF, each of the Parties hereto has executed this Agreement the
day and year first above written.
VALERO NATURAL GAS PARTNERS, L.P.
By: VALERO NATURAL GAS COMPANY
its General Partner
By: /s/ DON M. HEEP
Name: Don M. Heep
Title: Vice President Finance
VALERO MERGER PARTNERSHIP, L.P.
By: VALERO MANAGEMENT COMPANY
its General Partner
By: /s/ STAN L. MCLELLAND
Name: Stan L. McLelland
Title: Executive Vice President
VALERO NATURAL GAS COMPANY
By: /s/ DON M. HEEP
Name: Don M. Heep
Title: Vice President Finance
VALERO ENERGY CORPORATION
By: /s/ STAN L. MCLELLAND
Name: Stan L. McLelland
Title: Executive Vice President
A-10
<PAGE> 89
SCHEDULE 1 TO AGREEMENT OF MERGER
COMMON UNITS HELD BY SUBSIDIARY UNITHOLDERS
- - - - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON UNITS
SUBSIDIARY BENEFICIALLY OWNED
<S> <C>
-----------------------------------------------------------------------------------------
VT Company............................................................ 7,374,282
VM Company............................................................ 510,970
VH Company............................................................ 412,626
Rio Pipeline Company.................................................. 214,051
Val Gas Company....................................................... 117,965
Reata Industrial Gas Company.......................................... 42,552
Valero Management Company............................................. 38,081
Valero Gathering Company.............................................. 25,210
VLDC Company.......................................................... 15,126
V.H.C. Pipeline Company............................................... 14,476
Valero Industrial Gas Company......................................... 9,280
---------
8,774,619
---------
---------
</TABLE>
- - - - - --------------------------------------------------------------------------------
<PAGE> 90
EXHIBIT M-1
PURCHASE AGREEMENT
This Purchase Agreement ("Agreement") dated December 20, 1993 is between Valero
Natural Gas Partners, L.P., a Delaware limited partnership (the "Partnership"),
and Valero Natural Gas Company, a Delaware corporation (the "Company").
WHEREAS, pursuant to an Agreement of Merger dated December 20, 1993 (the "Merger
Agreement") among the Partnership, Valero Merger Partnership, L.P., a Delaware
limited partnership ("Newco"), and the Company, and subject to the terms and
conditions thereof, among other things, (i) Newco will merge with and into the
Partnership (the "Merger"), and (ii) certain former holders of the common units
of limited partner interests in the Partnership (the "Common Units") will be
entitled to receive $12.10 per Common Unit from the Company (the "Merger
Consideration"); and
WHEREAS, the Partnership desires to issue and sell, and the Company desires to
buy, 9,711,919 common units of limited partner interests in the Partnership (as
surviving partnership to the Merger) (the "New Units") in exchange for the
Company's promise to pay to the former holders of Common Units the Merger
Consideration after the effective time of the Merger, as set forth in the Merger
Agreement.
NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency
are hereby acknowledged, the parties hereto hereby agree:
1. Subject to the closing of the Merger as provided in the Merger Agreement, the
Company hereby agrees to purchase from the Partnership, and the Partnership
agrees to issue and sell to the Company, 9,711,919 New Units in exchange for the
Company's promise to pay the Merger Consideration pursuant to the Merger
Agreement.
2. The closing shall take place on the Closing Date (as defined in the Merger
Agreement), immediately following the Effective Time of the Merger (as such term
is defined in the Merger Agreement). At the closing, the Partnership shall
deliver to the Company or its representative a certificate or certificates
representing the New Units registered in the name of the Company.
3. The parties hereto agree and stipulate that the agreed value of the
obligations and undertakings of the Company under this Agreement (for purposes
of the Delaware Revised Uniform Limited Partnership Act and the Second Amended
and Restated Agreement of Limited Partnership of the Partnership) is equal to
$117,514,210, representing the purchase of 9,711,919 New Units from the
Partnership at a purchase price of $12.10 per New Unit.
4. This Agreement may be amended in writing by the parties hereto. This
Agreement shall terminate upon termination of the Merger Agreement. No waiver or
modification of the terms of this Agreement shall be valid unless in writing
signed by the party to be charged and only to the extent therein set forth. This
Agreement shall be binding upon and inure to the benefit to the parties hereto,
their respective successors and assigns. This Agreement shall be governed by,
and construed in accordance with, the laws of the State of Delaware.
<PAGE> 91
NOW THEREFORE, the parties have executed this Agreement as of the date first
written above.
VALERO NATURAL GAS COMPANY
By /s/ DON M. HEEP
______________________________
Name: Don M. Heep
Title: Vice President Finance
VALERO NATURAL GAS PARTNERS, L.P.
By: VALERO NATURAL GAS COMPANY,
its General Partner
By /s/ DON M. HEEP
______________________________
Name: Don M. Heep
Title: Vice President Finance
<PAGE> 92
ANNEX B
DILLON, READ & CO. INC.
535 MADISON AVENUE
NEW YORK, NEW YORK 10022
212-906-7000
April 27, 1994
Special Committee of the
Board of Directors
Valero Natural Gas Company
General Partner of Valero Natural Gas Partners, L.P.
530 McCullough Avenue
San Antonio, Texas 78215
Gentlemen:
You have requested our opinion as to the fairness from a financial point of view
to the holders (the "Public Unitholders") of Valero Natural Gas Partners, L.P.
(the "Partnership") common units ("Common Units"), other than Valero Energy
Corporation ("Valero") and its affiliates, of the consideration to be received
by them pursuant to the proposed merger ("Merger") of the Partnership with
Valero Merger Partnership, L.P. ("Newco"). The Merger is to be effected pursuant
to a Merger Agreement (the "Merger Agreement") dated as of December 20, 1993
among the Partnership, Newco, Valero Natural Gas Company ("VNGC"), the general
partner of the Partnership and a wholly-owned subsidiary of Valero, and Valero.
The Merger Agreement provides that, upon consummation of the Merger, each issued
and outstanding Common Unit owned by the Public Unitholders will be converted
into the right to receive from VNGC cash in the amount of $12.10 per Common
Unit. The conditions precedent to consummation of the Merger include the
condition that the Merger shall be approved by the affirmative vote of a
majority of the Common Units held by the Public Unitholders and voted at a
meeting of the holders of the Common Units called for such purpose, and the
condition that the Merger shall be consummated by June 1, 1994.
Dillon, Read & Co. Inc. is acting as financial advisor to the Special Committee
of the Board of Directors of VNGC in connection with the Merger.
On December 20, 1993, we rendered our opinion (the "First Opinion") that, as of
the date thereof and based on and subject to the matters discussed therein, the
consideration to be received in the Merger by the Public Unitholders was fair to
the Public Unitholders from a financial point of view. In light of certain
developments since the date of our First Opinion discussed below and having been
advised that the Partnership is now prepared to solicit proxies pursuant to a
definitive proxy statement (the "Proxy Statement") relating to a meeting of
Unitholders called to consider the Merger, we elected to review and update our
First Opinion.
In arriving at our First Opinion, we reviewed certain business and financial
information relating to the Partnership, including certain financial forecasts
provided to us by the Partnership, and we reviewed and discussed the business
and prospects of the Partnership with the senior managements of the Partnership
and Valero. We considered certain financial and stock market data relating to
the Partnership and the Common Units, and we compared that information to
similar data for publicly-held companies in businesses similar to that of the
Partnership. We also considered the financial terms of certain transactions
involving the acquisition by controlling entities of noncontrol equity positions
in publicly-owned companies and certain recent acquisitions of properties
similar to those owned by the Partnership.
In connection with our review of our First Opinion and before rendering this
opinion (the "Current Opinion"), we requested and received from the Partnership
and reviewed, where available, more recent business and
<PAGE> 93
financial information relating to the Partnership, including recent revisions to
the financial forecasts referenced above as well as the information contained in
the Partnership's reports filed with the Securities and Exchange Commission
pursuant to Section 13 of the Securities Exchange Act of 1934, as amended.
Inconnection with both opinions, we considered such other information, financial
studies and analyses, and financial, economic and market criteria as we deemed
relevant.
In connection with our reviews, we did not independently verify any of the
foregoing information and, with your consent, we relied on its being complete
and accurate in all material respects. We did not make an independent evaluation
or appraisal of any assets or liabilities (contingent or otherwise) of the
Partnership or its subsidiaries, nor were we furnished with any such appraisal.
With respect to the financial forecasts provided to us, we utilized certain
information set forth therein and assumed that such information was reasonably
prepared on bases reflecting the best currently available estimates and
judgments of the managements of the Partnership and Valero as to the future
financial performance of the Partnership.
In connection with our First Opinion, we were requested not to approach and we
did not approach any unaffiliated persons or entities with respect to the
acquisition of the Partnership or any of its subsidiaries or any of their
assets. We are aware, however, that, since our First Opinion, Valero and then
VNGC received an unsolicited offer from an unaffiliated third party (the
"Offeror") to acquire all the Units owned by Valero for $16 in cash and, if the
offer were accepted by Valero, to offer to acquire Units from the Public
Unitholders on the same basis, and we have been apprised of subsequent, related
events to be described in the Proxy Statement.
In rendering both Opinions, we took into account (i) the fact that, given
Valero's ownership of an effective equity interest of approximately 49% in the
Partnership, the role of its wholly-owned subsidiary as general partner of the
Partnership and Valero's stated unwillingness to sell its interests in the
Partnership, a sale of the Common Units held by the Public Unitholders to a
third party was unlikely, (ii) the probability of a return of Common Unit market
prices to pre-October 1993 levels if the Offer were withdrawn, (iii) the
prospects for the Partnership given its current structure and ownership in the
current environment if the Offer were withdrawn, and (iv) representations
contained in the Merger Agreement regarding the continuation of Partnership
distributions during the pendency of the Merger Agreement and the payment,
subject to specified conditions, of an interim Partnership distribution through
the date of consummation of the Merger. Moreover, in rendering the Current
Opinion, we took into account (a) the position of the Offeror, as stated to the
Special Committee and independently confirmed by us, that, absent a
relinquishment of some portion of control of the assets and businesses of the
Partnership by Valero, the Offeror was unwilling to pursue any transaction
involving payment of a premium over the market price for Units held by the
Public Unitholders and (b) the agreement of Valero, as more fully described in
the Proxy Statement, to pay or cause to be paid to those persons who were Public
Unitholders on the effective date of the Merger an amount in cash equal to the
difference, if any, between $12.10 and the fair value of any greater amount of
consideration per Unit realized by Valero as a result of any sale of a
controlling interest in the Partnership during the two years following the
Merger (reduced by the amount of any capital contributions made by Valero to the
Partnership after the date of the Merger).
Our Current Opinion is based on economic, monetary and market conditions
existing on the date hereof.
Based upon and subject to the foregoing, we are of the opinion that the
consideration to be received in the Merger by the Public Unitholders is fair to
the Public Unitholders from a financial point of view as the date hereof.
Very truly yours,
Dillon, Read & Co. Inc.
By: /s/ JAMES W. HUNT
_________________________
James W. Hunt
Managing Director
<PAGE> 94
ANNEX C
CONSOLIDATED FINANCIAL STATEMENTS OF VNGP, L.P.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
AUDITED FINANCIAL STATEMENTS:
Report of Independent Public Accountants............................................ C-2
Consolidated Balance Sheets as of December 31, 1993 and 1992........................ C-3
Consolidated Statements of Income for the years ended December 31, 1993, 1992 and
1991............................................................................. C-4
Consolidated Statements of Partners' Capital for the years ended December 31, 1993,
1992 and 1991.................................................................... C-5
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1992
and 1991......................................................................... C-6
Notes to Consolidated Financial Statements.......................................... C-7
</TABLE>
C-1
<PAGE> 95
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Valero Natural Gas Company as General Partner of
Valero Natural Gas Partners, L.P. and to the Common Unitholders:
We have audited the accompanying consolidated balance sheets of Valero Natural
Gas Partners, L.P. (a Delaware limited partnership) as of December 31, 1993 and
1992, and the related consolidated statements of income, partners' capital and
cash flows for each of the three years in the period ended December 31, 1993.
