JUDGMENT DAY

As showdowns go, there are few more fearsome for a Canadian chief executive than facing a crowd of angry utility stockholders who have had their dividend cut. That's the prospect beleaguered TransCanada PipeLines Ltd. CEO Douglas Baldwin had to look forward to as he girded himself for the company's annual meeting at the Hilton Montreal Bonaventure Hotel on April 28. The optimistic scenario: making it back to headquarters in Calgary with his authority intact.

The anger has been boiling for months. Last Dec. 8, TransCanada, North America's largest shipper of natural gas and the world's second-largest gas pipeline company, announced that it would cut its annual dividend to 80 cents per share from $1.12, starting in 2000. The 14-member board of directors also unveiled a plan to sell $3 billion in assets. It was the latest instalment--and the worst -- in a stream of bad news emanating from TransCanada since its massive $15.6-billion takeover of Nova Corp. in July, 1998.

Investors and analysts deluged TransCanada with calls and e-mails. "I spent an hour on the phone with an Australian woman in tears who's trying to raise her handicapped son living off bond interest and her TCPL dividend income," says a former TransCanada executive.

TransCanada was the archetypal widows' and orphans' stock--a regulated monopoly that maintained a steady share price and paid out a steady dividend. It was an old reliable for mutual fund and pension fund managers as well, and, by extension, for the millions of Canadians whose money is entrusted to them. The stock virtually guaranteed no surprises.

But the past year-and-a-half has been nothing but. TransCanada's stock was worth $27.05 the day the Nova takeover was completed. By Dec, 8, 1999, it had declined by about 40%. After the dividend cut, panic selling among the company's 32,500 investors drove the price down by $2.50 within two hours. And it kept sinking, bottoming out at $9.80 in early February, pushing TransCanada's market capitalization down to $4.5 billion from more than $12 billion the day of the takeover.

More ominously, as annual meeting day approached, some institutional investors began talking with so-called catalyst investors, dissident shareholders who provoke change in company management.

Others started voicing criticisms on the record, something they almost never do. "The board is up for re-election," said Dom Grestoni, managing partner of IG Investment Management Ltd., the investment arm of Winnipeg-based mutual fund giant Investors Group. IG is TransCanada's biggest shareholder, with 18 million shares. "We would not put forward our own nominees precipitously, or alone. [But]we are considering those things."

On Bay Street, one institutional investor gave Baldwin a nickname: "the day before yesterday's man."

How did TransCanada go so disastrously astray? It's a many-faceted tale of a diversification strategy born in the early 1990s, and then accelerated under gung-ho former CEO George Watson. He departed abruptly last July, after locking horns with the board of directors. He declined a formal interview for this story.

Watson left his successors saddled with $13 billion of debt and a mishmash of non-regulated businesses that have lost $700 million, but which some insiders and analysts say hold the key to future growth. The company is also facing a formidable new competitor, Alliance Pipeline Ltd., which will invade its basic gas pipeline business this year.

Baldwin also declined to be interviewed, but TransCanada's chief financial officer, Russ Girling, outlined management's game plan. "We're a strong company that's woven into the fabric of the economy, and there's huge opportunity within our core businesses. There's no silver bullet, but [debt reduction]will change our financial strength."

Perhaps, but critics argue that shedding non-core operations and seeking shelter in the regulated pipeline business is itself a huge risk. In their desperation to clean up TransCanada's balance sheet, Baldwin and his team may sell off the most promising assets at liquidation-sale prices.

But all that will unfold after they endure the wrath of the widows and orphans at the annual shareholders meeting.

TransCanada entered the 1990s sitting pretty. North American gas demand was beginning to boom, and the company was launching a massive expansion that would double the capacity of its cross-Canada main line. Then-CEO and chairman Gerry Maier had been assembling what he called a "spider's web" of wholly- or partly-owned export pipelines. That web extended into the U.S. Midwest, Pacific Northwest, California and the Northeast.

As it had since its founding in the 1950s, TransCanada was cranking out earnings and dividends. It was the middleman between gas producers in Alberta and distributors in Eastern Canada and the United States. Rates were set by the National Energy Board (NEB), and they were based on the cost of both the company's debt and its operations, and an allowable rate of return tacked on.

On top of that, TransCanada was diversifying carefully into non-regulated--and possibly more profitable--new businesses and new markets. It was a leader in building natural gas-fired electricity plants. Maier was also testing the waters in foreign markets, where even statist governments were looking more favourably on privatization and foreign investment. Among other ventures, TransCanada built Mexico's first major, non-state-owned pipeline.

