Suncor has made a $4.3 billion share exchange offer for Canadian
Oil Sands.
Its shares were valued at $8.84, a 43% premium to its previous
closing.
The deal has some clear benefits for Canadian Oil Sands
shareholders.
Is an even better deal possible?
Since both Suncor and Canadian Oil Sands report in CAD, all
prices quoted are in that currency, unless otherwise noted. Share
price quotes are from the TSE, where there is more liquidity for
both company's shares.
On October 5,
Suncor Energy(NYSE:
SU) announced a $4.3 billion offer (prices as
of October 2 closing) for the outstanding shares of Canadian Oil
Sands (OTCQX:
COSWF). Under its terms, a COS shareholder
would receive .25 of a Suncor share ($35.37) for each COS share
($6.19). Effectively this would value a COS share at $8.84, a 43%
premium. If the deal were completed, Suncor would assume the COS
long-term net debt of $2.3 billion, making the total value of the
transaction about $6.6 billion. The offer is contingent on at least
two-thirds of Canadian Oil Sands' shareholders tendering their
shares to Suncor, and, unless withdrawn or extended, closes on
December 4, 2015.
Canadian Oil Sands Situation In Brief
Canadian Oil Sands Ltd. is unique among large Canadian energy
companies in that it is not a true producer. Its sole asset is a
36.74% stake in the Syncrude oil sands mining/upgrading operation
from which it takes its share of the oil produced. Syncrude is, in
turn, an operation jointly controlled by seven owners, including
also Imperial (NYSEMKT:
IMO) (25%) and Suncor (12%). Its operator is
Imperial. Unlike most of the partners, Canadian Oil Sands is
totally reliant on Syncrude's production for its income. What gives
its shares value, however, are the production facilities already in
place to deliver high-quality synthetic light crude and the
Syncrude long-life reserves. (At 2014 year end, Syncrude held 4.4
billion barrels of proved plus probable reserves, of which the COS
share would be 1.6 billion barrels.)
I had
previously writtenof the
headwinds Canadian Oil Sands faces currently, in part from the
present low levels of crude pricing, in part from regular problems
at the Syncrude operation, which is not near nameplate capacity,
and in some part at least from the cost overlay that the current
management structure creates. These problems are exacerbated by the
fact that the Syncrude stake is COS' only holding. Two very recent
events - a fire at the Syncrude upgrader and a Moody's downgrade of
COS long-term debt - highlighted its current difficulties. So did a
recent company presentation which indicated that the company was
presently selling oil at a loss of $6.00 per barrel. In its
commentary, Moody's was alluding to a cash bleed if current prices
persisted, and its downgrade could put pressure on the present
dividend. The company last recorded its breakeven costs at C$62.00
(US$50.00) per barrel, which included C$5.00 in costs directly
attributable to COS itself.
Canadian Oil Sands long-term debt of $2.3 billion is largely
USD-denominated. Although no large principal payment is due before
2019, the current low range of the CAD results in higher than
anticipated annual interest payments. The company also has other
large liabilities, including at least $1.6 billion in deferred
taxes, $356 in future employee benefits, and $1.2 billion in future
site reclamation costs (although the last is projected over 70
years).
It must be added that the company also faces possible future
headwinds from two reviews currently underway in Alberta. The first
is a review of royalties paid on oil extracted from public land.
The second, perhaps more problematic for an oil sands
miner/upgrader, is a review of potential penalties for greenhouse
gas emissions. The results of both reviews would come into effect
in 2017 or later.
Over time, the COS share price, especially with dividend cuts,
has fallen steeply, even before the more recent drop in crude
prices. Near $34.00 in 2011, it reached a bottom of only $5.76 on
August 24. Since the company has become a near-proxy for WTI, its
NAV has fallen sharply with the decline in forward strip
pricing.
What Does the Suncor Deal Offer to COS Shareholders?
To many shareholders at least, the Suncor offer presents an
opportunity to take them out of the near-term deterioration and
future uncertainty that has hammered the share price for some time.
Particularly if the "lower for longer" thesis has some real legs,
investors are presented with a way out.
