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Featured Articles
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Jan 2010
| Source: Oilweek Magazine
| | | The deal's the thing
| | | M&A activity heats up as a new cycle begins
| | | by R.P. Stastny
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| Wheeling and dealing across Canadian industry heated up somewhat this past summer, a specialist in the mergers and acquisition (M&A) arena says, and while the global recession-and in particular the evaporation of private equity-blunted overall activity in 2009, 2010 could be a much different animal.
Colin Walker, managing director of Toronto-based specialty investment banking firm Crosbie & Company Inc., which tracks M&A data across all sectors of the economy, says the first quarter of 2009 saw just 160 transactions. In the second quarter, activity rose by 28 per cent to 205 transactions. An impressive jump, but this was still only about halfway to the frothy activity levels seen between 2005 and 2007.
"The conditions that gave rise to those high activity levels are gone now," Walker says.
Building a case for a "new normal" in M&A activity levels, Walker notes that before the financial meltdown, there was a tremendous amount of private equity available and incredible liquidity in the capital markets. With strong valuations in hand, companies could finance deals in a variety of ways and the future appeared predictable and profitable, which spurred activity on the M&A front.
"But today, nobody knows what the future will bring," he says. "Private equity groups have become more active again, but they´ve pulled in their horns. The economics for private equity have changed significantly because you can´t get leverage."
The hedge funds are basically gone, according to Walker. A lot of the junior debt capital used in some of the bigger private equity deals is gone. Banks don´t want to lend above a certain absolute dollar level under any circumstances. And while the syndicated loans market isn´t gone altogether, it´s a shadow of what it once was.
"In Canada, the whole shadow banking system, as it´s become known-institutionally funded lending businesses-are unable to fund," Walker adds. "So that´s put a strain on the banks and the remaining players to fill the void. Securitization is gone, so it´s down to banks to fill the void. The term that people are using to describe it is ‘de-leveraging.´ And it´s only partway through. It´s a very, very different kind of environment than we were in 24 months ago."
In the oil and gas space, M&A activity tracks a similar slide from highs in 2005, but the underlying sentiment is altogether more optimistic. Commenting on Walker´s assessment of the M&A market, Scott Bratt, FirstEnergy Capital Corp.´s managing director of corporate finance, says, "There is capital out there. The oilpatch didn´t see a huge restriction on bank lending. There was a bank contraction and we´re seeing some of it now. Some bank funds are being reined in, but it wasn´t as catastrophic as people thought it could´ve been."
Bratt points out that the oil and gas industry hasn´t seen a lot of train wrecks. Producers have largely avoided going into CCAA-Company Creditors Arrangement Act-or bankruptcy by merging out. He agrees there has been de-leveraging worldwide, but says, "I don´t think it has had as much of an impact on the oil and gas sector. By and large, the industry has come through this downturn reasonably healthy."
Trends
Some high-profile announcements last year signalled a turning of the tide in M&A activity. Suncor´s merger with Petro-Canada, the Sinopec/Addax deal, Korean National Oil Corp. acquiring Harvest Energy, and a succession of lower profile acquisitions by the likes of Crescent Point, Petrobank, and others quickened the pace.
A number of themes driving this M&A market have emerged.
"There was a swell of private companies created during the bull market over the past five years," explains Bratt. "Some of the successful ones decided to crystallize their gains. Particularly in southeast and southwest Saskatchewan, there´s a bit of a wave of consolidation activity."
The disparity between low natural gas prices and relatively strong oil prices has pushed investors towards oil-weighted companies. So large pools like the Bakken or the lower Shaunavon in southwestern Saskatchewan have become hives of activity.
"In these large pools, the market has awarded very strong valuations-or multiples-to certain aggregators," Bratt says. "Crescent Point is an example. It´s a very successful company. Glamis [Resources Ltd.] is a new one that has come out just recently."
A partial list of juniors bought by one or the other of these companies includes Wave Energy Ltd. (lower Shaunavon), Cannaught Energy Ltd. (Bakken), Gibraltar Exploration Ltd. (lower Shaunavon), Wild River Resources Ltd. (lower Shawnavan), and Medora Resources Inc. (Bakken).