These financial statements and the schedules referred to below are the
responsibility of the Partnership's management. Our responsibility is to express
an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Valero Natural Gas Partners,
L.P. as of December 31, 1993 and 1992, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1993, in
conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supplemental schedules V, VI and IX
are presented for purposes of complying with the Securities and Exchange
Commission's rules and are not part of the basic financial statements. These
schedules have been subjected to the auditing procedures applied in the audits
of the basic financial statements and, in our opinion, fairly state in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN & CO.
San Antonio, Texas
February 17, 1994
C-2
<PAGE> 96
VALERO NATURAL GAS PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
- - - - - -----------------------------------------------------------------------------------------------
DECEMBER 31,
------------------------
1993 1992
- - - - - -----------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments................................ $ 5,523 $ 6,598
Cash held in debt service escrow................................... 34,186 32,864
Receivables, less allowance for doubtful accounts of $2,102
(1993) and $633 (1992).......................................... 154,503 171,660
Inventories........................................................ 25,434 35,080
Prepaid expenses and other......................................... 5,321 8,273
224,967 254,475
PROPERTY, PLANT AND EQUIPMENT-including construction in
progress of $16,728 (1993) and $14,341 (1992), at cost............. 939,565 916,734
Less: Accumulated depreciation.................................. 199,763 173,518
739,802 743,216
DEFERRED CHARGES AND OTHER ASSETS.................................... 80,313 86,790
$1,045,082 $1,084,481
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Current maturities of long-term debt and capital lease
obligations..................................................... $ 28,908 $ 26,121
Accounts payable................................................... 216,953 237,176
Accrued interest................................................... 18,692 16,710
Other accrued expenses............................................. 8,719 7,422
273,272 287,429
LONG-TERM DEBT, less current maturities.............................. 506,429 534,286
CAPITAL LEASE OBLIGATIONS, less current maturities................... 103,787 104,075
DEFERRED CREDITS AND OTHER LIABILITIES............................... 1,548 2,672
LIMITED PARTNERS' CAPITAL............................................ 158,448 154,461
GENERAL PARTNERS' CAPITAL............................................ 1,598 1,558
$1,045,082 $1,084,481
- - - - - -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
C-3
<PAGE> 97
VALERO NATURAL GAS PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER UNIT AMOUNTS)
- - - - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1993 1992 1991
<S> <C> <C> <C>
- - - - - ----------------------------------------------------------------------------------------------
OPERATING REVENUES..................................... $1,326,458 $1,197,129 $1,144,001
COSTS AND EXPENSES:
Cost of sales........................................ 1,090,363 954,600 896,322
Operating expenses................................... 120,171 118,284 108,614
Depreciation expense................................. 36,446 34,404 39,231
Total........................................ 1,246,980 1,107,288 1,044,167
OPERATING INCOME....................................... 79,478 89,841 99,834
OTHER INCOME, NET...................................... 1,263 624 4,013
INTEREST AND DEBT EXPENSE:
Incurred............................................. (68,007) (66,679) (67,532)
Capitalized.......................................... 1,713 1,200 721
NET INCOME............................................. 14,447 24,986 37,036
Less: General Partners' Interest..................... 1,217 1,596 1,973
NET INCOME ALLOCABLE TO LIMITED PARTNERS............... $ 13,230 $ 23,390 $ 35,063
NET INCOME PER LIMITED PARTNER UNIT.................... $ .72 $ 1.27 $ 1.90
WEIGHTED AVERAGE LIMITED PARTNER UNITS OUTSTANDING (in
thousands)........................................... 18,487 18,487 18,487
</TABLE>
- - - - - --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
C-4
<PAGE> 98
VALERO NATURAL GAS PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
(THOUSANDS OF DOLLARS)
- - - - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIMITED PARTNERS' CAPITAL
------------------------------------------------------------------------------------------
GENERAL
PREFERENCE COMMON PREFERENCE COMMON PARTNERS'
UNITS UNITS TOTAL UNITHOLDERS UNITHOLDERS TOTAL CAPITAL
<S> <C> <C> <C> <C> <C> <C> <C>
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
BALANCE -- December 31, 1990.......... 9,690,980 8,795,558 18,486,538 $ 151,436 $ 18,518 $ 169,954 $ 1,611
Net income.......................... -- -- -- 14,307 20,756 35,063 1,973
Distributions....................... -- -- -- (24,277) (21,939) (46,216) (1,820)
Conversion of Common Units to
Preference Units.................. 26,400 (26,400) -- 35 (35) -- --
BALANCE -- December 31, 1991.......... 9,717,380 8,769,158 18,486,538 141,501 17,300 158,801 1,764
Net income.......................... -- -- -- 231 23,159 23,390 1,596
Distributions....................... -- -- -- (12,188) (15,542) (27,730) (1,802)
Conversion of Common Units to
Preference Units.................. 32,620 (32,620) -- 54 (54) -- --
Conversion of Preference Units to
Common Units upon termination
of the Preference Period.......... (9,750,000) 9,750,000 -- (129,598) 129,598 -- --
BALANCE -- December 31, 1992.......... -- 18,486,538 18,486,538 -- 154,461 154,461 1,558
Net income.......................... -- -- -- -- 13,230 13,230 1,217
Distributions....................... -- -- -- -- (9,243) (9,243) (1,177)
BALANCE -- December 31, 1993.......... -- 18,486,538 18,486,538 $ -- $ 158,448 $ 158,448 $ 1,598
</TABLE>
- - - - - --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
C-5
<PAGE> 99
VALERO NATURAL GAS PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
- - - - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1993 1992 1991
<S> <C> <C> <C>
- - - - - -----------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................... $ 14,447 $24,986 $37,036
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation expense...................................... 36,446 34,404 39,231
Amortization of deferred charges and other, net........... 2,459 3,520 3,075
Changes in current assets and current liabilities......... 13,364 26,676 (1,336)
Changes in deferred items and other, net.................. 3,765 (11,700) 6,275
Net cash provided by operating activities............... 70,481 77,886 84,281
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital additions............................................ (36,061) (35,893) (33,074)
Dispositions of property, plant and equipment................ 2,585 934 7,926
Other, net................................................... 334 1,493 269
Net cash used in investing activities................... (33,142) (33,466) (24,879)
CASH FLOWS FROM FINANCING ACTIVITIES:
Reduction of long-term debt and capital lease obligations.... (26,119) (22,971) (17,500)
Increase in cash held in debt service escrow for principal... (1,875) (1,875) (4,018)
Proceeds from unexpended debt proceeds held by trustee....... -- -- 937
Partnership distributions.................................... (10,420) (29,532) (48,036)
Net cash used in financing activities................... (38,414) (54,378) (68,617)
NET DECREASE IN CASH AND TEMPORARY CASH INVESTMENTS............ (1,075) (9,958) (9,215)
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD..... 6,598 16,556 25,771
CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD........... $ 5,523 $ 6,598 $16,556
</TABLE>
- - - - - --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
C-6
<PAGE> 100
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Control
Valero Natural Gas Partners, L.P. ("VNGP, L.P."), Valero Management Partnership,
L.P. (the "Management Partnership") and various subsidiary operating
partnerships (the "Subsidiary Operating Partnerships"), all Delaware limited
partnerships, are the successors to substantially all of the natural gas and
natural gas liquids businesses, assets and liabilities of substantially all of
the subsidiaries of Valero Natural Gas Company ("VNGC") and the transmission
division of Rio Grande Valley Gas Company ("Rio"). VNGC is, and Rio at the time
of such succession was, a wholly owned subsidiary of Valero Energy Corporation
(unless otherwise required by the context, the term "Energy" as used herein
refers to Valero Energy Corporation and its consolidated subsidiaries, both
individually and collectively). VNGC is the general partner of VNGP, L.P. and
the Management Partnership (in such capacity, the "General Partner"), while
subsidiaries of VNGC are general partners (the "Subsidiary General Partners") of
the respective Subsidiary Operating Partnerships.
In March 1987, VNGP, L.P. sold in an underwritten public offering 9.5 million
preference units of limited partner interests (the "Preference Units"),
representing a 52% limited partner interest in VNGP, L.P. VNGP, L.P.
concurrently issued approximately 8.6 million common units of limited partner
interests (the "Common Units"), representing a 47% limited partner interest, to
subsidiaries of Energy, and issued a 1% general partner interest in VNGP, L.P.
to VNGC. Subsequent to March 1987, VNGP, L.P. issued .4 million additional
Common Units to a subsidiary of Energy. In addition, approximately .2 million
Common Units held by a subsidiary of Energy were transferred to employees of
Energy and converted into Preference Units in connection with an employee
benefit plan adopted by Energy. During 1992, all outstanding Preference Units
were automatically converted into Common Units (see "Allocation of Net Income
and Cash Distributions"). The original Common Units and former Preference Units
converted into Common Units are collectively referred to herein as the "Units."
Holders of the Units are referred to herein as the "Unitholders."
Under the partnership structure, VNGP, L.P. holds a 99% limited partner interest
and VNGC holds a 1% general partner interest in the Management Partnership. The
Management Partnership in turn holds a 99% limited partner interest and various
wholly owned subsidiaries of VNGC each hold a 1% general partner interest in the
various Subsidiary Operating Partnerships to which the acquired businesses,
assets and liabilities were transferred. Valero Transmission, L.P.
("Transmission"), one of the Subsidiary Operating Partnerships, owns and
operates the principal pipeline system of the Partnership. (References to
Transmission prior to March 25, 1987 refer to Valero Transmission Company, a
wholly owned subsidiary of VNGC, and after that date to its successor in
interest, Valero Transmission, L.P.) Transmission is principally a transporter
of natural gas as it transports gas for affiliates and third parties.
Transmission also sells natural gas to intrastate customers under long-term
contracts; however, most of the Partnership's gas sales are made through other
Subsidiary Operating Partnerships which operate special marketing programs
("SMPs"). Subsequent to March 1987, VNGP, L.P. acquired a wholly owned
subsidiary that makes certain intrastate gas sales, and formed certain
subsidiary partnerships, one of which leases certain assets from Energy under
capital leases as described in Note 5. Also, during 1992, an additional
Subsidiary Operating Partnership was formed to make certain intrastate gas
sales. VNGP, L.P., the Management Partnership, the original Subsidiary Operating
Partnerships and the additional entities acquired or formed subsequent to March
1987 are collectively referred to herein as the "Partnership." As of December
31, 1993, Energy's total effective equity interest in the Partnership was
approximately 49%.
In October 1993, Energy publicly announced its proposal to acquire the 9.7
million issued and outstanding Common Units in VNGP, L.P. held by persons other
than Energy (the "Public Unitholders") pursuant to a merger of VNGP, L.P. with a
wholly owned subsidiary of Energy. The Board of Directors of VNGC appointed a
special committee of outside directors (the "Special Committee") to consider the
merger and to determine the fairness of the transaction to the Public
Unitholders. The Special Committee thereafter retained
C-7
<PAGE> 101
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
independent financial and legal advisors to assist the Special Committee. Upon
the recommendation of the Special Committee, the Board of Directors of VNGC
unanimously approved the merger. Effective December 20, 1993, Energy, VNGP, L.P.
and VNGC entered into an agreement of merger (the "Merger Agreement") providing
for the merger. In the merger, the Common Units held by the Public Unitholders
will be converted into the right to receive cash in the amount of $12.10 per
Common Unit. As a result of the merger, VNGP, L.P. would become a wholly owned
subsidiary of Energy.
Consummation of the merger is subject to, among other things, (i) approval of
the Merger Agreement by the holders of a majority of the issued and outstanding
Common Units; (ii) approval by the holders of a majority of the Common Units
held by the Public Unitholders and voted at a special meeting of holders of
Common Units to be called to consider the Merger Agreement; (iii) receipt of
satisfactory waivers, consents or amendments to certain of Energy's financial
agreements; and (iv) completion of an underwritten public offering of
convertible preferred stock by Energy. Energy currently owns approximately 47.5%
of the outstanding Common Units and intends to vote its Common Units in favor of
the merger.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and are not the basis
for reporting taxable income to Unitholders. The consolidated financial
statements include the accounts of VNGP, L.P. and its consolidated subsidiaries.
All significant interpartnership transactions have been eliminated in
consolidation.