Still, whatever it limitations, the Suncor deal offers not only
some form of rescue, but certain positive benefits. Obviously, if
the deal goes through, current COS shareholders will retain their
interest in Syncrude and garner an additional 12% working interest
(an increase of almost one-third). As investors who are presumably
convinced of the value of oil sands investment for the future, they
will now gain as well exposure to Suncor's much greater and diverse
oil sands production, which by 2019 could be something like 630,000
bbls/d or better (presuming the Total and COS deals).
Traditionally, Canadian Oil Sands had appealed to income seeking
investors, although dividend cuts have muted that appeal. An
acquisition by Suncor would actually increase the annual dividend
now received by COS investors from $0.20 to $0.29 per share (some
45%). It would also give current COS shareholders exposure to
future SU dividend increases and to share buybacks that are
considerably more likely, at least in the near future, with the
larger, financially more stable, company.
The Suncor deal also offers some real potential for cost savings
on the current Syncrude production. The current operator is
Imperial Oil (with many Exxon personnel). There seem to have been
improvements. Still, the results have not been spectacular, and
there have been suggestions that costs are high. In announcing the
COS offer, Suncor has declared its intention of "working with the
operator" using key personnel. Suncor has similar mining/upgrading
operations nearby and a 48.74% stake would give it clout; more
importantly, it has expertise. At the same time, Suncor has denied
that it wants to replace Imperial as the Syncrude operator. (IMO's
operating contract expires in 2016, but two years notice is
required for termination. Even if SU wanted the operatorship, this
could not occur before 2018.)
At the same time, even without a reduction in operating costs,
Suncor could produce relatively immediate savings on the 100,000
bbl/d or so current COS share of production by a major reduction in
the $5.00 per barrel costs directly attributable to COS itself
(administrative, insurance interest, taxation). Some have estimated
such synergies at $25 million annually.
The further advantage offered by Suncor is that it is an
integrated company, offering a measure of protection from its
downstream activity in periods of lower pricing, with its
downstream also offering the possibility of more profitable
marketing for the Syncrude product.
In response to the Suncor offer, the Canadian Oil Sands board
has issued a
brief statementsimply saying for
the moment that it is reviewing the proposal and will communicate
with shareholders later. It has engaged RBC to advise it on the
matter. Nevertheless, the COS board is almost certainly likely to
advise rejection and to say that the offer greatly undervalues the
company.
The Suncor offer is low. Analysts have called it
"opportunistic". One shareholder, Seymour Schulich, a prominent
Canadian businessman who may own 5% of the company, has called it
"ridiculous," and said he believes the company is worth $20.00.
(Schulich bought about 3% of COS as early as 2004. A company of
which he is a director, Newmont Mining, sold its own 6.4% stake in
COS in 2013.) Suggested prices in this high range seem to be based
on current replacement costs for Syncrude, and not NAV, which
reflects forward strip prices; nor do they reflect possible cost
increases from carbon penalties or increased royalties.
Actually, Suncor made a higher offer for Canadian Oil Sands on
April 9, an exchange of each COS share for .32 SU share, which was
rejected by the COS board on April16. This would have valued each
COS share at $11.84. Still, at that time, everything was higher. On
April 8 closing, SU was at $38.84, COS at $10.77, and WTI at
$50.44. Most importantly, forward strip pricing was then at much
higher levels than it is currently.
The one apparent downside to the current Suncor bid is that
because Canadian Oil Sands is not involved directly in production,
and has a single product - SCO, or sweet light crude that trades in
tandem with WTI - whose quantity is to a certain extent
predictable, the COS share has become almost a proxy for the price
of crude. If WTI rises sharply, the COS share price should rise
sharply also. For those who believe in higher near-term prices, the
beaten-down price of COS presented an attractive proposition, and
some have bought it for this reason on its recent lows. Were its
shares traded for Suncor however, that same immediate traction
would be diminished: Suncor has not suffered nearly as much in the
downturn, and its holdings are much more diverse than a single
product.
