With North Americans burning through oil and gas as fast as it can be pumped, the race is on to find and develop more resources. In this endeavor, deep pockets are a critical advantage. That fact and other circumstances have helped spark a red-hot M&A market in Canada’s oil patch. In turn, IR practitioners at the remaining oil and gas companies are becoming some of the country’s most M&A savvy.
Take David Carey, now vice president of business development at ARC Resources, a Calgary-based investment and production management firm. Like many energy sector IR veterans in Canada, Carey has seen duty on both sides of the M&A coin. Two years ago, his former company, Gulf Canada, garnered an Investor Relations magazine award for communications efforts during its C$1.5 bn takeover of Crestar Energy. This year, analysts and investors again lauded Gulf Canada for its IR work during its takeover by Houston-based Conoco in 2001.
Valued at C$9.8 bn (including $3.1 bn in debt) the Conoco/Gulf Canada deal rivaled anything in Canadian oil patch history. While the sheer size may have been daunting, the communications puzzle was complicated because the cross-border deal’s advantages had to be diligently explained to a variety of constituencies including the government, regulators, investors and the public.
For their part, investors in Gulf Canada shares had a straightforward decision. Conoco offered them a 34 percent share price premium in cash. Investors didn’t need to know anything about Conoco. They simply had to decide whether it offered a fair price – and be assured the deal would be completed.
‘Our communications with analysts and shareholders were focused largely on keeping them informed about progress during the approval process,’ says Carey. ‘We were fortunate to have a good group working with governmental regulatory bodies, ensuring they understood the transaction so we could get the approvals needed.’
While Conoco led up the effort to secure approvals, its management kept Carey tightly in the loop. ‘[Gulf Canada] shareholders were comfortable that I knew what was going on at all times,’ says Carey.
That comfort level helped keep most institutional shareholders on-side from day one. Carey says shareholders liked the price and were particularly pleased they were being paid in cash. Retail investors reflected the most uncertainty. Questions usually involved whether Gulf shareholders could choose Conoco stock instead of cash, or if the tender applied to preference shares. Conoco and Gulf Canada had to work closely to remain consistent. To aid in the education effort, Conoco set up a special web site with responses to FAQs.
The Conoco premium
The Conoco/Gulf Canada deal highlighted a year that saw acquisitive American giants snatch up some C$40 bn worth of Canadian oil and gas companies. US companies are taking advantage of a weak Canadian dollar and relatively lower valuations to fill up on Canadian assets, say analysts. Such a trend might once have sparked concern among Canadians. This time around, however, the merger provoked little critical sentiment.
‘We emphasized with the press and Canadian governments that many of Gulf’s assets were those that required a strong balance sheet to develop,’ says Carey. ‘We also underlined the fact that Conoco did not have a significant presence in Canada so there would continue to be a large office in Calgary looking after Canadian assets.’
That seemed to do the trick. As Gulf stock surged, the deal was swiftly completed. But the new company’s M&A tango is far from over. Now, Conoco is merging with Philips Petroleum. If successful, the union would create America’s third largest oil company and largest refiner. However, the deal, structured with no true premium, and going through a lengthy approval process, is seen by some as vulnerable to hostile challenges. When it comes to oil companies, bigger may be better, but a merger of big equals poses unique risks. Still, that’s just the kind of deal that two other Calgary-based companies want to make.
EnCana: paradigm shift
Like everyone else, investors like to think in paradigms. Among Canadian energy sector investors, the M&A paradigm in 2001 had been the uncomplicated ‘acquisition at a premium to stock price’. But when Canada’s largest gas companies – Alberta Energy Company (AEC) and PanCanadian Energy, which was spun off from Canadian Pacific in fall 2001- agreed to merge in January, the paradigm changed. And showing the market a different way of valuing a transaction became the IR challenge.
‘This was a merger of equals choosing to get together from positions of strength,’ notes Brian Ferguson, vice president of corporate communications and corporate secretary at AEC. ‘Neither company was for sale.’
Under the merger agreement, the market would decide the relative value of each company’s stock price; and the average price during a recent ten-day period would be used to peg an exchange ratio. Ferguson notes a similar ratio would have applied using a 20-day or six-month average. Nevertheless, some analysts and shareholders complained that at 1.472 PanCanadian common shares for each AEC common share, the deal undervalued PanCanadian.
While finding a valuation that pleased everyone proved elusive, both stocks shook off discontent and performed well leading up to the successful April 4 shareholder vote. Prospects for the new, combined company, EnCana, have fired investor imagination.
In fact, Ferguson says he hasn’t met a single investor concerned about EnCana’s business plan or strategy: ‘EnCana will be a leader not only in North America but worldwide.’
For EnCana, the advantages of bigness are clear. Besides hundreds of millions worth of savings due to capital and operating cost synergies, Ferguson says the merger partners are a natural fit in terms of growth profiles. ‘There are compelling business reasons why this merger will create a strong company going forward,’ says Ferguson. ‘You have a very large company with a significant growth profile today, tomorrow and into the future.’
Besides maximizing shareholder returns, Ferguson notes diversifying operations globally also reduces investor risk and the larger entity promises greater trading liquidity.
