Restless shareholders pushing for more M&As in oilpatch

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CALGARY – ARC Resources Ltd. is willing to strike more deals following its blockbuster merger with rival natural gas producer Seven Generations Energy Ltd., which would turn the Calgary-based intermediate into the largest producer in the prolific Montney shale gas formation.

“We certainly don’t need M&A going forward, but if something else presented itself we would evaluate it,” said Chris Bibby, chief financial officer of ARC Resources Ltd., on a conference call following the all-share deal announced Wednesday night, which will turn ARC Resources into the third largest gas producer in Canada after Tourmaline Oil Corp. and Canadian Natural Resources Ltd, and the sixth largest Canadian energy company in output terms overall.

“This is in the best interest of our stakeholders,” Seven Generations president and CEO Marty Proctor said on the call. Proctor will become the combined company’s vice-chair of the board.

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Analysts say ARC Resources’ deal for Seven Generations could spark more mergers and acquisitions in the Calgary oilpatch, where equity values have not rebounded to match a big uptick in underlying commodity prices.

Alberta’s AECO natural gas benchmark price has been rising steadily this year and averaged US$3.91 per thousand cubic feet on Thursday, up 93 cents from the day before. Similarly, the West Texas Intermediate oil benchmark price has risen in recent weeks, though it traded down 1 per cent to US$57.93 per barrel Thursday. U.S. crude has shot up nearly 20 per cent year-to-date.

“I think we could see more ARC and Seven Gen type deals,” said Michael Zuk, managing partner at Athena Capital Markets Ltd. in Calgary, noting the combination of the two companies will create a gas major that produces 340,000 barrels of oil equivalent per day that will attract more institutional investors that had previously been drawn only to Tourmaline and Canadian Natural.

I think we could see more ARC and Seven Gen type deals

Michael Zuk, Athena Capital Markets

“It gets them into a different stratosphere of competing with the Tourmalines of the world,” Zuk said. “You’re creating more competition at the top end of the paradigm. I think that’s important.”

Zuk said the ARC/Seven Generations merger made sense because the two companies are drilling in the same formation, the prolific Montney in northwest Alberta and northeast British Columbia, and have complementary infrastructure such as gas processing facilities and pipeline assets. Future mergers between natural gas companies will be judged against this deal to determine how well all of those factors fit together.

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Seven Generations has also attempted to advance liquefied natural gas (LNG) export projects on Canada’s West Coast, including through its investment in Steelhead LNG and involvement with natural gas competitors in the Rockies LNG project, which is an early stage plan to build a project in B.C.

“In today’s market scale is important, and the combined entity will become the dominant player in the Montney, with an enterprise value of $8.1 billion, putting it on a similar level to natural gas producer Tourmaline,” Canaccord Genuity analyst Anthony Petrucci wrote in a Thursday note, adding the combined company will have the infrastructure in place to process 1.5 billion cubic feet of natural gas per day.

Similarly, BMO Capital Markets analyst Randy Ollenberger said the deal would make ARC Resources the “King of the Montney” and “could increase its relevance to investors.”

The deal valued Seven Generations’ equity at $2.4 billion but the target also had $1.8 billion in long-term debt on its balance sheet as well as $267 million drawn on its credit facility. The combined value of the debt and equity of the merged company is roughly $8.1 billion.

ARC Resources’ stock closed nearly 5 per cent higher to reach $7.78 per share Thursday following its announced deal to use its own shares to acquire rival Seven Generations, which was up around 5.75 per cent to $8.48 per share. The transaction is expected to close in the second quarter, subject to the approval of both companies’ shareholders and regulators.

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The merger will increase ARC’s production and diversify its asset base, while the “free cash flow generation will improve with Arc‘s lower decline rate, and pro forma leverage will improve given Arc‘s lower debt levels and stronger leverage metrics,” wrote Paresh Chari, senior analyst at Moody’s Canada Inc.

Accountancy firm PricewaterhouseCoopers released a report Feb. 5 on the deal-making trends for the coming year and predicted that “we expect to see an increase in deal volume, continued upstream consolidation and restructuring,” in the energy space this year.

Investors are getting “restless” with underperforming oil and gas equities and in some cases, demanding management teams explore mergers as an exit strategy, Athena’s Zuk said, noting that he believed more deals are in the works.

As an example, Brookfield Infrastructure Partners, which owns roughly 20 per cent of Calgary-based Inter Pipeline Ltd., sharply criticized the company’s performance in a release after markets closed Wednesday and announced a hostile takeover bid to take the midstream company private for $13.5 billion, including debt.

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Raymond James analyst Chris Cox said in a Thursday research note Brookfield’s offer represents “a merciful exit” for Inter Pipeline “that has delivered consistently disappointing results for shareholders for years.”

Still, most analysts believe Brookfield will increase its current offer from $16.50 per share as a proxy fight drags on.

Shares in Inter Pipeline jumped 29 per cent, or $3.92, to $17.32 per share in Thursday trading, which is above the offer price Brookfield floated in its after-markets release Wednesday.

Brookfield has previously made unsolicited offers of $17 per share and $18.25 per share, according to Inter Pipeline. Inter Pipeline also said in a release Thursday that its financial advisors determined the two offers “did not reflect the intrinsic value of the company and were not sufficiently pre-emptive to grant Brookfield exclusivity.”

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