But at home, regulatory and financial pressures were building. While the NEB began chipping away at pipeline companies' historically fat returns, U.S. regulators loosened their hold on pipelines. Annual returns climbed toward 15%. "Until the early '90s, the Canadian sector was fundamentally more attractive than that in the U.S.," says David Fleischer, a managing director at Goldman Sachs Group Inc. in New York City. Since then, he says, "Canadian pipeline companies have been nickel-and-dimed downward." That made it harder for TransCanada to attract and hold equity investors.

Worse, both TransCanada's customers and the producers that fed it gas were getting rebellious. In the mid-1990s, TransCanada's main rivals--Westcoast Energy Inc., which taps northeast British Columbia's gas fields, and Enbridge Inc., formerly IPL Energy Inc.--bought two Ontario natural gas distributors that sold gas supplied by TransCanada. "Their archcompetitors bought their key customers," says one prominent Calgary pipeline executive.

At the other end of the pipe, increasing gas production was overwhelming TransCanada's export capacity. This created an artificial surplus within Alberta--so-called trapped gas--and that drove down prices. By one estimate, producers were losing $5 billion a year in revenues.

Their solution: Form a consortium of their own and build a new gas pipeline from northwest Alberta's remotest fields to Chicago. The Alliance pipeline was a direct challenge not only to TransCanada, but to the provincially regulated monopoly shipper of export-bound gas within Alberta, Nova Corp.

Both companies tried to kill Alliance--and failed. "Nova and TCPL underestimated the depth of producers' hostility, their determination to break our monopolies," says one former TransCanada executive. "They thought Alliance was just a bluff to wring concessions from us."

The Alliance pipeline is now under construction. On April 30, it will begin accepting shipping orders from producers, and it is scheduled to open in October. Ironically, producers who use it will have to pay more to get their gas to market: Alliance will charge lower tolls than TransCanada, but its pipeline only goes to Chicago. Producers who ship to markets farther east will have to pay for additional transport. So they may stick with TransCanada.

Squeezed from both ends, TransCanada's executives gradually settled on a two-pronged counterstrategy. First, they concluded their best prospects lay outside regulated gas pipelines--they should move into other businesses and into other countries. Those businesses included so-called midstream ventures, such as the processing of raw natural gas and stripping out oxymoronically-named "gas liquids," including propane. Gas-powered electricity generation was another bright spot. There were also nebulous "energy services," such as marketing, price hedging, and fee-based work for producers and buyers.

Second, with Alliance on the horizon, TransCanada needed to guarantee its supply from producers. The obvious move: Take over Nova's pipelines within Alberta. Nova also held access to the continent's next--and last--big untapped gas fields, in the Northwest Territories and Alaska.

Maier, who stepped down as CEO in 1994 but remained company chairman until mid-1998, says TransCanada was also gravely concerned that a U.S. pipeline giant, perhaps $50-billion, Houston-based Enron Corp., might snap up Nova. If that happened, TransCanada would be both buying from, and selling to, competitors--a virtual doomsday scenario.

Buying Nova might also help TransCanada win favour from producers. It would reduce costs and salve one of producers' worst irritants: contracting with two separately regulated monopolies to move gas from field to market.

The TransCanada-Nova deal, a $15.6-billion share and debt swap, was announced in January, 1998. The companies described it as a "pooling of interests," but everyone on the Street called it a takeover. The deal closed in July. TransCanada got Nova's pipeline system, its generally sound midstream assets, plus some solid international projects, including the GasAndes pipeline linking Argentina to Chile.

TransCanada made plans to move into a sparkling new $200-million 36-storey headquarters, one of Calgary's first new skyscrapers since the dark days of the national energy program. As for management, TransCanada executives would be mostly in charge, although Nova's chairman, Richard Haskayne, would head the board.

In a move widely seen as a sop to Nova CEO Ted Newall and Nova president Jeffrey Lipton, Nova's $4-billion worth of remains were spun off as a commodity chemicals producer. A puny player by world standards, Nova Chemicals Corp. was not expected to survive for long. How differently things turned out.

By this time, George Watson was at the helm at TransCanada. He had joined the company as chief financial officer in late 1989. In 1994, he succeeded Maier as CEO.

Watson has an interesting résumé, to say the least. A former banker with the Canadian Imperial Bank of

Commerce, he is also a veteran of Dome Petroleum Ltd., an epic Canadian corporate disaster. Driven by chairman Smilin' Jack Gallagher and his visions of opening up the Arctic, Dome went on a debt-fuelled acquisitions binge in the 1970s and 1980s. To avert Dome's collapse, Ottawa allowed U.S.-owned Amoco Canada Petroleum Co. Ltd. to take over the company for $5.5 billion in 1988.

Watson, 52, is regarded by many as intelligent--even brilliant--and highly entrepreneurial. He's also colourful, tough, growth-oriented and willing to take risks -- Dome trademarks. Gas pipelines were not enough for him. Watson envisaged TransCanada as an "energy solutions company."