Alan Tambosso, president of Calgary´s Sayer Energy Advisors, says that Crescent Point alone has purchased over $1.6 billion worth of assets.
Tambosso says resource plays are the "flavour of the week." Not only are the Bakken and lower Shaunavon plays riding this wave of interest, so is Alberta´s Cardium and British Columbia´s Montney. "Those are the type of plays that get the financing," Tambosso says. "The market sees them as having the most growth potential in a very mature basin. They´re sort of the last frontiers for growth."
Valuation gap
Another theme driving M&A activity is the wide gap between companies the market views favourably, on which it confers premium valuations, and the companies that get discounted valuations. That disparity is wider today than it has been for years, according to Bratt. Some companies are trading at two times adjusted cash flow while others trade at 10 times.
"Say you acquire an asset for five times cash flow," Bratt says. "You can make the asset look very good to your shareholders if that transaction then gets revalued at your multiple, say 10 times. In a sense, you´ve doubled the value of your money, though it doesn´t work quite like that. But if you´re trading at two times, you can´t even buy that asset in a market that´s selling at four or five times cash flow."
What accounts for companies trading at larger multiples often comes down to who´s running the company. "The sweet spot for premium valuation," Bratt says "is proven team, oil weighted, resource play, and size."
As for size, mid-cap companies trade at better valuations than small companies because there is typically a flight to liquidity in downturns. Investors want to be able to trade out of a position if they need to. A large shareholder in a very small public company may not be able to sell without moving the market.
Within this market sentiment, gas-weighted juniors can find themselves stranded like minnows in a tide pool. Faced with annual declines of 20 to 30 per cent, they may not be able to maintain production.
Tom Pavic, vice-president of Sayer, points out that while low valuations make some producers attractive acquisition targets, it´s also the worst time to sell.
"When gas companies are cheap, they´re not as keen to sell unless they´re in financial distress, which is one of the things that has been driving some activity," he says. "Some companies might be keen to buy, but it takes two sides to make a transaction."
Hostiles
It may take two to tango, but a hostile takeover can become an option. Unsolicited offers tend to come in cycles. In the late 1990s, when oil prices fell to $10 a barrel and gas prices were depressed, there were at least a dozen of them in western Canada. But generally, Bratt considers hostiles rare.
"If you talk to most guys with 20 years´ [investment banking] experience," Bratt says, "they´ve probably only worked on three or four hostile transactions in their career. That´s not many."
The reason there aren´t more hostile transactions is because many Calgary companies do business with each other, either as joint-venture partners or otherwise. So the western Canadian oilpatch tends to be fairly friendly group.
"[Also], the universe of potential buyers for any given company, unless you´re in a very specialized play, is fairly large," he adds. "A hostile party wouldn´t go hostile if there is a lot of competition for the asset."
An example of limited interest is the recent hostile bid for Petro Andina Resources Inc., which went public a few years ago and was operationally very successful, building its production to 15,000 barrels per day in Argentina. Then the Argentine government slapped an export tax on crude oil, effectively capping the price Petro Andina could sell its production for (to roughly US$40 a barrel). So politics choked off investor interest in the company, especially when oil was pushing US$100 a barrel.
"In June, [Petro Andina´s] stock was trading at $6.20 a share." Bratt says. "It traded up to $7 a share and then they were hit with a hostile bid at $8.10 a share from Plus Petrol [a private Argentine company]."
At that point, FirstEnergy had a 60-day clock in which to find a better offer. Through a competitive bidding process, it found some alternatives for Petro Andina and at the last minute, it invited the hostile party into the process to try and force a higher bid.
"The unique part of this transaction was that everybody ended up getting what they wanted," Bratt recalls. "The hostile party wanted just the assets in Argentina but had to buy the whole public company. Petro Andina, quite frankly, was content to sell their Argentina assets and redeploy the money, time and effort in some of their other plays outside of Argentina.
"It should close today [mid-November] and the shareholders will get $7.65 in cash and a new company-a company called Parex Resources. We did a financing on Parex when we announced this deal was struck two months ago at $3 a share. So the total came up to at least $10.65, which is a lot better than the $8.10 offer."
