Melissa Davis

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El Paso Critics Mull What Might Have Been

Melissa Davis

Betty Killen still has the "Vote Blue" T-shirt she wore to last year's big El Paso (EP Quote - Cramer on EP - Stock Picks) proxy fight.

The pale blue shirt, donned by many that humid day in downtown Houston, clearly identified Killen as a member of a proud dissident team that sought to replace the energy giant's entire board in the name of corporate reform. The dissidents narrowly lost. But Killen still treasures the T-shirt, anyway.

"My grandniece was going through my closet the other day, and she said, 'We need to get rid of this ugly blue shirt,'" Killen says. "I told her, 'Don't throw that away!'"

Instead, Killen wishes she had good reason to wear the shirt again.

"I always wonder what would happen if we could say, 'Just vote all over again. Just one more time,'" she told TheStreet.com this week. "It was so close. We had high hopes that maybe we could actually get something done."

Exactly a year has passed since Killen's group tried to make history by winning the biggest proxy fight of the decade. They were hoping to oust company leaders that, they felt, had unjustly enriched themselves while recklessly driving the company into the ground. But their well-orchestrated campaign, partially financed by legendary oilman Oscar Wyatt, fell just shy despite some powerful endorsements. The dissidents, officially led by millionaire businessman Selim Zilkha, wound up where dissidents usually do -- on the losing side -- after a couple of big institutions changed their votes in favor of the incumbents at the last minute.

El Paso has gone on to hire a permanent CEO, former Halliburton (HAL Quote - Cramer on HAL - Stock Picks) executive Doug Foshee, and adopt a number of changes that the dissidents themselves had recommended. But El Paso's stock, down 1.6% to $7.23 on Wednesday, fetches even less now than it did when investors were agonizing over the company's survival on that fateful day last summer.

Killen, for one, wonders if El Paso can ever fully recover.

"I certainly hope it does," she sighed. "But I just don't see it turning any corners."

Obstacle Course

Instead, El Paso seems to be smashing into new obstacles.

These days, the company is fielding fewer questions about Enron-like issues -- such as energy trading, mark-to-mark accounting and off balance sheet debt -- and far more about the old-fashioned topic of exploration and production. El Paso has somehow wound up with 40% less proved reserves, or the amount of energy it can commercially produce, than it claimed to have last year. And that bothers some people just as much as seeing a bunch of paper trading profits evaporate into thin air.

"It is absolutely impossible to have a 40% reduction in proved reserves on a diverse portfolio like El Paso's if the engineering, geology and accounting were done with integrity and prudence," said David Scheidegger, a former employee of a company acquired by El Paso. And "for the record, I am an engineer, a geologist and an accountant."

A company-ordered study has already placed blame on past E&P employees, and two separate government agencies -- the Department of Justice and the Securities and Exchange Commission -- continue to investigate the matter. In the meantime, El Paso has replaced Rod Erskine, the former head of E&P, with a respected veteran from Apache (APA Quote - Cramer on APA - Stock Picks).

Lisa Stewart took over as El Paso's E&P president in February. One former employee, a victim of recent layoffs, marvels that Stewart was even willing to "jump into that quagmire." But El Paso itself says that Stewart spotted opportunity.

"It was her view that the company had good assets, good people and that the situation could be turned around," explained Bruce Connery, El Paso's vice president of investor and public relations.

But El Paso has cautioned that the division's rebound -- crucial to the company's recovery -- will take time. In the meantime, Stewart is cleaning house. One former employee estimates that she has gotten rid of nearly half of the division's past leaders. Still, he is waiting for several E&P vice presidents -- the executives who oversaw the reserves that later got cut -- to feel the broom as well.

El Paso says it is unable to comment on whether any current vice presidents were involved with the booking problems. Interestingly enough, however, some people are pointing the finger at one of El Paso's biggest foes instead.

Hero or Villain?

To Killen -- and hundreds of other ordinary El Paso shareholders -- Wyatt is a bona fide hero.

The outspoken oilman, now approaching 80, funneled millions of dollars of his own money into a proxy fight that gave small investors an unusually loud voice. But Wyatt had already earned the respect of some shareholders -- namely his former employees -- even before then. They had watched Wyatt build Coastal into a multibillion-dollar energy empire before selling it off to El Paso in early 2001. Some felt a slip in oversight almost immediately afterwards, however.

"Coastal was very tightly controlled by management," Killen stated. "If you needed a new pencil, you would have to show that you had used the last one down to the nub, if you know what I mean. If little things -- like getting new pencils -- were allowed now, what about the big things? That's what scared me."

Killen retired and cashed in nearly all her stock after the merger.

"It was not Coastal any more," she said simply. "It was not Oscar Wyatt's company. It was time to diversify."

But others are far less generous. They actually criticize Wyatt for some of the company's current troubles. One former employee insists that Wyatt had to know that Coastal's reserves -- largely blamed for the new revisions -- were being overstated.

"That was his baby," the former staffer said of Coastal's E&P division. "If he didn't know, then he isn't the Oscar Wyatt that we have all come to love and loathe."