Statements of Cash Flows
In order to determine net cash provided by operating activities, net income has
been adjusted by, among other things, changes in current assets and current
liabilities, excluding changes in cash and temporary cash investments, cash held
in debt service escrow for principal (see Note 3), and current maturities of
long-term debt and capital lease obligations. Those changes, shown as an
(increase)/decrease in current assets and an increase/ (decrease) in current
liabilities, are provided in the following table. Temporary cash investments are
highly liquid low-risk debt instruments which have a maturity of three months or
less when acquired and whose carrying amount approximates fair value. (Dollars
in thousands.)
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------------
1993 1992 1991
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash held in debt service escrow for interest........... $ 553 $ 483 $ 343
Receivables, net........................................ 17,157 3,118 19,963
Inventories............................................. 9,646 (656) (10,430)
Prepaid expenses and other.............................. 2,952 (3,679) (2,005)
Accounts payable........................................ (20,223) 31,504 (13,277)
Accrued interest........................................ 1,982 (2,653) 2,011
Other accrued expenses.................................. 1,297 (1,441) 2,059
-------- ------- --------
Total......................................... $ 13,364 $26,676 $ (1,336)
-------- ------- --------
-------- ------- --------
---------------------------------------------------------------------------------------
</TABLE>
Cash interest paid by the Partnership (net of amounts capitalized) for the years
ended December 31, 1993, 1992 and 1991 was $62.7 million, $66.4 million and
$62.5 million, respectively. No cash payments for federal income taxes were made
during these periods as the Partnership is not subject to federal income taxes
(see "Income Taxes" below). Cash payments for state income taxes made during
these periods were insignificant.
C-8
<PAGE> 102
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Noncash investing and financing activities for the years ended December 31, 1992
and 1991 included $26 million and $75 million, respectively, of various natural
gas and natural gas liquids facilities acquired by the Partnership through
capital lease transactions entered into with Energy. See Note 5.
Transactions with Energy
The Partnership enters into various types of transactions with Energy in the
normal course of business on market-related terms and conditions. The
Partnership is charged a management fee for the direct and indirect costs
incurred by Energy on behalf of the Partnership that are associated with
managing its operations. The Partnership sells natural gas and natural gas
liquids ("NGLs") to, and purchases NGLs from, Energy's refining subsidiary. The
Partnership sold natural gas to Energy's retail natural gas distribution
business operated by Rio until September 30, 1993, when Rio was sold by Energy.
The Partnership operates for a fee two natural gas processing plants and related
facilities for Energy and sells natural gas to, purchases natural gas and NGLs
from, and processes natural gas owned by Energy in connection with these NGL
operations. The Partnership also enters into other operating transactions with
Energy, including certain leasing transactions discussed in Note 5. As of
December 31, 1993 and 1992, the Partnership had recorded approximately $31.8
million and $13.5 million, respectively, of accounts payable and accrued
expenses, net of accounts receivable, due to Energy.
During the fourth quarter of 1992, the Partnership recognized a charge to
earnings through the management fee billed by Energy of approximately $4.4
million, or $.23 per limited partner unit, representing the Partnership's
allocable portion of the cost of a voluntary early retirement program
implemented by Energy.
The following table summarizes transactions between the Partnership and Energy
for the years ended December 31, 1993, 1992 and 1991 (in thousands):
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------------
1993 1992 1991
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
NGL sales to and services for Energy.................... $98,590 $96,696 $86,936
Natural gas sales to Energy............................. 59,735 50,991 38,072
Purchases of NGLs and natural gas, and transportation
and other charges from Energy......................... 38,868 54,674 19,752
Interest expense from capital lease transactions with
Energy................................................ 12,828 10,071 9,584
Management fees for direct and indirect costs billed by
the General Partner and affiliated companies.......... 80,727 82,024 73,324
---------------------------------------------------------------------------------------
</TABLE>
The direct and indirect costs incurred by the General Partner on behalf of the
Partnership that are charged to the Partnership through the management fee
include, among other things, salaries and wages and other employee-related
costs. Effective January 1, 1993, Energy adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards ("SFAS") No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions." This
statement requires a change in Energy's accounting for postretirement benefits
other than pensions from a pay-as-you-go basis to an accrual basis of
accounting. Energy is amortizing the transition obligation over 20 years, which
is greater than the average remaining service period until eligibility of active
plan participants. As a result of Energy's adoption of this statement, the
Partnership's proportionate share of other postretirement employee benefits
included in the management fee in 1993 increased by approximately $1.5 million
and the Partnership's proportionate share of the total accumulated
postretirement benefit obligation at December 31, 1993 was approximately $15
million. The adoption of this statement by Energy did not affect the
Partnership's cash flows in 1993, nor is it expected to affect the Partnership's
future cash flows, as Energy expects to continue to fund its postretirement
benefits
C-9
<PAGE> 103
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
other than pensions, and require reimbursement from the Partnership for the
Partnership's proportionate share of such funding, on a pay-as-you-go basis.
Gas Sales and Transportation
In the course of making gas sales and providing transportation services to
customers, Transmission experiences measurement and other volumetric differences
related to the amounts of gas received and delivered. Transmission has in the
past experienced overall net volume gains due to such differences and its Rate
Order allows such volumes to be sold to its customers. Transmission historically
has derived a substantial benefit from such sales. The amount included in
operating income in 1993 was substantially the same as in 1992. However, the
implementation of more precise gas measurement equipment and standards and the
reduction in Transmission's total sales volumes, discussed in Note
6 -- "Customer Audit of Transmission", is expected to reduce operating income
from such sales in future periods.
Inventories
Inventories are carried principally at weighted average cost not in excess of
market. Inventories as of December 31, 1993 and 1992 were as follows (in
thousands):
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
DECEMBER 31,
-------------------
1993 1992
--------------------------------------------------------------------------------------
<S> <C> <C>
Natural gas in underground storage............................... $23,184 $27,768
Natural gas liquids.............................................. 2,250 7,312
$25,434 $35,080
--------------------------------------------------------------------------------------
</TABLE>
In addition to the above noted natural gas storage inventories, which are
located at the Wilson Storage Facility in Wharton County, Texas (see Note 5),
the Partnership also had natural gas in third-party storage facilities,
available under exchange agreements, totalling $10.8 million and $1.2 million at
December 31, 1993 and 1992, respectively. Such amounts are included in
receivables in the accompanying consolidated balance sheets.
Property, Plant and Equipment
Property, plant and equipment at date of inception of the Partnership was
increased by the excess of the acquisition cost of the holders of the Preference
Units over VNGC's historical net cost basis. Accordingly, approximately 51% of
property, plant and equipment was recorded at fair value reflecting the value
attributable to the holders of the Preference Units while the remaining 49% was
recorded at historical net book cost to reflect the value attributable to the
General Partner and the holders of the original Common Units.
Property additions and betterments include capitalized interest and acquisition
and administrative costs allocable to construction and property purchases.
Assets under capital leases are included in property, plant and equipment and
are recorded at the lesser of the fair value of the leased property at the
inception of the lease or the present value of the related future minimum lease
payments.
The costs of minor property units (or components thereof), net of salvage,
retired or abandoned are charged or credited to accumulated depreciation. Gains
or losses on sales or other dispositions of major units of property are credited
or charged to income.
C-10
<PAGE> 104
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Provision for depreciation of property, plant and equipment is made primarily on
a straight-line basis over the estimated useful lives of the depreciable
facilities. Assets under capital leases are depreciated on a straight-line basis
over the lease term. The rates for depreciation are as follows:
<TABLE>
<S> <C>
--------------------------------------------------------------------------
Natural gas facilities........................................ 2 1/4% -- 20%
Natural gas liquids facilities................................ 4 1/2% -- 20%
--------------------------------------------------------------------------
</TABLE>
During the fourth quarter of 1992, the Partnership extended the estimated useful
lives of the majority of its natural gas liquids facilities from 14 to 20 years
to better reflect the estimated periods during which such assets are expected to
remain in service. The effect of this change in accounting estimate, which was
made retroactive to January 1, 1992, was to decrease depreciation expense and
increase net income for 1992 by approximately $5.6 million, or $.29 per limited
partner unit.
Other Assets
Payments made or agreed to be made in connection with the settlement of certain
disputed contractual issues with gas suppliers of Transmission are initially
deferred. The balance of such payments is subsequently reduced as recoveries are
made through Transmission's rates. The balance of deferred gas costs of $67
million and $72 million at December 31, 1993 and 1992, respectively, is included
in noncurrent other assets and is expected to be recovered over future periods.
See Note 6 -- "Customer Audit of Transmission."
Debt issuance costs are included in deferred charges and other assets and are
amortized by the effective interest method over the term of each respective
issue of the Management Partnership's First Mortgage Notes ("First Mortgage
Notes"). See Note 3.
Income Taxes
Income and deductions of the Partnership for federal income tax purposes are
includable in the tax returns of the individual partners. Accordingly, no
recognition has been given to federal income taxes in the accompanying
consolidated financial statements of the Partnership. At December 31, 1993 and
1992, the net difference between the tax bases and the reported amounts of
assets and liabilities in the accompanying Consolidated Balance Sheets was $314
million and $322 million, respectively. Under the Revenue Act of 1987, certain
publicly traded limited partnerships will be taxed as corporations after
December 31, 1997 unless specifically exempted. This Act exempted natural
resource partnerships including those dealing with natural gas transportation
and processing of natural gas liquids, such as the Partnership, from its
taxation provision.
Price Risk Management Activities
The Partnership, through its Market Center Services Program established in 1992,
enters into exchange-traded futures and options contracts, forward contracts,
swaps and other financial instruments with third parties to hedge natural gas
inventories and certain anticipated natural gas purchase requirements in order
to minimize the risk of market fluctuations. The Partnership also utilizes such
price risk management techniques to provide services to gas producers and end
users. Changes in the market value of these contracts are deferred until the
gain or loss is recognized on the hedged transaction. As of December 31, 1993
and 1992, the Partnership had outstanding contracts for natural gas totalling
approximately 15.0 billion cubic feet ("Bcf") and 4.8 Bcf, respectively, for
which the Partnership is the fixed price payor and 27.1 Bcf and 10.0 Bcf,
respectively, for which the Partnership is the fixed price receiver. Such
contracts run for a period of one to twelve months. A portion of such contracts
represented hedges of natural gas volumes in underground storage and in
third-party storage facilities which totalled approximately 10.3 Bcf and 7.4 Bcf
at December 31, 1993 and 1992, respectively. See "Inventories" above.
C-11
<PAGE> 105
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1993 and 1992, the Partnership recognized $18.7 million and $12.9 million,
respectively, in gas cost reductions and other benefits from this program. An
additional $5.1 million and $3.6 million in other reductions of cost of gas was
generated by transactions entered into in 1993 and 1992, respectively, which is
recognized in income in the subsequent year as the related gas is sold.
Allocation of Net Income and Cash Distributions
Net income is allocated to partners based on their effective ownership interest
in the operating results of the Partnership, except that additional depreciation
expense pertaining to the excess of the Partnership's acquisition cost over the
historical cost basis in net property, plant and equipment and certain other
assets in which the former holders of Preference Units have an ownership
interest is allocated solely to such holders as a noncash charge to net income.
The allocation of additional depreciation expense to the former holders of
Preference Units does not affect the cash distributions with respect to the
Units. Under the Partnership structure, the income of the Subsidiary Operating
Partnerships is allocated to the Subsidiary General Partners, which hold a 1%
general partner interest, and to the Management Partnership, which holds a 99%
limited partner interest. As a result, net income allocable to the Subsidiary
General Partners is not reduced by interest expense associated with the
Management Partnership's First Mortgage Notes.
The Partnership is required to make quarterly cash distributions with respect to
all Units in an amount equal to "Distributable Cash Flow" as defined in the
Second Amended and Restated Agreement of Limited Partnership of VNGP, L.P. (the
"Partnership Agreement") and as determined by the General Partner. With the
payment on May 30, 1992 of the cash distribution of $.625 per Unit for the first
quarter of 1992, the Partnership completed the payment of cumulative cash
distributions of $12.50 per Preference Unit resulting in the termination of the
period (the "Preference Period") during which the holders of Preference Units
were entitled to a preferential distribution amount. As a result of the
termination of the Preference Period, all outstanding Preference Units were
automatically converted into Common Units in accordance with the terms of the
Partnership Agreement. The Partnership subsequently reduced cash distributions
to $.125 per Unit for the remaining quarters of 1992 and the first three
quarters of 1993. On January 25, 1994, the VNGC Board of Directors declared a
cash distribution of $.125 per Unit for the fourth quarter of 1993 that is
payable March 1, 1994 to holders of record as of February 7, 1994. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a discussion of factors that have reduced the amount of cash
available for distribution to Unitholders.