It´s unusual to have a hostile takeover to work on, but last summer, it was particularly unusual for First Energy, because it had two on the go. A month after Petro Andina, TransAlta went hostile on Canadian Hydro Developers in the specialized alternative energy market.
"Everyone cancelled their vacations," Bratt says. "We were fighting a war on two fronts." He notes that hostile transactions are very much a team effort, a chess match of strategy, thinking through moves and counter moves to clients for a better alternative. "It´s very involved, very complicated, very interesting."
In dealing with a hostile party and issues of access to a data room, good legal counsel is key. Coincidentally, on the Petro Andina transaction, FirstEnergy worked with Burnett Duckworth and Palmer as its co-advisor, while on the Canadian Hydro transaction BDP worked the side of the fence for TransAlta.
"So we ran a competitive process and found a couple of alternative friendly bids for Canadian Hydro," Bratt says. "We invited the hostile party at the last minute and, in that case again, TransAlta outbid the other parties." TransAlta´s hostile offer was for $4.55 and FirstEnergy´s worldwide auction resulted in a $5.25 bid from TransAlta, an extra $105 million.
Heating up
In August, Tri-Star Oil & Gas merged with Petrobank to form new company called PetroBakken. Then in November, Brett Herman and the former Tri-Star management team re-emerged to take the reins of Result Energy Inc. Bringing a non-brokered private placement of up to $26 million with them to Result, the day of the announcement saw Result´s stock jump from $0.10 to about $0.35.
Expect a lot more recaps in the coming year as undervalued juniors are taken over by market-proven management teams. These new teams bring a market following and pack a hefty lift in valuation-300 or 400 per cent is typical.
Recent examples are Cequence Energy Ltd., which was formed as part of the re-capitalization of Sabretooth Energy Ltd. in July 2009. In the same month, Glamis Resources announced a reorganization and investment agreement with Trent Yanko, Paul Colborne, Dale Mennis, and Matt Janisch.
On a related note, M&A activity blips upward as income trusts head towards the 2011 finish line set by the federal government for conversions out of this organizational structure. Michael Tims, chairman of oil an gas investment dealer Peters & Co. Limited says, "And whenever there´s change, it causes boards to re-evaluate, it causes management teams to re-evaluate, causes shareholders to re-evaluate. So everybody thinks through how they want to be positioned."
Recaps, wide valuation gaps, consolidations, conversions-to this list add international deals and major producers shedding assets to free up cash for more core projects, and it becomes clear that M&A activity will be heating up in 2010.
Scotia Capital recently identified EnCana and Suncor as playing a role in this. "A majority of the large caps will go through a material restructuring or rationalization," Adam Waterous, global head of investment banking for Scotia Capital and head of Scotia Waterous, told media in November. There will be "a substantial increase in the number of conventional oil and gas assets on the market in 2010 relative to the last two to three years."
The wildcard in M&A activity is Asian acquirers.
China´s purchases of oil and gas supplies worldwide have been estimated at $15 billion so far this year, double the amount in 2008. Apart from the Korean bid for Harvest, they have indicated interest in other assets. But as Peters & Co.´s Tims points out, it isn´t clear whether Investment Canada will approve these Asian bids.
"It´s one thing for foreign publicly traded companies such as Total or Shell taking over Deer Creek and Duvernay," Tims says, "but Investment Canada doesn´t have a policy clearly in mind for deals where the acquirers are highly state-controlled."
The government will have to think through the effects of foreign national ownership on Canadian public companies, their boards and their investors. It will also have to consider what blanket approval of these deals might signal to other state-owned companies.
As for whether M&A transaction values will reach 2005 levels again, Tims observes a notable absence of the largest publicly traded companies in the Canadian energy M&A market. These supermajors, in fact, have largely divested themselves of operations in Canada, and there´s no indication they´re eager to come back.
In a global context, Canada is a medium- to high-cost producer of natural gas and oil. Canada has other advantages-technical and political-but doesn´t necessarily leap off the whiteboard at multinational companies. The size of the deposits, with the exception of the oilsands or maybe Horn River, just isn´t that large on a global scale.
"So I think we´ll see the intermediate and small companies continue to buy and sell and consolidate," Tims says. "But whether we´ll see a bunch of other big transactions, we´ll have to wait to see what happens with the Investment Canada rulings."
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