A limpid story perhaps, but it still must be told. Since the merger announcement on January 27, Ferguson has spent most of his time away from his Calgary home. And it doesn’t look like the pace will be letting up any time soon. Leading up to the shareholder vote, Ferguson’s attentions have focused on current holders – particularly those less than enchanted at not getting a quick premium. With the vote completed, the next step is to broaden EnCana’s profile in the US and Europe. ‘We want to leverage the benefit of being compared to a truly North American peer group,’ says Ferguson.
As part of that strategy, Ferguson promises EnCana will enhance disclosure beyond that offered by either company previously.
For example, EnCana shareholders will receive parallel statements allowing them to make a comparison using US and Canadian Gaap and different currencies.
Having set high expectations, Ferguson is keenly aware investors expect regular reports on whether EnCana is following through. Fortunately, AEC brings to the table considerable savvy when it comes to integrating companies, having been involved in several acquisitions since it went public in 1993.
While PanCanadian is technically acquiring AEC (PanCanadian shareholders ended up with 54 percent of the combined entity), AEC’s aggressive corporate culture seems bound to predominate. ‘We’ve learned a few things,’ comments Ferguson, ‘like that it is important to be decisive rather than focusing on perfection in your merger. Speed is clearly an advantage in this competitive business.’
A decisive approach to more M&A is what shareholders can expect a merged AEC/PanCanadian to take throughout this year.
‘This is an excellent time to be a buyer of assets in North America,’ concludes Ferguson. ‘One of EnCana’s strengths is its balance sheet which lets us add value for shareholders both through the drill bit and by selective asset acquisition.’
Meanwhile, a merged AEC/PanCanadian Energy expects to shed up to C$1 bn in assets, even as it leverages PanCanadian’s strong balance sheet to target new acquisitions. That sell-off, and all the other non-core remnants of last year’s merger frenzy, are expected to become ‘starter kits’ for companies in the junior oil and gas sector. So far, small company share prices have languished in the glare of all the merger activity at the top. But a mid-range vacuum has certainly opened up. In the race to get bigger, a second wave of M&A may well be nigh. And the opportunity for IR as a skill set may never be greater.
US invasion
Canada’s biggest energy sector M&As in 2001
May 29 – C$6.7 bn, Conoco buys Gulf Canada
September 4 – C$5.3 bn, Devon Energy buys Anderson Exploration
September 20 – C$5.5 bn, Duke Energy buys Westcoast Energy
October 8 – C$3.28 bn, Burlington Resources buys Canadian Hunter
Analysts gush
The disappearance last year of several Canadian oil and gas company head offices led to the feeling in some quarters that the shift outside the country of decision-making centers might have a harmful effect on the local society. Hence the AEC/PanCanadian linkup possessed a distinctly patriotic flavor. Both the federal and provincial governments were quick to give the deal their seal of approval, and both companies indicated that a hostile bid would be considered quite impolite and improper. This angered some shareholders who were anticipating the ‘takeover at a premium’ paradigm.
But management asked shareholders to wait for value. Their charms were various. First, they could point to the rise in both companies’ stock price. Six weeks after the merger announcement, PanCanadian had risen 10 percent and AEC 15 percent. If shareholders in either company didn’t like it, they could sell (heightening the chances that those who stayed would vote for the deal). Second, there seemed to be a distinct lack of competing interest anyway. Potential US acquirers had made recent acquisitions and were digesting their targets, according to merger proponents. The ultimate quid pro quo, however, for forfeiting a snappy premium, would be EnCana’s longer-term business case. ‘EnCana’s combined growth potential would be unique amongst its peer group,’ maintains Christopher Theal, an analyst at CIBC World Markets in Calgary. ‘That’s a big advantage when it comes to attracting institutional capital,’ he adds.
Indeed, much of the EnCana rationale is in attracting big, institutional capital – especially US capital. Canadian oil and gas producers have suffered lower multiples than US counterparts and getting bigger is seen as one way of closing the valuation gap. ‘By putting these companies together, you get an entity that will attract more attention from the US and elsewhere just because of its sheer size and liquidity,’ says Gord Currie, an analyst at Canaccord Capital. ‘If that results in a higher multiple then management can claim to have created significant shareholder value.’
EnCana could argue that it should be ranked with peers such as Anadarko, Burlington and Devon in the US. The combined company is Canada’s third largest corporation and comprises about 3 percent of the Toronto Stock Exchange index. It also accounts for about 20 percent of Canada’s natural gas production. ‘That makes it a ‘must-own’ company – certainly for Canadian fund managers,’ says Brian Prokop, an analyst and principal at Peters & Co. ‘At the same time, the decision for US investors looking for exposure to Canadian gas is made much easier. Ultimately, being able to access more capital in North America and beyond should lead to a lower cost of capital and allow EnCana to go out and do even bigger and better things.’
That the whole can be greater than the sum of its parts is a compelling theme. But one thing on the minds of shareholders as they cast their votes was how the merger’s execution will fare in the real, often messy, world. The phrase ‘growing pains’ and the word ‘restructuring’ are often linked in the media following a grandly trumpeted merger or acquisition. And in this case, it is very much the former, an unusual situation for both shareholders and the companies themselves.