If the proposed merger with Energy described above under "Organization and
Control" occurs after March 9, 1994, the General Partner intends and expects to
declare and pay a pro rata distribution to holders of record of the Common Units
on the effective date of the merger based upon the number of days elapsed
between February 7, 1994 and such effective date.
2. SHORT-TERM BANK LINES
The Partnership, through the Management Partnership, currently maintains five
separate short-term bank lines of credit totalling $80 million. In accordance
with the terms of the indenture of mortgage and deed of trust pursuant to which
the Management Partnership's First Mortgage Notes were issued (the "Mortgage
Note Indenture"), at least $20 million of revolving credit agreements must be
maintained at all times; however, no more than $50 million of borrowings are
permitted to be outstanding at any time. See Note 3. The Partnership had
borrowings of as much as $39.9 million under its short-term bank lines during
1993. No borrowings were outstanding under these lines at December 31, 1993 or
1992. The lines of credit mature at various times during 1994, bear interest at
each respective bank's prime, quoted money market or Eurodollar rate and require
commitment fees based on the unused amount of the credit. If the proposed merger
with Energy does not occur, the General Partner believes that these short-term
bank lines could be renewed or replaced with other short-term lines during 1994
on terms and conditions similar to those currently existing. If the proposed
merger with Energy is completed, the General Partner anticipates that new bank
credit agreements will be negotiated and that the Partnership's existing
short-term bank lines will be cancelled.
C-12
<PAGE> 106
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT
Long-term debt balances were as follows (in thousands):
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
DECEMBER 31,
-------------------
1993 1992
--------------------------------------------------------------------------------------
<S> <C> <C>
First Mortgage Notes............................................. $534,286 $559,643
Less current maturities........................................ 27,857 25,357
Long-term debt, less current maturities........................ $506,429 $534,286
--------------------------------------------------------------------------------------
</TABLE>
The First Mortgage Notes, which are currently comprised of eight remaining
series due serially from 1994 through 2009, are secured by mortgages on and
security interests in substantially all of the currently existing and
after-acquired property, plant and equipment of the Management Partnership and
each Subsidiary Operating Partnership and by the Management Partnership's
limited partner interest in each Subsidiary Operating Partnership (the
"Mortgaged Property"). As of December 31, 1993, the First Mortgage Notes have a
remaining weighted average life of approximately 7.3 years and a weighted
average interest rate of 10.12% per annum. Interest on the First Mortgage Notes
is payable semiannually, but one-half of each interest payment and one-fourth of
each annual principal payment are escrowed quarterly in advance. At December 31,
1993 and 1992, $34.2 million and $32.9 million, respectively, had been deposited
with the Mortgage Note Indenture trustee ("Trustee") in an escrow account. The
amount on deposit is classified as a current asset (cash held in debt service
escrow) and the liability to be paid off when the cash is released by the
Trustee from escrow is classified as a current liability.
The Mortgage Note Indenture contains covenants prohibiting the Management
Partnership and the Subsidiary Operating Partnerships (collectively referred to
herein as the "Operating Partnerships") from incurring additional indebtedness,
including any additional First Mortgage Notes, other than (i) up to $50 million
of indebtedness to be incurred for working capital purposes (provided that for a
period of 45 consecutive days during each 16 consecutive calendar month period
no such indebtedness will be permitted to be outstanding) and (ii) up to the
amount of any future capital improvements financed through the issuance of debt
or equity by VNGP, L.P. and the contribution of such amounts as additional
equity to the Management Partnership. The Mortgage Note Indenture also prohibits
the Operating Partnerships from (a) creating new indebtedness unless certain
cash flow to debt service requirements are met; (b) creating certain liens; or
(c) making cash distributions in any quarter in excess of the cash generated in
the prior quarter, less (i) capital expenditures during such prior quarter
(other than capital expenditures financed with certain permitted indebtedness),
(ii) an amount equal to one-half of the interest to be paid on the First
Mortgage Notes on the interest payment date occurring in or next following such
prior quarter and (iii) an amount equal to one-quarter of the principal required
to be paid on the First Mortgage Notes on the principal payment date occurring
in or next following such prior quarter, plus cash which could have been
distributed in any prior quarter but which was not distributed. The Operating
Partnerships are further prohibited from purchasing or owning any securities of
any person or making loans or capital contributions to any person other than
investments in the Subsidiary Operating Partnerships, advances and contributions
of up to $20 million per year and $100 million in the aggregate to entities
engaged in substantially similar business activities as the Operating
Partnerships, temporary investments in certain marketable securities and certain
other exceptions.
The Mortgage Note Indenture also prohibits the Operating Partnerships from
consolidating with or conveying, selling, leasing or otherwise disposing of all
or any material portion of their property, assets or business as an entirety to
any other person unless the surviving entity meets certain net worth
requirements and certain other conditions are met, or from selling or otherwise
disposing of any part of the Mortgaged Property, subject to certain exceptions.
The Mortgage Note Indenture also provides that it will be an event of default if
VNGC withdraws as General Partner of the Management Partnership prior to 1997,
if VNGC is removed as General
C-13
<PAGE> 107
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Partner but the Subsidiary General Partners are not also removed, or if the
General Partner or any Subsidiary General Partner withdraws or is removed and is
not replaced within 30 days.
Maturities of long-term debt for the years ending December 31, 1995 through 1998
are $30.3 million, $32.9 million, $35.3 million and $37.9 million, respectively.
Based on the borrowing rates currently available to the Partnership for
long-term debt with similar terms and average maturities, the fair value of the
Partnership's First Mortgage Notes, including current maturities, at December
31, 1993 was approximately $562 million. At December 31, 1992, the fair value of
the First Mortgage Notes was essentially equal to their carrying value.
4. INDUSTRY SEGMENT INFORMATION
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------
1993 1992 1991
-----------------------------------------------------------------------------------------
<S> <C> <C> <C>
(THOUSANDS OF DOLLARS)
Operating revenues:
Natural gas...................................... $ 900,252 $ 743,026 $ 764,226
Natural gas liquids.............................. 441,741 466,017 390,708
Intersegment eliminations........................ (15,535) (11,914) (10,933)
Total.................................... $1,326,458 $1,197,129 $1,144,001
Operating income:
Natural gas...................................... $ 53,458 $ 32,484 $ 37,140
Natural gas liquids.............................. 26,020 57,357 62,694
Total.................................... 79,478 89,841 99,834
Other income, net.................................. 1,263 624 4,013
Interest expense, net.............................. (66,294) (65,479) (66,811)
Net income............................... $ 14,447 $ 24,986 $ 37,036
Identifiable assets:
Natural gas...................................... $ 865,487 $ 889,620 $ 900,588
Natural gas liquids.............................. 154,767 174,170 126,380
Other............................................ 43,008 43,292 52,489
Intersegment eliminations........................ (18,180) (22,601) (17,967)
Total.................................... $1,045,082 $1,084,481 $1,061,490
Depreciation expense:
Natural gas...................................... $ 28,549 $ 28,136 $ 27,977
Natural gas liquids.............................. 7,897 6,268 11,254
Total.................................... $ 36,446 $ 34,404 $ 39,231
Capital expenditures:
Natural gas...................................... $ 20,511 $ 22,537 $ 26,931
Natural gas liquids.............................. 15,550 13,356 6,143
Total.................................... $ 36,061 $ 35,893 $ 33,074
-----------------------------------------------------------------------------------------
</TABLE>
The Partnership operates in the natural gas and natural gas liquids industry
segments. The natural gas operations consist of purchasing, gathering,
transporting and selling natural gas, principally to gas distribution companies,
electric utilities, pipeline companies and industrial customers. The Partnership
also transports gas for a fee for sales customers, other pipelines and end users
and provides price risk management services to gas producers and end users
through its Market Center Services Program. The natural gas liquids operations
include the extraction of natural gas liquids, principally from natural gas
throughput of the natural gas operations, and the fractionation and
transportation of natural gas liquids. The primary markets for sales of natural
gas liquids are petrochemical plants, refineries and domestic fuel distributors.
Intersegment revenue
C-14
<PAGE> 108
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
eliminations relate primarily to transportation provided by the natural gas
segment for the natural gas liquids segment. During 1993, natural gas sales and
transportation revenues from San Antonio City Public Service accounted for
approximately 11% of the Partnership's total consolidated operating revenues. No
single unaffiliated customer accounted for more than 10% of the Partnership's
total consolidated operating revenues during 1992 or 1991. Energy and its
consolidated subsidiaries accounted for approximately 12%, 12% and 11% of the
Partnership's total consolidated operating revenues during 1993, 1992 and 1991,
respectively.
The Partnership's natural gas segment has a concentration of customers in the
natural gas transmission and distribution industries while its natural gas
liquids segment has a concentration of customers in the refining and
petrochemical industries. These concentrations of customers may impact the
Partnership's overall exposure to credit risk, either positively or negatively,
in that the customers may be similarly affected by changes in economic or other
conditions. However, the General Partner believes that the Partnership's
portfolio of accounts receivable is sufficiently diversified to the extent
necessary to minimize any potential credit risk. Historically, the Partnership
has not had any significant problems in collecting its accounts receivable. The
Partnership's accounts receivable are generally not collateralized.
5. LEASE AND OTHER COMMITMENTS
Valero Gas Storage Company ("Gas Storage"), a wholly owned subsidiary of VNGC,
is the lessee under an operating lease for a gas storage facility (the "Wilson
Storage Facility"). Gas Storage and Valero Transmission Company had previously
entered into a gas storage agreement ("Gas Storage Agreement") which required
Valero Transmission Company to pay to Gas Storage amounts essentially equivalent
to the lease payments and operating costs in connection with Valero Transmission
Company's use of the Wilson Storage Facility. Upon formation of the Partnership,
Valero Transmission Company assigned the Gas Storage Agreement to Valero
Transmission, L.P., and Valero Transmission, L.P. assumed Valero Transmission
Company's obligation to make such payments to Gas Storage. The remaining primary
lease term for the Wilson Storage Facility is six years with options to renew at
varying terms. The future minimum lease payments related to this lease are
included in the table below. The Partnership has other noncancelable operating
leases with remaining terms ranging generally from one year to 13 years.
During 1992, the Partnership entered into a capital lease with Energy to lease a
gas processing plant near Thompsonville in South Texas and 48 miles of NGL
product pipeline (the "Thompsonville Project"). The Thompsonville Project lease
commenced December 1, 1992 and has a term of 15 years. During 1991, the
Partnership entered into capital leases with Energy to lease an interest in an
approximate 105-mile pipeline in East Texas (the "East Texas pipeline") and
certain fractionation facilities in Corpus Christi, Texas. The East Texas
pipeline lease commenced February 1, 1991 and has a term of 25 years while the
lease for the fractionation facilities commenced December 1, 1991 and has a term
of 15 years. As a result of the settlement and dismissal in 1992 of certain
claims asserted in litigation filed against Energy and certain of its
affiliates, officers and directors, Energy agreed to adjust the payments and
certain other terms under these capital leases. Such adjusted payments are
reflected in the table of future minimum lease payments shown below.
The assets and associated obligations related to the capital leases with Energy
described above are not subject to the Mortgage Note Indenture. The Partnership
has the right to purchase all or any portion of these assets, subject to certain
restrictions, under purchase option provisions of the respective lease
agreements. The total cost of these leased facilities, which is included in the
accompanying consolidated balance sheets under property, plant and equipment,
was approximately $101 million. Amortization of these capital leases, which is
included in depreciation expense in the accompanying consolidated income
statements, was $5.3 million, $3.5 million and $2.2 million for 1993, 1992 and
1991, respectively.