Wyatt declined to be interviewed for this story because he is currently embroiled in litigation against El Paso. He has been named the lead plaintiff in a series of shareholder lawsuits that accuse the company of, among other things, overstating reserves.

New Math

To be fair, experts have always relied on judgment calls -- as well as science -- when calculating energy reserves.

They have just grown more cautious since new rules, with stiff penalties, took effect last year. The Sarbanes-Oxley Act now requires senior executives to certify that corporate financial statements, which include reserves for energy companies, are accurate. And it can trigger fines of up to $5 million and 20 years in prison for serious violations.

"This has a marvelous way of making people second-guess everything they do and err on the side of conservatism," says John Olson, a veteran energy analyst at Sanders Morris Harris who owns El Paso shares himself.

Some wonder whether El Paso's past management will now be held accountable. El Paso finally slashed its reserves after hiring Ryder Scott -- one of the most conservative auditors in the business -- following Foshee's arrival last year. Olson says the company, which now faces a writedown of up to $3 billion as a result of the revision, is doing the right thing by scrubbing its books clean.

But others wonder. At least one former El Paso employee, among hundreds recently laid off, defends the past reserves figures and the former head of the division. He suspects that current management may actually be understating reserves now so that it can enjoy upside revisions in the future.

"I think the reserve cuts were excessive," he says bluntly.

Still, new management teams often seek out past excesses so they can start with a clean slate. And many people -- including some of last year's dissidents -- are still willing to give El Paso's current leadership a chance.

Scorecard

By now, Foshee has spent nine months as El Paso's "turnaround CEO."

He joined the company last fall after making a name for himself by executing a huge asbestos settlement for Halliburton. Some had hoped for a leader with more hands-on energy experience. But others felt satisfied.

"He wasn't the first choice, by any stretch of the imagination," says one former employee. "But he was the guy who said, 'Yes.' And I'm always impressed with people who are willing to take on something that's insurmountable."

El Paso points to the hiring of Foshee and Stewart, along with asset sales and cost reductions, as major accomplishments for the company. And Olson, for one, gives new management decent marks.

Foshee "has done an admirable job under great adversity," Olson said. "He has strengthened the board and taken a no-nonsense approach to taking the company apart and putting it back together in a much heartier fashion."

Some dissidents are simply relieved that Foshee has kept the company afloat. Even Stephen Chesebro, who would have landed Foshee's job if the dissidents had won, says he's not "throwing any rocks."

Chesebro calls Foshee a "good guy" who has taken a number of necessary steps -- such as cutting the E&P budget and adding energy talent to the board -- that his own team had planned. He supports the company's efforts.

But he also questions whether El Paso made enough changes with enough speed to save it in the end.

"They do not seem to have the same sense of urgency that we felt," Chesebro said. "Our pitch was: Do it quickly. Do it effectively. And move on."

Rearview Mirror

Chesebro has moved on.

He continues to serve as chairman of Harvest Natural Resources (HNR Quote - Cramer on HNR - Stock Picks), a company that -- unlike El Paso -- has seen its stock nearly double since last summer's proxy fight. He still hears from some of his old supporters, wishing now more than ever that the dissidents had won, but he isn't looking back.

Still, he doesn't regret the historic proxy fight, either.

"It was bittersweet," he admitted. "However, I am extremely pleased that we, as a group, stood up for change -- for corporate governance the way it ought to be. It was time for somebody to step up and say, 'Let's do this right.'"

Zilkha has moved on as well. The savvy businessman, who once ranked as El Paso's largest individual shareholder, began cutting his stake in the company immediately after the proxy fight and sold the last of his shares on the stunning reserves news.

He is a man whose family is accustomed to success. His father, for example, rated a New York Times headline -- "Baghdad Banker Reaches Wall Street" -- after his arrival in this country 50 years ago.

Zilkha went on to score his own victories and the broad admiration of those around him. He made a fortune for himself and his investors through his leadership at Mothercare and Zilkha Energy, a company now controlled by El Paso. He currently oversees a "very fine" wind energy firm -- although it is still searching for profits -- and two successful vineyards in his home base of California.

The winery Web site boasts of his family's many achievements. It mentions nothing, however, about the proxy fight that so many people remember Zilkha by.

Still, Zilkha does take pride in that battle.

"I was fighting for what I believed in," he said. "And I wasn't surprised that I got so close. I was surprised that I did not win."

For the first time in three years, El Paso may finally host a calm annual meeting when it greets shareholders in Houston Sept. 9. Wyatt won't be screaming about El Paso's Enron-like accounting, as he first did two summers ago, because of his pending litigation against the company. Zilkha probably won't even show up since he no longer owns a single share of the stock.

Still, Killen recognizes that ordinary shareholders -- even outside El Paso -- may have lost their one big shot at stardom last year.

"I know it wasn't the little voter, the small shareholder, who made the difference in the end," she said. "But it did make you feel like you could change things. ... I was just hoping we could turn this into a bigger story for the whole world."