But several people who know him acknowledge that he did not have an intimate understanding of the complex world of pipeline operations and its matrix of relationships. Nor was he regarded as a crack administrator, or as a people person. He brought in his own team as well, which put some existing managers' noses out of joint.

Watson may also have been too focused on growth for its own sake, another trademark of Dome. Maier says that, especially in less familiar international terrain, the difference between a great idea and meticulous execution is also usually the difference between profits and losses.

Watson was impatient. He decreed that by 2000, TransCanada would generate 50% of its earnings from non-regulated enterprises. He pushed into Mexico, Venezuela, Colombia, Brazil, Argentina, Chile, Barbados, Thailand, Tanzania, Malaysia, Singapore, Indonesia, Australia, China, the Netherlands and Britain.

The consensus is that Watson engineered some great projects, including a group of pipelines in South America. But he also picked up some losers. Among them were some troubled U.S. gas processing assets, including a Louisiana liquids business, that TransCanada eventually sold at a $170-million loss. "Watson bought too much, too fast, and overpaid," says one financial analyst.

Even the Nova deal was problematic. It was promoted as taking two good companies and turning them into one supercompetitor, a seamless and low-cost pipeline network. The cynic's view was that marrying two slow-moving monopolies would spawn a single, shambling behemoth with eternal, regulated single-digit returns. "We bought Nova mostly to keep it from falling to someone else," says a former TransCanada PipeLines employee. "I think we let Newall and Lipton outfox us in the negotiations." Indeed, today, a re-energized, low-debt Nova Chemicals is thriving.

Once the deal was done, critics say Watson was strangely slow to implement changes. "Big mergers are hard," says Bob Hastings, an analyst with the Vancouver brokerage firm Goepel McDermid. "Those who do it well have moved extremely quickly." Watson downsized the workforce at a glacial pace. The merger was supposed to yield annual savings of $100 million. So far, it has cost $400 million.

By early 1999, it was clear that Watson's vision of wringing huge profits from unregulated new businesses was a pipe dream. TransCanada was buckling under the debt it had assumed to buy them, and its stock price was sliding.

Watson won't get into specifics about his departure. But in a brief phone conversation, he hinted that he went to the board with a vision for growing TransCanada out of its woes using e-business. Well-informed sources say Watson also tried to limit asset sales to about $1 billion. But board chairman Haskayne, a chartered accountant, insisted on reducing debt quickly, even if this meant selling some of the best, money-making assets.

Haskayne also declined to be interviewed, but one source says several board members backed Watson. Board meetings became marathons of micromanagement, and at least one deteriorated into a shouting match.

In July, TransCanada announced that Watson had stepped down. Watson insists he wasn't fired, but chose to retire since he disagreed with the board. "I would have taken a different direction," he says.

The board replaced Watson with Douglas Baldwin, a former president of Esso Resources Canada Ltd., Imperial Oil Ltd.'s upstream arm. Reportedly, he was Haskayne's personal choice. He is generally regarded as a good organizer and cost-cutter, and a likable man. But neither Baldwin nor Imperial, with whom the 63-year-old, Saskatchewan-born engineer spent a remarkable 40 years, are renowned for their ability to seize growth opportunities.

Baldwin hasn't shown many signs of seizing the initiative at TransCanada yet, either. With a big annual meeting approaching, two sources say they heard he was on a four-week, or even six-week, vacation cruise through March--an "amazing" decision given TransCanada's crisis. Company spokesman Glenn Herchak confirmed that Baldwin was on holidays in late March, adding, "I don't think it's for that long. He's been working really hard."

Most analysts initially assumed Baldwin would be a caretaker. And he started off by making the right noises about cutting costs and restoring growth. Last fall, TransCanada published a glossy corporate brochure that introduced the new team and reiterated Watson's structure for an "energy solutions" company--gas transmission, marketing, midstream and international. It also called TCPL's midstream unit "a vital core business."

Just weeks later, Baldwin and his team unveiled a radical departure now known as the "December plan." First, there was the dividend cut. As well, TransCanada said it would dump its international unit, worth $1.7 billion; its midstream unit, worth $800 million or so; and several smaller ventures. The company even axed the 5% discount on shares offered to investors who reinvest their dividends. In total, TransCanada hopes to raise $3 billion, after write-downs and restructuring charges of $700 million charged to 1999. As a result, the company posted a loss of $70 million for the year.

What will remain is natural gas transmission, gas marketing and power generation -- together worth about $22 billion--and about 3,000 employees. TransCanada had already shaved staff from 5,000 at the merger to 4,400 in December. Baldwin called the package "clear and decisive actions" to "capture North American energy growth opportunities." It sounds a lot like the old TransCanada.