C-15
<PAGE> 109
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The related future minimum lease payments under the Partnership's capital leases
and noncancelable operating leases as of December 31, 1993 are as follows (in
thousands):
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
OPERATING LEASES
-------------------------------
OTHER PARTNERSHIP
PARTNERSHIP COMMITMENTS
CAPITAL LEASE (WILSON STORAGE
LEASES COMMITMENTS FACILITY
--------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1994............................................ $ 12,867 $1,873 $10,438
1995............................................ 12,867 147 10,438
1996............................................ 13,867 134 10,438
1997............................................ 15,114 105 9,832
1998............................................ 15,361 103 10,156
Remainder....................................... 213,557 449 15,660
Total minimum lease payments.................... 283,633 $2,811 $66,962
Less amount representing interest............. 178,795
Net present value of minimum lease payments..... 104,838
Less current maturities....................... 1,051
Capital lease obligations..................... $103,787
--------------------------------------------------------------------------------------------
</TABLE>
The future minimum lease payments listed above under the caption "Partnership
Lease Commitments" exclude certain operating lease commitments which are
cancelable by the Partnership upon notice of one year or less. Consolidated rent
expense was approximately $698,000, $833,000 and $746,000 for the years ended
December 31, 1993, 1992 and 1991, respectively, and excludes amounts billed by
Energy to the Partnership for its proportionate use of Energy's corporate
headquarters office complex and related charges which are included in the
management fee charged to the Partnership. See Note 1 -- "Transactions with
Energy." Rentals paid of $10,438,000 per year for 1993, 1992 and 1991 in
connection with the Wilson Storage Facility were included in the computation of
Transmission's weighted average cost of gas.
The obligations of Gas Storage under the gas storage facility lease include its
obligation to make scheduled lease payments and, in the event of a declaration
of default and acceleration of the lease obligation, to make certain lump sum
payments based on a stipulated loss value for the gas storage facility less the
fair market sales price or fair market rental value of the gas storage facility.
Under certain circumstances, a default by Energy or a subsidiary of Energy,
including VNGC, with respect to its own indebtedness could result in a cross
default under the gas storage facility lease. The General Partner believes that
it is unlikely that a default by Energy or a subsidiary of Energy would result
in acceleration of the gas storage facility lease, and further believes that
such event, if it occurred, would not have a material adverse effect on the
Partnership.
6. LITIGATION AND CONTINGENCIES
Take-or-Pay and Related Claims
As a result of past market conditions and contracting practices in the natural
gas industry, numerous producers and other suppliers brought claims against
Transmission asserting that it was in breach of contractual provisions requiring
that it take, or pay for if not taken, certain specified volumes of natural gas.
The Partnership has settled substantially all of the significant take-or-pay
claims, pricing differences and contractual disputes heretofore brought against
it. Although additional claims may arise under older contracts until their
expiration or renegotiation, the General Partner believes that the Partnership
has resolved substantially all of the significant take-or-pay claims that are
likely to be made. As described below, Energy and/or the Partnership have agreed
to bear a portion of certain potential liabilities that may be incurred by
certain Partnership suppliers. Although the General Partner is currently unable
to predict the total amount Transmission or the Partnership ultimately may pay
or be required to pay in connection with the resolution of
C-16
<PAGE> 110
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
existing and potential take-or-pay claims, the General Partner believes that any
remaining claims can be resolved on terms satisfactory to the Partnership and
that the resolution of such claims and any potential claims has not had and will
not have a material adverse effect on the Partnership's financial position or
results of operations.
In 1987, Transmission and a producer from whom Transmission has purchased
natural gas entered into an agreement resolving certain take-or-pay issues
between the parties in which Transmission agreed to pay one-half of certain
excess royalty claims arising after the date of the agreement. The royalty
owners of the producer recently completed an audit of the producer and have
presented to the producer a claim for additional royalty payments in the amount
of approximately $17.3 million, and accrued interest thereon of approximately
$19.8 million. Approximately $8 million of the royalty owners' claim accrued
after the effective date of the agreement between the producer and Transmission.
The producer and Transmission are reviewing the royalty owners' claims. No
lawsuit has been filed by the royalty owners. The General Partner believes that
various defenses under the agreement may reduce any liability of Transmission to
the producer in this matter.
Valero Transmission Company and one of its gas suppliers are parties to various
gas purchase contracts assigned to and assumed by Valero Transmission, L.P. upon
formation of the Partnership in 1987. The supplier is also a party to a series
of gas purchase contracts between the supplier, as buyer, and certain trusts, as
seller, which are in litigation. Neither the Partnership nor Valero Transmission
Company is a party to this litigation or the contracts between Transmission's
supplier and the trusts. However, because of the relationship between
Transmission's contracts with the supplier and the supplier's contracts with the
trusts, and in order to resolve existing and potential disputes, the supplier,
Valero Transmission Company and Valero Transmission, L.P. have agreed that they
will cooperate in the conduct of this litigation, and that Valero Transmission
Company and Valero Transmission, L.P. will bear a substantial portion of the
costs of any appeal and any nonappealable final judgment rendered against the
supplier. In the litigation, the trusts allege that Transmission's supplier has
breached various minimum take, take-or-pay and other contractual provisions, and
assert a statutory nonratability claim. The trusts seek alleged actual damages,
including interest, of approximately $30 million and an unspecified amount of
punitive damages. The District Court ruled on the plaintiff's motion for summary
judgment, finding, among other things, that as a matter of law the three gas
purchase contracts at issue were fully binding and enforceable, the supplier
breached the minimum take obligations under one of the contracts, the supplier
is not entitled to claimed offsets for gas purchased by third parties and the
"availability" of gas for take-or-pay purposes is established solely by the
delivery capacity testing procedures in the contracts. Damages, if any, have not
been determined. Because of existing contractual obligations of Valero
Transmission, L.P. to its supplier, the lawsuit may ultimately involve a
contingent liability for Valero Transmission, L.P. The General Partner believes
that the claims brought against the supplier have been significantly overstated,
and that the supplier has a number of meritorious defenses to the claims
including various regulatory, statutory, contractual and common law defenses.
The Court recently granted the supplier's Motion for Continuance of the former
January 10, 1994 trial date. This litigation is not currently set for trial.
Payments that Transmission has made or agreed to make in connection with
settlements to date are included in its deferred gas costs. The General Partner
believes that the rate order under which Transmission currently operates (the
"Rate Order"), issued in 1979 by the Railroad Commission of Texas (the "Railroad
Commission," which regulates the sale and transportation of natural gas by
intrastate pipeline systems in Texas), allows for the recovery of such costs.
See Note 1 -- "Other Assets" and "Customer Audit of Transmission" below. Certain
take-or-pay and other claims have been resolved through the Partnership agreeing
to provide discounted transportation services. These agreements do not involve a
cash outlay by the Partnership but in certain cases have the effect of reducing
transportation margins over an extended period of time.
C-17
<PAGE> 111
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Any liability of Energy with respect to take-or-pay claims involving
Transmission's intrastate pipeline operations has been assumed by the
Partnership. Based upon the General Partner's beliefs and rate considerations
discussed above, no liabilities have been recorded for any unresolved
take-or-pay claims.
Other Litigation
Seven lawsuits were filed in Chancery Court in Delaware against VNGP, L.P., VNGC
and Energy and certain officers and directors of VNGC and/or Energy in response
to the announcement by Energy on October 14, 1993 of its proposal to acquire the
publicly-traded Common Units of VNGP, L.P. pursuant to a proposed merger of
VNGP, L.P. with a wholly owned subsidiary of Energy. See Note 1 -- "Organization
and Control." The suits were consolidated into a single proceeding by the
Chancery Court on November 23, 1993. The plaintiffs sought to enjoin or rescind
the proposed merger, alleging that the corporate defendants and the individual
defendants, as officers or directors of the corporate defendants, engaged in
actions in breach of the defendants' fiduciary duties to the Public Unitholders
by proposing the merger. The plaintiffs alternatively sought an increase in the
proposed merger consideration, unspecified compensatory damages and attorneys'
fees. In December 1993, the parties reached a tentative settlement of the
consolidated lawsuit. The terms of the settlement will not require a material
payment by Energy or the Partnership. However, there can be no assurance that
the settlement will be completed, or that it will be approved by the Chancery
Court.
In March 1993, two indirect wholly owned subsidiaries of Energy serving as
general partners of two of VNGP, L.P.'s principal Subsidiary Operating
Partnerships were served as third party defendants in a lawsuit originally filed
in 1991 by a subsidiary of The Coastal Corporation ("Coastal") against
TransAmerican Natural Gas Corporation ("TANG"). In August 1993, Energy, VNGP,
L.P. and certain of their respective subsidiaries were named as additional
third-party defendants (collectively, including the original defendant
subsidiaries, the "Valero Defendants") in this lawsuit. In its counterclaims
against Coastal and third-party claims against the Valero Defendants, TANG
alleges that it contracted to sell natural gas to Coastal at the posted field
price of one of the Valero Defendants and that the Valero Defendants and Coastal
conspired to set the posted field price at an artificially low level. TANG also
alleges that the Valero Defendants and Coastal conspired to cause TANG to
deliver unprocessed or "wet" gas, thus precluding TANG from extracting NGLs from
its gas prior to delivery. TANG seeks actual damages of approximately $50
million, trebling of damages under antitrust claims, punitive damages of $300
million, and attorneys' fees. The General Partner believes that the plaintiff's
claims have been exaggerated, and that Energy and the Partnership have
meritorious defenses to such claims. In the event of an adverse determination
involving Energy, Energy likely would seek indemnification from the Partnership
under terms of the partnership agreements and other applicable agreements
between VNGP, L.P., its subsidiary partnerships and their respective general
partners. The Valero Defendants' motion for summary judgment on TANG's antitrust
claims was argued on January 24, 1994. The court has not ruled on such motion.
The current trial setting for this case is March 14, 1994.
In September 1991, a lawsuit was filed by Valero Transmission, L.P. alleging
breach of contract against a producer. On January 11, 1993, the defendant filed
a cross-action against Valero Transmission, L.P., Valero Industrial Gas, L.P.
and Reata Industrial Gas, L.P. The defendant asserted claims for actual damages
for failure to pay for goods and services delivered. Additionally, the defendant
asserted various other cross-claims, including conversion, breach of contract,
breach of an alleged duty to market gas in good faith, tortious breach of a duty
imposed by law and tortious negligence. The defendant sought actual damages
aggregating not less than $1 million, injunctive relief, attorneys fees and
costs, and exemplary damages in the amount of not less than $20 million. In
January 1994, the parties reached a tentative settlement of the lawsuit on terms
immaterial to the Partnership.
The Partnership was a party to a lawsuit originally filed in 1988 in which
Energy, Valero Transmission Company, VNGP, L.P., the Management Partnership and
Valero Transmission, L.P. (the "Valero Defendants") and a subsidiary of Coastal
were alleged to be liable for failure to take minimum quantities of gas,
C-18
<PAGE> 112
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
failure to make take-or-pay payments and other breach of contract and breach of
fiduciary duty claims. The plaintiffs sought declaratory relief, actual damages
in excess of $37 million and unspecified punitive damages. During the third
quarter of 1992, the plaintiffs, Coastal and the Valero Defendants settled this
lawsuit on terms which were not material to the Valero Defendants and on July
19, 1993, this lawsuit was dismissed. On November 16, 1992, prior to entry of
the order of dismissal, NationsBank of Texas, N.A., as trustee for certain
trusts (the "Intervenors"), filed a plea in intervention to intervene in the
lawsuit. The Intervenors asserted that they held a non-participating mineral
interest in the lands subject to the litigation and that their rights were not
protected by the plaintiffs in the settlement. On February 4, 1993, the Court
struck the Intervenors' plea in intervention. However, on February 2, 1993, the
Intervenors had filed a separate suit in the 160th State District Court, Dallas
County, Texas, against all prior defendants and an additional defendant,
substantially adopting in form and substance the allegations and claims in the
original litigation. In February 1994, the parties reached a tentative
settlement of the lawsuit on terms immaterial to the Partnership.