Suncor's bid may have been strategically set low. If a competing
bid emerges, Suncor has the possibility of raising its own offer.
Even if there is no competing bid, but if forward crude prices
stabilize at higher levels over the next two months, and/or if a
significant number major investors show reluctance to take up the
Suncor bid, it has the ability to improve the offer. Suncor has
said it is in contact with major COS stakeholders; my guess would
be that at the moment most are uncommitted, but probably
encouraging Suncor to sweeten the pot. A representative for TD
Asset Management, Canadian Oil Sands' largest shareholder (just
under 5 percent), called the Suncor offer "a little light."
Suncor's own reactionwas to
describe any COS rejection as anticipated, and to call its own
offer "full and fair." It is continuing to meet with major
shareholders to persuade them of the deal's merits.
At the same time, given Suncor's previous offer, the only known
basis for an upside would be to assume that Suncor might be willing
to exchange about one-third of a SU share for one COS share. With
an October 5 closing of SU at $34.60, that would be an implied COS
value of $11.52, about $2.00 to the upside of current COS trading.
For Suncor, the deal is likely to be slightly dilutive in the near
term; even better forward strip pricing probably would not justify
its going much beyond these levels.
An Imperial Oil Bid?
Although a competitive bid for Canadian Oil Sands could possibly
come from a third party, such as a pension fund, only its Syncrude
partners, Suncor and Imperial Oil, seem poised to reap the
immediate synergies of a merger. On whether Imperial will make a
competitive bid, however, there can only be speculation.
Analysts seem dividedon the
matter, some anticipating an Imperial bid, some not.
Those who do not see an Imperial bid forthcoming note that
Imperial is now very much involved in the further expansion of its
Kearl project, and it may have much more interest in developing
future in situ steam driven SAGD projects, whose costs - and carbon
emissions - are somewhat lower. It may be quite content to have
Suncor's greater involvement in resolving Syncrude's perennial
difficulties.
For its part, the market is clearly anticipating some upward
movement, either in a competing bid from Imperial or from a
sweetening of the Suncor offer. Since the Suncor announcement,
Canadian Oil Sands shares have jumped to a current $9.25-$9.75
range, which at mid-point would be a 7.5% premium to the implied
$8.84 valuation in the original announcement. While a positive
sign, that is not a huge mark of confidence that something better
will emerge.
What Options Have COS Shareholders?
Canadian Oil Sands shareholders who have held their shares for
the past year or more have experienced a roller-coaster ride, and
ultimately the share price has been decimated. A total rejection of
this or any improved deal would probably mean a large decline in
share price, perhaps to new lows, especially given its exposure to
debt reclassification, possible dividend reductions, and future
added royalty or carbon emissions costs. There would also be the
loss of any implied takeout premium. Only those investors with a
firm conviction of considerably higher crude prices sooner would
probably wish to opt for COS braving it out on its own. Even for
those who bought shares at recent lows anticipating higher oil
prices, the present market price offers some immediate gain.
On the other hand, investors who have little confidence that
either a competitive bid will emerge or that Suncor will improve
the deal to better persuade COS shareholders, have the immediate
option of selling their shares in the current market at a small
premium to the $8.84 now offered by Suncor. This could also appeal
to those who wish to put the cash to other uses more
immediately.
Still, the current offer is open until December 4, and perhaps
the best course is to wait and see how events play out. Forward
crude prices could increase substantially in that period, a
competitive bid could emerge, and Suncor may have to improve its
offer to please major shareholders. Apart from a major bidding war
or a huge crude price increase, both of which are possible but
unlikely, the most reasonable upside is probably in the $2.00 range
from the current market price. The downside is a small loss from
the current share price if the current deal is maintained as
is.
DISCLAIMER:The information provided above is not a
recommendation to buy or sell a stock. It intends to increase
investor awareness and to assist investors in making smarter
decisions. Prospective investors should always do their own further
research, and take into account their own current financial
holdings, their risk levels and their shorter or longer-term
outlooks.
Editor's Note: This article discusses one or more securities
that do not trade on a major U.S. exchange. Please be aware of the
risks associated with these stocks.
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