The market felt shocked and betrayed by the dividend cut. "All the signals had been the dividend was safe," says analyst Bob Hastings. "The past CEO had said so, and Baldwin gave reassurances in meetings."

"For management to run a company in a regulated fashion, then knock 50% off the value of the stock--that's not going to endear you to the investor," says Investors Group's Dom Grestoni. "We realize there are no guarantees in life. But nowhere were any danger signals raised [by management]" The cut also incensed TransCanada employees, many of whom banked a big part of their retirement strategy on shares.

TransCanada's subsequent investor relations effort was equally bad. "There was no explanation [from management]" says Luc Fournier, a fund manager with the Industrial Alliance Life Insurance Co. "The market is very skeptical right now. They will have to make a very great pitch going forward."

To boost its earnings quickly, TransCanada needs to convince the National Energy Board to let it increase rates. There are no hearings scheduled yet, but they will happen some time this year. Garry Mihaichuk, president of TransCanada's gas transmission arm, wants a return on equity of 12% to 13% and an increase in Alberta-to-market tolling of about 10 cents per thousand cubic feet of gas. That would boost TransCanada's pretax earnings by about $180 million.

Given TransCanada's current weakness, it seems bizarre that no one has taken it over on the cheap yet. Some analysts say no U.S. pipeline company will wade into a land of single-digit, regulated returns. By that reasoning, TransCanada's weaknesses are also its de facto poison pill.

Others say a takeover is possible after rate talks conclude. Potential buyers are biding their time. Girling admits that management is nervous: "We'll be vulnerable if any potential buyer sees the shimmer of hope before the [stock]market generally. We hope the market sees it first."

While investors and industry executives shake their heads over TransCanada's dividend debacle, nobody likes Baldwin's divestment plan either. "To go from one extreme to the other--'Well, the buying isn't working, so let's sell it all'--is too much," says Fleischer of Goldman Sachs. He thinks TransCanada should sell the dogs, take an enormous hit, then use robust earnings from its star assets to grow its way out of trouble.

One former TransCanada employee says the international operations will generate earnings of $100 million this year on an estimated equity stake of between $300 million and $500 million. That means a return on equity of 25% to 33%. Plus they offer good prospects for future growth. And they're for sale?

"They're eating their seed corn," says a former TransCanada executive.

Girling and Mihaichuk see huge potential for TransCanada's remaining core assets. The stodgy old Canadian pipeline business, including the main line in service since 1957, generated profits of $510 million in 1999.

The two men project that North America's annual natural gas consumption will increase by 7.6 trillion cubic feet over the next decade. U.S. supply basins are maxed out. The new supply will have to come from Western Canada and the Far North. If TransCanada sheds debt, and increases what Girling calls its "equity thickness," it will position itself to raise new capital and expand. "Even half the projected growth in gas consumption would allow us to double the main line," enthuses Mihaichuk.

Renewed interest in the Far North is a major story in itself. Companies are steadily exploring their way north along the Rocky Mountains, and recently made major discoveries in the Fort Liard area of the Northwest Territories. There's also talk of tapping a motherlode of up to 64 trillion cubic feet around the Mackenzie River Delta, and bringing down the huge volumes of natural gas being reinjected into oilfields surrounding Prudhoe Bay, Alaska. Foothills Pipelines Ltd.--a group of former Nova subsidiaries now 50%- to 75%-owned by TransCanada--holds a legal right of way along the Alaska Highway, a huge advantage to TransCanada. The principal caveat--and it's a big one--is that any northern pipeline faces seven to 10 years of political, regulatory and financial hurdles.

Then there is the human factor. A former TransCanada executive says some people within the company would like to take the sell-the-dogs course Fleischer described. But he says steering a straight line has become an issue of face for management. Only a new CEO could credibly change course again.

In late March, some shareholders appeared disgusted enough to help bring this about. Investors Group's Grestoni says his company isn't traditionally an "activist" investor. But, he says "We are reassessing our holding and what, if any, action we want to take." What bugs him the most is that "This is the same board and some of the same management team who made the decisions to go into non-regulated ventures, who are now proposing to change strategy."

Some institutional investors talk of a more unusual scenario: converting TransCanada to an income trust, which would prevent management from making unwise capital-spending decisions and force them to distribute cash to investors. By one institutional investor's analysis, an income trust structure would distribute even more than the old annual dividend of $1.12. Such trusts are common in the oil and gas production sector. But it would spell the end of TransCanada as a corporate force capable of making its own strategic decisions.

The ultimate irony for market players: TransCanada's stock price hovered around $10 in early April. Even at 80 cents a share, its dividend would provide about an 8% annual yield, a great buy for investors searching for income--widows, orphans and others. And whatever management team is in charge after the annual meeting, they'll think more than twice before cutting that dividend again.