City of Houston Franchise Fee Audit
In a letter dated September 1, 1993 from the City of Houston (the "City") to
Valero Transmission Company ("VTC"), the City stated its intent to bring suit
against VTC for certain claims asserted by the City under the franchise
agreement between the City and VTC. VTC is the general partner of Valero
Transmission, L.P. The franchise agreement was assigned to and assumed by Valero
Transmission, L.P. upon formation of the Partnership in 1987. In the letter, the
City declared a conditional forfeiture of the franchise rights based on the
City's claims. In a letter dated October 27, 1993, the City claimed that VTC
owes to the City franchise fees and accrued interest thereon aggregating
approximately $13.5 million. In a letter dated November 9, 1993, the City
claimed an additional $18 million in damages related to the City's allegations
that VTC engaged in unauthorized activities under the franchise agreement by
transmitting gas for resale and by transporting gas for third parties on the
franchised premises. The City has not filed a lawsuit. The General Partner
believes that the City's claims are significantly overstated and that VTC has a
number of meritorious defenses to the claims. Any liability of VTC with respect
to the City's claims has been assumed by the Partnership.
Customer Audit of Transmission
Transmission's Rate Order provides for Transmission to sell gas at its weighted
average cost of gas, as defined ("WACOG"), plus a margin of $.15 per Mcf. In
addition to the cost of gas purchases, Transmission's WACOG has included
storage, gathering and other fixed costs totalling approximately $19 million per
year, and amortization of deferred gas costs related to the settlement of
take-or-pay and related claims (see Note 1 -- "Other Assets" and "Take-or-Pay
and Related Claims" above). Transmission's gas purchases include high-cost
casinghead gas and certain special allowable gas that Transmission is required
to purchase contractually and under the Railroad Commission's priority rules.
Transmission's sales volumes have been decreasing with the expiration of its
sales contracts including the July 1992 expiration of a contract representing
approximately 37% of Transmission's sales volumes for the first six months of
1992. As a result of each of these factors, Transmission's WACOG and gas sales
price are substantially in excess of market clearing levels.
Transmission's WACOG has been periodically audited by certain of its customers,
as allowed under the Rate Order. One such customer (the "Customer") questioned
the application of certain of Transmission's current rate policies to future
periods in light of the decreases that have occurred in Transmission's
throughput, and the Customer has recently completed its audit of Transmission's
WACOG with respect thereto. For 1993, the Customer represented approximately 70%
of Transmission's sales volumes and such percentage is expected to increase as
other sales contracts expire and are not renewed. As a result of the Customer's
audit, Transmission and the Customer entered into a settlement agreement which
excludes certain of the fixed costs described
C-19
<PAGE> 113
VALERO NATURAL GAS PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
above from Transmission's WACOG, effective with July 1993 sales, resulting in a
reduction of the Partnership's annual net income by approximately $6 million.
Upon the termination of Transmission's gas sales contract with the Customer in
1998, Transmission's fixed costs, including storage (see Note 5), would be
charged to income instead of recovered through its gas sales rates. Transmission
expects to recover its deferred gas costs over a period of approximately eight
years. The recovery of any additional payments made in connection with any
future settlements would be limited.
The Partnership is also a party to additional claims and legal proceedings
arising in the ordinary course of business. The General Partner believes it is
unlikely that the final outcome of any of the claims or proceedings to which the
Partnership is a party, including those described above, would have a material
adverse effect on the Partnership's financial position or results of operations;
however, due to the inherent uncertainties of litigation, the range of possible
loss, if any, cannot be estimated with a reasonable degree of precision and
there can be no assurance that the resolution of any particular claim or
proceeding would not have an adverse effect on the Partnership's results of
operations for the fiscal period in which such resolution occurred.
7. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The results of operations by quarter for the years ended December 31, 1993 and
1992 were as follows (in thousands of dollars, except per Unit amounts):
<TABLE>
<CAPTION>
- - - - - ------------------------------------------------------------------------------------------------------
NET INCOME
NET (LOSS) PER
OPERATING OPERATING INCOME LIMITED
REVENUES INCOME (LOSS) PARTNER UNIT
- - - - - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1993-Quarter Ended:
March 31........................................... $ 331,484 $21,747 $ 5,133 $ .26
June 30............................................ 326,259 23,496 7,699 .39
September 30....................................... 336,893 19,812 3,621 .18
December 31........................................ 331,822 14,423 (2,006) (.11)
Total........................................... $1,326,458 $79,478 $14,447 $ .72
1992-Quarter Ended:
March 31........................................... $ 265,745 $18,785 $ 2,617 $ .13
June 30............................................ 276,609 22,035 6,155 .31
September 30....................................... 314,245 30,032 13,901 .72
December 31........................................ 340,530 18,989 2,313 .11
Total........................................... $1,197,129 $89,841 $24,986 $ 1.27
- - - - - ------------------------------------------------------------------------------------------------------
</TABLE>
C-20
<PAGE> 114
ANNEX D-1
PER UNIT BASES & INCOME ALLOCATIONS
AS OF DECEMBER 31, 1993(1)(2)(3)(4)
<TABLE>
<CAPTION>
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
GAIN AT CHARACTER OF
CUMULATIVE CUMULATIVE SUSPENDED LOSSES BASIS ASSUMED GAIN OR (LOSS)
MONTH ACQUISITION NET CASH ------------------ FOR CALC. SALES PRICE ------------------
OF ENTRY PRICE INC./(LOSS) DISTRIBUTIONS(5) ORDINARY CAPITAL GAIN/(LOSS) $12.22(6) ORDINARY CAPITAL
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1987 March.... $ 22.75 $(7.79) $ (13.30) $ 7.84 $0.95 $ 10.57 $ 1.65 $(2.33) $ 3.98
April.... 28.00 (7.10) (13.30) 7.37 0.72 15.81 (3.59) 1.09 (4.68)
May...... 24.02 (7.50) (13.30) 7.72 0.75 11.82 0.40 (0.31) 0.71
June..... 28.00 (7.14) (13.30) 7.34 0.77 15.79 (3.57) (0.36) (3.21)
July..... 26.91 (7.04) (12.63) 7.24 0.76 15.37 (3.15) (0.41) (2.74)
August... 28.22 (8.28) (12.63) 8.21 1.02 16.67 (4.45) (3.06) (1.38)
September... 29.50 (9.13) (12.63) 8.99 1.09 17.94 (5.72) (4.01) (1.71)
October... 29.50 (6.14) (12.63) 5.42 0.71 16.98 (4.76) 1.85 (6.61)
November... 24.25 (6.44) (11.99) 6.60 0.77 13.31 (1.09) 0.25 (1.34)
December... 24.00 (5.79) (11.99) 6.01 0.70 13.05 (0.83) 1.35 (2.18)
1988 January... 23.76 (6.27) (11.99) 6.44 0.74 12.80 (0.58) 0.51 (1.08)
February... 23.89 (6.22) (11.38) 6.27 0.85 13.53 (1.31) 0.19 (1.50)
March.... 22.05 (5.93) (11.38) 5.94 0.87 11.68 0.54 (0.33) 0.87
April.... 21.00 (5.97) (11.38) 5.92 0.92 10.61 1.61 (0.55) 2.16
May...... 20.87 (5.52) (10.75) 5.53 0.84 11.09 1.13 0.97 0.15
June..... 20.74 (5.40) (10.75) 5.38 0.85 10.95 1.27 0.07 1.20
July..... 20.21 (5.38) (10.75) 5.41 0.79 10.40 1.82 (0.12) 1.94
August... 19.43 (4.23) (10.13) 4.48 0.56 10.23 1.99 2.46 (0.47)
September... 17.98 (4.06) (10.13) 4.29 0.57 8.77 3.45 2.60 0.85
October... 18.90 (4.69) (10.13) 4.68 0.79 9.68 2.54 0.60 1.95
November... 19.00 (4.02) (9.50) 4.13 0.66 10.39 1.83 1.53 0.30
December... 16.80 (3.43) (9.50) 3.61 0.57 8.17 4.05 3.25 0.80
1989 January... 18.90 (4.18) (9.50) 4.13 0.79 10.26 1.96 1.12 0.84
February... 20.34 (4.86) (8.88) 4.61 0.96 12.30 (0.08) 0.36 (0.44)
March.... 20.61 (5.12) (8.88) 4.78 1.03 12.54 (0.32) 0.09 (0.41)
April.... 20.61 (5.35) (8.88) 4.93 1.09 12.52 (0.30) (0.16) (0.14)
May...... 20.48 (5.29) (8.25) 4.83 1.10 12.99 (0.77) (0.08) (0.68)
June..... 22.18 (5.25) (8.25) 4.77 1.10 14.67 (2.45) (0.05) (2.40)
July..... 23.23 (5.62) (8.25) 5.13 1.09 15.70 (3.48) (0.59) (2.88)
August... 20.61 (5.15) (7.63) 4.67 1.04 13.67 (1.45) (0.06) (1.39)
September... 19.29 (4.85) (7.63) 4.38 1.02 12.33 (0.11) 0.27 (0.38)
October... 18.51 (4.44) (7.63) 3.98 0.98 11.52 0.70 0.74 (0.04)
November... 19.03 (4.00) (7.00) 3.56 0.94 12.65 (0.43) 1.22 (1.65)
December... 17.72 (3.95) (7.00) 3.47 0.95 11.31 0.91 1.27 (0.37)
1990 January... 19.29 (3.69) (7.00) 3.19 0.95 12.87 (0.65) 1.24 (1.89)
February... 17.85 (3.55) (6.38) 3.05 0.93 12.03 0.19 1.22 (1.03)
March.... 16.67 (3.40) (6.38) 2.89 0.93 10.84 1.38 1.25 0.13
April.... 16.44 (3.32) (6.38) 2.79 0.94 10.59 1.63 1.30 0.33
May...... 15.88 (2.83) (5.75) 2.36 0.85 10.64 1.58 1.97 (0.39)
June..... 15.49 (2.94) (5.75) 2.38 0.93 10.24 1.98 1.63 0.35
July..... 17.85 (2.93) (5.75) 2.45 0.85 12.58 (0.36) 1.30 (1.66)
August... 17.59 (3.14) (5.13) 2.58 0.90 12.92 (0.70) 0.86 (1.56)
September... 18.38 (3.00) (5.13) 2.44 0.89 13.70 (1.48) 0.99 (2.47)
October... 18.38 (2.91) (5.13) 2.37 0.90 13.72 (1.50) 0.98 (2.48)
November... 17.98 (2.86) (4.50) 2.42 0.74 13.90 (1.68) 1.00 (2.68)
December... 16.14 (2.66) (4.50) 2.22 0.72 12.05 0.17 1.19 (1.01)
1991 January... 16.93 (4.64) (4.50) 4.21 0.69 12.82 (0.60) (1.67) 1.07
February... 16.80 (4.71) (3.88) 4.26 0.70 13.30 (1.08) (1.79) 0.71
March.... 16.67 (4.81) (3.88) 4.34 0.71 13.15 (0.93) (1.95) 1.02
April.... 16.01 (3.67) (3.88) 3.29 0.61 12.49 (0.27) (0.42) 0.15
May...... 12.73 (3.67) (3.25) 3.37 0.61 9.92 2.30 (0.56) 2.87
June..... 12.08 (2.98) (3.25) 2.60 0.58 9.15 3.07 0.27 2.80
July..... 13.26 (3.24) (3.25) 3.10 0.37 10.35 1.87 (0.57) 2.43
August... 12.99 (3.26) (2.63) 3.08 0.36 10.67 1.55 (0.63) 2.18
September... 12.73 (3.30) (2.63) 3.11 0.36 10.39 1.83 (0.78) 2.61
October... 13.52 (3.27) (2.63) 3.06 0.37 11.17 1.05 (0.86) 1.92
November... 13.52 (2.69) (2.00) 2.48 0.36 11.79 0.43 (0.20) 0.63
December... 11.68 (2.08) (2.00) 1.90 0.33 9.96 2.26 0.49 1.77
</TABLE>
<PAGE> 115
<TABLE>
<CAPTION>
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
GAIN AT CHARACTER OF
CUMULATIVE CUMULATIVE SUSPENDED LOSSES BASIS ASSUMED GAIN OR (LOSS)
MONTH ACQUISITION NET CASH ------------------ FOR CALC. SALES PRICE ------------------
OF ENTRY PRICE INC./(LOSS) DISTRIBUTIONS(5) ORDINARY CAPITAL GAIN/(LOSS) $12.22(6) ORDINARY CAPITAL
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1992 January... $ 12.34 $(1.90) $(2.00) $ 1.61 $0.41 $ 10.57 $ 1.65 $ 0.52 $1.13
February... 11.42 (1.91) (1.38) 1.59 0.43 10.27 1.95 0.44 1.51
March.... 10.50 (1.62) (1.38) 1.37 0.35 9.35 2.87 0.68 2.19
April.... 9.84 (1.75) (1.38) 1.44 0.41 8.69 3.53 0.57 2.97
May...... 9.98 (1.78) (0.75) 1.45 0.43 9.44 2.78 0.46 2.32
June..... 9.32 (1.59) (0.75) 1.31 0.37 8.77 3.45 0.57 2.88
July..... 9.32 (1.31) (0.75) 1.26 0.12 8.77 3.45 0.55 2.90
August... 9.32 (1.29) (0.63) 1.25 0.11 8.89 3.33 0.52 2.82
September... 9.32 (1.25) (0.63) 1.21 0.11 8.88 3.34 0.49 2.85
October... 10.37 (1.25) (0.63) 1.20 0.11 9.92 2.30 0.42 1.88
November... 10.11 (1.23) (0.50) 1.17 0.12 9.78 2.44 0.36 2.07
December... 9.32 (1.18) (0.50) 1.11 0.12 8.99 3.23 0.35 2.88
1993 January... 9.06 (1.71) (0.50) 1.63 0.12 8.72 3.50 (0.27) 3.77
February... 8.79 (1.60) (0.38) 1.52 0.12 8.58 3.64 (0.23) 3.87
March.... 9.06 (1.49) (0.38) 1.40 0.12 8.84 3.38 (0.18) 3.57
April.... 8.79 (1.36) (0.38) 1.27 0.12 8.57 3.65 (0.14) 3.79
May...... 8.79 (1.25) (0.25) 1.16 0.13 8.69 3.53 (0.13) 3.66
June..... 8.93 (1.00) (0.25) 0.91 0.12 8.82 3.40 (0.01) 3.41
July..... 9.32 (0.81) (0.25) 0.83 9.21 3.01 (0.03) 3.04
August... 9.84 (0.69) (0.13) 0.71 9.86 2.36 (0.02) 2.38
September... 9.84 (0.56) (0.13) 0.58 9.85 2.37 0.00 2.36
October... 11.81 (0.43) (0.13) 0.44 11.82 0.40 0.02 0.38
November... 11.81 (0.30) 0.31 11.94 0.28 0.01 0.27
December... 12.47 (0.16) 0.16 12.59 (0.37) 0.01 (0.38)
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Assumptions: (1) This schedule uses high trade prices for each acquisition month
(2) Units held through December 31, 1993
(3) Passive loss restrictions apply
(4) Cumulative Section 754 net income/loss calculated through
12/31/93
(5) Cumulative cash distributions calculated through 12/31/93. Cash
distributions received by Public Unitholders after December 31,
1993 will reduce the Unitholder's basis in the Common Units and
increase the Unitholders gain (or reduce the Unitholder's loss)
on a dollar-for-dollar basis. Such amount will be reflected as
additional/(decreased) capital gain/(loss).
(6) Basis and, correspondingly, sales price increased by .12 for
legal fees
<PAGE> 116
ANNEX D-2
PER UNIT BASES & INCOME ALLOCATIONS
AS OF DECEMBER 31, 1993(1)(2)(3)(4)
<TABLE>
<CAPTION>
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
GAIN AT CHARACTER OF
CUMULATIVE CUMULATIVE SUSPENDED LOSSES BASIS ASSUMED GAIN OR (LOSS)
MONTH OF ACQUISITION NET CASH ------------------ FOR CALC. SALES PRICE ------------------
ENTRY PRICE INC./(LOSS) DISTRIBUTIONS(5) ORDINARY CAPITAL GAIN/(LOSS) $12.22 ORDINARY CAPITAL
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
March.... $ 22.75 $(7.79) $ (13.30) $ 7.84 $0.95 $ 10.57 $1.65 $(2.33) $ 3.98
April.... 19.24 (7.10) (13.30) 7.37 0.72 7.05 5.17 1.09 4.08
May...... 20.43 (7.50) (13.30) 7.72 0.75 8.23 3.99 (0.31) 4.30
June..... 20.19 (7.14) (13.30) 7.34 0.77 7.98 4.24 (0.36) 4.60
July..... 20.07 (7.04) (12.63) 7.24 0.76 8.53 3.69 (0.41) 4.10
August... 22.92 (8.28) (12.63) 8.21 1.02 11.37 0.85 (3.06) 3.92
September... 23.30 (9.13) (12.63) 8.99 1.09 11.74 0.48 (4.01) 4.49
October... 15.20 (6.14) (12.63) 5.42 0.71 2.68 9.54 1.85 7.69
November... 16.00 (6.44) (11.99) 6.60 0.77 5.06 7.16 0.25 6.91
December... 17.46 (5.79) (11.99) 6.01 0.70 6.51 5.71 1.35 4.36
1988 January... 19.75 (6.27) (11.99) 6.44 0.74 8.79 3.43 0.51 2.92
February... 20.00 (6.22) (11.38) 6.27 0.85 9.64 2.58 0.19 2.39
March.... 19.50 (5.93) (11.38) 5.94 0.87 9.13 3.09 (0.33) 3.42
April.... 19.13 (5.97) (11.38) 5.92 0.92 8.74 3.48 (0.55) 4.03
May...... 17.00 (5.52) (10.75) 5.53 0.84 7.22 5.00 0.97 4.02
June..... 18.88 (5.40) (10.75) 5.38 0.85 9.08 3.14 0.07 3.06
July..... 18.13 (5.38) (10.75) 5.41 0.79 8.31 3.91 (0.12) 4.03
August... 16.50 (4.23) (10.13) 4.48 0.56 7.31 4.91 2.46 2.45
September... 16.13 (4.06) (10.13) 4.29 0.57 6.92 5.30 2.60 2.70
October... 16.88 (4.69) (10.13) 4.68 0.79 7.65 4.57 0.60 3.97
November... 15.38 (4.02) (9.50) 4.13 0.66 6.76 5.46 1.53 3.93
December... 14.75 (3.43) (9.50) 3.61 0.57 6.12 6.10 3.25 2.85
1989 January... 15.75 (4.18) (9.50) 4.13 0.79 7.11 5.11 1.12 3.99
February... 17.13 (4.86) (8.88) 4.61 0.96 9.08 3.14 0.36 2.78
March.... 18.00 (5.12) (8.88) 4.78 1.03 9.94 2.28 0.09 2.19
April.... 18.00 (5.35) (8.88) 4.93 1.09 9.91 2.31 (0.16) 2.47
May...... 17.88 (5.29) (8.25) 4.83 1.10 10.39 1.83 (0.08) 1.92
June..... 18.25 (5.25) (8.25) 4.77 1.10 10.74 1.48 (0.05) 1.53
July..... 18.63 (5.62) (8.25) 5.13 1.09 11.09 1.13 (0.59) 1.72
August... 17.63 (5.15) (7.63) 4.67 1.04 10.69 1.53 (0.06) 1.59
September... 17.13 (4.85) (7.63) 4.38 1.02 10.17 2.05 0.27 1.79
October... 15.63 (4.44) (7.63) 3.98 0.98 8.64 3.58 0.74 2.84
November... 14.88 (4.00) (7.00) 3.56 0.94 8.49 3.73 1.22 2.51
December... 15.13 (3.95) (7.00) 3.47 0.95 8.72 3.50 1.27 2.22
1990 January... 15.63 (3.69) (7.00) 3.19 0.95 9.20 3.02 1.24 1.78
February... 15.38 (3.55) (6.38) 3.05 0.93 9.55 2.67 1.22 1.44
March.... 15.00 (3.40) (6.38) 2.89 0.93 9.17 3.05 1.25 1.80
April.... 14.25 (3.32) (6.38) 2.79 0.94 8.41 3.81 1.30 2.51
May...... 12.63 (2.83) (5.75) 2.36 0.85 7.38 4.84 1.97 2.87
June..... 13.88 (2.94) (5.75) 2.38 0.93 8.62 3.60 1.63 1.96
July..... 14.13 (2.93) (5.75) 2.45 0.85 8.86 3.36 1.30 2.07
August... 14.88 (3.14) (5.13) 2.58 0.90 10.21 2.01 0.86 1.15
September... 16.13 (3.00) (5.13) 2.44 0.89 11.45 0.77 0.99 (0.22)
October... 15.88 (2.91) (5.13) 2.37 0.90 11.22 1.00 0.98 0.02
November... 14.88 (2.86) (4.50) 2.42 0.74 10.80 1.42 1.00 0.43
December... 14.13 (2.66) (4.50) 2.22 0.72 10.03 2.19 1.19 1.00
1991 January... 14.25 (4.64) (4.50) 4.21 0.69 10.14 2.08 (1.67) 3.75
February... 14.38 (4.71) (3.88) 4.26 0.70 10.87 1.35 (1.79) 3.13
March.... 14.63 (4.81) (3.88) 4.34 0.71 11.11 1.11 (1.95) 3.06
April.... 10.38 (3.67) (3.88) 3.29 0.61 6.85 5.37 (0.42) 5.79
May...... 10.50 (3.67) (3.25) 3.37 0.61 7.69 4.53 (0.56) 5.10
June..... 10.75 (2.98) (3.25) 2.60 0.58 7.82 4.40 0.27 4.13
July..... 10.75 (3.24) (3.25) 3.10 0.37 7.85 4.37 (0.57) 4.94
August... 11.00 (3.26) (2.63) 3.08 0.36 8.67 3.55 (0.63) 4.18
September... 11.50 (3.30) (2.63) 3.11 0.36 9.16 3.06 (0.78) 3.84
October... 11.63 (3.27) (2.63) 3.06 0.37 9.27 2.95 (0.86) 3.81
November... 10.63 (2.69) (2.00) 2.48 0.36 8.90 3.32 (0.20) 3.53
December... 8.25 (2.08) (2.00) 1.90 0.33 6.52 5.70 0.49 5.20
</TABLE>
<PAGE> 117
<TABLE>
<CAPTION>
- - - - - ------------------------------------------------------------------------------------------------------------------------
GAIN AT CHARACTER OF
CUMULATIVE CUMULATIVE SUSPENDED LOSSES BASIS ASSUMED GAIN OR (LOSS)
MONTH OF ACQUISITION NET CASH ------------------ FOR CALC. SALES PRICE ------------------
ENTRY PRICE INC./(LOSS) DISTRIBUTIONS(5) ORDINARY CAPITAL GAIN/(LOSS) $12.22 ORDINARY CAPITAL
- - - - - -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1992
January..... $9.38 $(1.90) $ (2.00) $1.61 $0.41 $ 7.61 $4.61 $ 0.52 $4.09
February... 9.63 (1.91) (1.38) 1.59 0.43 8.48 3.74 0.44 3.30
March.... 7.75 (1.62) (1.38) 1.37 0.35 6.60 5.62 0.68 4.94
April... 8.75 (1.75) (1.38) 1.44 0.41 7.59 4.63 0.57 4.06
May...... 8.50 (1.78) (0.75) 1.45 0.43 7.96 4.26 0.46 3.80
June..... 7.75 (1.59) (0.75) 1.31 0.37 7.21 5.01 0.57 4.45
July..... 7.88 (1.31) (0.75) 1.26 0.12 7.32 4.90 0.55 4.34
August... 8.00 (1.29) (0.63) 1.25 0.11 7.57 4.65 0.52 4.13
September... 8.00 (1.25) (0.63) 1.21 0.11 7.56 4.66 0.49 4.17
October... 8.00 (1.25) (0.63) 1.20 0.11 7.56 4.66 0.42 4.24
November... 8.63 (1.23) (0.50) 1.17 0.12 8.30 3.92 0.36 3.56
December... 7.88 (1.18) (0.50) 1.11 0.12 7.54 4.68 0.35 4.33
1993
January..... 8.00 (1.71) (0.50) 1.63 0.12 7.66 4.56 (0.27) 4.83
February... 8.00 (1.60) (0.38) 1.52 0.12 7.78 4.44 (0.23) 4.67
March.... 8.13 (1.49) (0.38) 1.40 0.12 7.90 4.32 (0.18) 4.50
April.... 7.88 (1.36) (0.38) 1.27 0.12 7.65 4.57 (0.14) 4.71
May...... 8.00 (1.25) (0.25) 1.16 0.13 7.90 4.32 (0.13) 4.45
June..... 7.75 (1.00) (0.25) 0.91 0.12 7.64 4.58 (0.01) 4.58
July..... 8.13 (0.81) (0.25) 0.83 8.02 4.20 (0.03) 4.24
August... 8.75 (0.69) (0.13) 0.71 8.76 3.46 (0.02) 3.48
September... 8.75 (0.56) (0.13) 0.58 8.76 3.46 0.00 3.46
October... 9.00 (0.43) (0.13) 0.44 9.01 3.21 0.02 3.19
November... 10.75 (0.30) 0.31 10.88 1.34 0.01 1.33
December... 10.88 (0.16) 0.16 11.00 1.22 0.01 1.22
- - - - - ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Assumptions: (1) This schedule uses low trade prices for each acquisition month
(2) Units held through December 31, 1993
(3) Passive loss restrictions apply
(4) Cumulative Section 754 net income/loss calculated through
12/31/93
(5) Cumulative cash distributions calculated through 12/31/93. Cash
distributions received by Public Unitholders after December 31,
1993 will reduce the Unitholder's basis in the Common Units and
increase the Unitholders gain (or reduce the Unitholder's loss)
on a dollar-for-dollar basis. Such amount will be reflected as
additional/(decreased) capital gain/(loss).
(6) Basis and, correspondingly, sales price increased by .12 for
legal fees
<PAGE> 118
ANNEX D-3
PER UNIT BASES & INCOME ALLOCATIONS
AS OF DECEMBER 31, 1993(1)(2)(3)(4)
<TABLE>
<CAPTION>
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
GAIN AT CHARACTER OF
CUMULATIVE CUMULATIVE SUSPENDED LOSSES BASIS ASSUMED GAIN OR (LOSS)
MONTH ACQUISITION NET CASH ------------------ FOR CALC. SALES PRICE ------------------
OF ENTRY PRICE INC./(LOSS) DISTRIBUTIONS(5) ORDINARY CAPITAL GAIN/(LOSS) $12.22 ORDINARY CAPITAL
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1987
March... $22.75 $(7.79) $(13.30) $7.84 $0.95 $10.57 $ 1.65 $(2.33) $ 3.98
April... 23.62 (7.10) (13.30) 7.37 0.72 11.43 0.79 1.09 (0.30)
May..... 22.23 (7.50) (13.30) 7.72 0.75 10.02 2.20 (0.31) 2.50
June.... 24.10 (7.14) (13.30) 7.34 0.77 11.89 0.33 (0.36) 0.69
July.... 23.49 (7.04) (12.63) 7.24 0.76 11.95 0.27 (0.41) 0.68
August... 25.57 (8.28) (12.63) 8.21 1.02 14.02 (1.80) (3.06) 1.27
September... 26.40 (9.13) (12.63) 8.99 1.09 14.84 (2.62) (4.01) 1.39
October... 22.35 (6.14) (12.63) 5.42 0.71 9.83 2.39 1.85 0.54
November... 20.13 (6.44) (11.99) 6.60 0.77 9.18 3.04 0.25 2.78
December... 20.73 (5.79) (11.99) 6.01 0.70 9.78 2.44 1.35 1.09
1988
January... 21.75 (6.27) (11.99) 6.44 0.74 10.80 1.42 0.51 0.92
February... 21.94 (6.22) (11.38) 6.27 0.85 11.59 0.63 0.19 0.45
March... 20.78 (5.93) (11.38) 5.94 0.87 10.40 1.82 (0.33) 2.14
April... 20.06 (5.97) (11.38) 5.92 0.92 9.68 2.54 (0.55) 3.09
May..... 18.93 (5.52) (10.75) 5.53 0.84 9.16 3.06 0.97 2.09
June.... 19.81 (5.40) (10.75) 5.38 0.85 10.02 2.20 0.07 2.13
July.... 19.17 (5.38) (10.75) 5.41 0.79 9.35 2.87 (0.12) 2.99
August... 17.96 (4.23) (10.13) 4.48 0.56 8.77 3.45 2.46 0.99
September... 17.05 (4.06) (10.13) 4.29 0.57 7.84 4.38 2.60 1.77
October... 17.89 (4.69) (10.13) 4.68 0.79 8.66 3.56 0.60 2.96
November... 17.19 (4.02) (9.50) 4.13 0.66 8.57 3.65 1.53 2.12
December... 15.78 (3.43) (9.50) 3.61 0.57 7.15 5.07 3.25 1.82
1989
January... 17.33 (4.18) (9.50) 4.13 0.79 8.68 3.54 1.12 2.42
February... 18.73 (4.86) (8.88) 4.61 0.96 10.69 1.53 0.36 1.17
March... 19.30 (5.12) (8.88) 4.78 1.03 11.24 0.98 0.09 0.89
April... 19.30 (5.35) (8.88) 4.93 1.09 11.21 1.01 (0.16) 1.16
May..... 19.18 (5.29) (8.25) 4.83 1.10 11.69 0.53 (0.08) 0.62
June.... 20.22 (5.25) (8.25) 4.77 1.10 12.70 (0.48) (0.05) (0.43)
July.... 20.93 (5.62) (8.25) 5.13 1.09 13.39 (1.17) (0.59) (0.58)
August... 19.12 (5.15) (7.63) 4.67 1.04 12.18 0.04 (0.06) 0.10
September... 18.21 (4.85) (7.63) 4.38 1.02 11.25 0.97 0.27 0.70
October... 17.07 (4.44) (7.63) 3.98 0.98 10.08 2.14 0.74 1.40
November... 16.95 (4.00) (7.00) 3.56 0.94 10.57 1.65 1.22 0.43
December... 16.42 (3.95) (7.00) 3.47 0.95 10.02 2.20 1.27 0.93
1990
January... 17.46 (3.69) (7.00) 3.19 0.95 11.03 1.19 1.24 (0.06)
February... 16.61 (3.55) (6.38) 3.05 0.93 10.79 1.43 1.22 0.21
March... 15.83 (3.40) (6.38) 2.89 0.93 10.00 2.22 1.25 0.96
April... 15.34 (3.32) (6.38) 2.79 0.94 9.50 2.72 1.30 1.42
May..... 14.25 (2.83) (5.75) 2.36 0.85 9.01 3.21 1.97 1.24
June.... 14.68 (2.94) (5.75) 2.38 0.93 9.43 2.79 1.63 1.16
July.... 15.99 (2.93) (5.75) 2.45 0.85 10.72 1.50 1.30 0.20
August... 16.23 (3.14) (5.13) 2.58 0.90 11.57 0.65 0.86 (0.21)
September... 17.25 (3.00) (5.13) 2.44 0.89 12.57 (0.35) 0.99 (1.35)
October... 17.13 (2.91) (5.13) 2.37 0.90 12.47 (0.25) 0.98 (1.23)
November... 16.43 (2.86) (4.50) 2.42 0.74 12.35 (0.13) 1.00 (1.12)
December... 15.13 (2.66) (4.50) 2.22 0.72 11.04 1.18 1.19 (0.01)
1991
January... 15.59 (4.64) (4.50) 4.21 0.69 11.48 0.74 (1.67) 2.41
February... 15.59 (4.71) (3.88) 4.26 0.70 12.09 0.13 (1.79) 1.92
March... 15.65 (4.81) (3.88) 4.34 0.71 12.13 0.09 (1.95) 2.04
April... 13.19 (3.67) (3.88) 3.29 0.61 9.67 2.55 (0.42) 2.97
May..... 11.62 (3.67) (3.25) 3.37 0.61 8.80 3.42 (0.56) 3.98
June.... 11.41 (2.98) (3.25) 2.60 0.58 8.49 3.73 0.27 3.46
July.... 12.00 (3.24) (3.25) 3.10 0.37 9.10 3.12 (0.57) 3.69
August... 12.00 (3.26) (2.63) 3.08 0.36 9.67 2.55 (0.63) 3.18
September... 12.12 (3.30) (2.63) 3.11 0.36 9.78 2.44 (0.78) 3.23
October... 12.57 (3.27) (2.63) 3.06 0.37 10.22 2.00 (0.86) 2.86
November... 12.07 (2.69) (2.00) 2.48 0.36 10.35 1.87 (0.20) 2.08
December... 9.97 (2.08) (2.00) 1.90 0.33 8.24 3.98 0.49 3.49
</TABLE>
<PAGE> 119
<TABLE>
<CAPTION>
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
GAIN AT CHARACTER OF
CUMULATIVE CUMULATIVE SUSPENDED LOSSES BASIS ASSUMED GAIN OR (LOSS)
MONTH ACQUISITION NET CASH ------------------ FOR CALC. SALES PRICE ------------------
OF ENTRY PRICE INC./(LOSS) DISTRIBUTIONS(5) ORDINARY CAPITAL GAIN/(LOSS) $12.22 ORDINARY CAPITAL
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1992
January.... $10.86 $(1.90) $(2.00) $1.61 $0.41 $9.09 $3.13 $0.52 $2.61
February... 10.52 (1.91) (1.38) 1.59 0.43 9.38 2.84 0.44 2.41
March... 9.13 (1.62) (1.38) 1.37 0.35 7.97 4.25 0.68 3.57
April... 9.30 (1.75) (1.38) 1.44 0.41 8.14 4.08 0.57 3.51
May..... 9.24 (1.78) (0.75) 1.45 0.43 8.70 3.52 0.46 3.06
June.... 8.53 (1.59) (0.75) 1.31 0.37 7.99 4.23 0.57 3.66
July.... 8.60 (1.31) (0.75) 1.26 0.12 8.05 4.17 0.55 3.62
August... 8.66 (1.29) (0.63) 1.25 0.11 8.23 3.99 0.52 3.48
September... 8.66 (1.25) (0.63) 1.21 0.11 8.22 4.00 0.49 3.51
October... 9.18 (1.25) (0.63) 1.20 0.11 8.74 3.48 0.42 3.06
November... 9.37 (1.23) (0.50) 1.17 0.12 9.04 3.18 0.36 2.82
December... 8.60 (1.18) (0.50) 1.11 0.12 8.26 3.96 0.35 3.60
1993
January.... 8.53 (1.71) (0.50) 1.63 0.12 8.19 4.03 (0.27) 4.30
February... 8.40 (1.60) (0.38) 1.52 0.12 8.18 4.04 (0.23) 4.27
March... 8.59 (1.49) (0.38) 1.40 0.12 8.37 3.85 (0.18) 4.03
April... 8.33 (1.36) (0.38) 1.27 0.12 8.11 4.11 (0.14) 4.25
May..... 8.40 (1.25) (0.25) 1.16 0.13 8.29 3.93 (0.13) 4.05
June.... 8.34 (1.00) (0.25) 0.91 0.12 8.23 3.99 (0.01) 4.00
July.... 8.72 (0.81) (0.25) 0.83 8.61 3.61 (0.03) 3.64
August... 9.30 (0.69) (0.13) 0.71 9.31 2.91 (0.02) 2.93
September... 9.30 (0.56) (0.13) 0.58 9.31 2.91 0.00 2.91
October... 10.41 (0.43) (0.13) 0.44 10.41 1.81 0.02 1.79
November... 11.28 (0.30) 0.31 11.41 0.81 0.01 0.80
December... 11.67 (0.16) 0.16 11.80 0.42 0.01 0.42
- - - - - ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Assumptions: (1) This schedule uses average trade prices for each acquisition
month
(2) Units held through December 31, 1993
(3) Passive loss restrictions apply
(4) Cumulative Section 754 net income/loss calculated through
12/31/93
(5) Cumulative cash distributions calculated through 12/31/93.
Cash distributions received by Public Unitholders after
December 31, 1993 will reduce the Unitholder's basis in the
Common Units and increase the Unitholders gain (or reduce
the Unitholder's loss) on a dollar-for-dollar basis. Such
amount will be reflected as additional/(decreased) capital
gain/(loss).
(6) Basis and, correspondingly, sales price increased by $.12 for
legal fees
