Analysts on Monday warned Canadian energy investors to brace for a material hit after the government blocked Petronas? $5.9-billion takeover of Progress Energy Resources Corp. on the basis of not meeting the net benefits.
?Overall, we believe this is a major surprise and is not good for Canadian oil and gas equities as the decision and lack of clarity will very likely lead to U.S. investors running for the hills,? said Phil Skolnick, an analyst at Canaccord Genuity in New York.
Under the Investment Canada Act, Petronas now has up to 30 days to make submissions, following which Christian Paradis, Minister of Industry, will either confirm its initial decision ? blocking the transaction, or approve the acquisition.
?Accordingly, while the deal is not dead at this juncture, the hurdles which must be met are unclear,? energy analysts at RBC Capital Markets, led by Greg Pardy, told clients. ?Given the lack of granularity associated with the factors underlying this decision, we expect the knee-jerk market reaction come Monday will be to cast doubt on other pending transactions.?
As the Street grapples with the prospect that the Nexen Inc. and Celtic Exploration Ltd. acquisitions could suffer similar fates, energy analysts at Raymond James tried to quantify the potential damage.
?It?s no great leap to suggest Nexen and Celtic could each trade back south of $22 today, effectively erasing $2-billion in equity value for investors,? they said.
The analysts also warned that the pain could stretch further.
Talisman Energy Inc. was downgraded to hold from buy Mr. Skolnick Canaccord Genuity as he sees the company having a difficult time selling itself in light of the Petronas news. He told clients that the ?fixes itself or has to sell itself? thesis for Talisman is not as attractive as it was prior to the weekend.
Talisman shares have performed well since CNOOC?s proposed acquisition of Nexen was announced. Talisman?s gains, due to expectations that it could also be acquired, suggest a share price decline to about US$11.80 per share, Mr. Skolnick warned. He added that another 5% in losses is possible given the amount of money that switched out of Nexen into Talisman following the CNOOC-Nexen news.
?Over time, we believe the recent change in CEO will eventually help the stock due to anticipation of positive operational improvements at Talisman, but we believe the perceived reduced take-out potential makes this a less exciting story to get new money interested in the stock over the next 6 to 12-months,? Mr. Skolnick said.
Warning that the government?s decision will likely send many Canadian energy company valuations plunging, his colleage Brian Kristjansen noted that Exxon Mobil?s recent bid for Celtic has relatively lower regulatory approval risk. As a result, the analyst believes weakness in Celtic?s share price could present a buying opportunity.
?We view the Exxon/Celtic deal as comparatively lower risk given the fact that Exxon is not a state-owned enterprise, and that there is a long history of corporate takeovers in the Canadian energy sector by U.S. companies (including Apache/BP Canada, Burlington/Canadian Hunter, Devon/Anderson Exploration, Conoco/Gulf Canada, Vintage Petroleum/Genesis Exploration, etc),? Mr. Kristjansen said in a research note.
?Furthermore, Exxon is already an operator in the Western Canadian Sedimentary Basin through its subsidiaries or controlled entities, the largest of which, Imperial Oil (a 69.6% Exxon-owned company), is one of Canada?s largest producers and one that recently announced plans to build a 20-acre office complex in Calgary,? he added.
While Canaccord acknowledged that the government?s decision is negative for oil sands stocks, they believe investors have largely abandoned the group as takeout plays due to the long lead time to seeing a deal come to fruition.
However, Mr. Skolnick noted that investors have chased natural gas stocks as takeout plays recently, warning that Athabasca Oil Corp. and Canadian Oil Sands Ltd. will likely be impacted the most.
Among senior integrateds, the analyst expects the greatest sell-off will occur in shares of EnCana Corp., Nexen and Talisman, while Canadian Natural Resources Ltd., Cenovus Energy Inc. and Suncor Energy Inc. should outperform as they were never considered acquisition targets and could possibly be used for safety.
EnCana?s strong performance is partly due to strength in natural gas prices and takeout speculation on LNG potentials, particularly given the market?s belief that Exxon?s recent announced acquisition of Celtic
is a precursor to Exxon acquiring EnCana, Mr. Skolnick said. However, he does not believe Exxon is in a hurry to make such a deal, otherwise it would have used Imperial Oil Ltd. as the buyer in order to avoid the net benefits test.
?Therefore, the sheer size of EnCana may be a setback,? the analyst said.
For Nexen, Mr. Skolnick thinks the odds of the proposed acquisition by CNOOC getting approval have fallen to somewhere above 50%, suggesting ?approval will now more than likely have conditions tied to it that could extend the time to closing or even possibly result in a re-pricing of the deal.?
While RBC expects Canadian energy producers will come under market pressure, they don?t suggest throwing the baby out with the bathwater. The analysts said there may be some unique aspects and deficiencies associated with the Progress case that aren?t readily apparent.
?In our minds, the need for foreign investment to develop Canada?s vast oil, oil sands and shale gas resources and importance of diversifying its exports into Asia would auger against a resource protectionist policy. Nonetheless, the bar on meeting the net benefits test appears to have been raised,? RBC said, noting the difference between foreign takeovers by national oil companies (NOC) and international oil companies (IOC).
The analysts that while NOCs are regarded as instruments of their respective governments with a cost of capital approaching zero, the investments of IOCs are generally seen as driven by market forces.
RBC believes the conditions needed to meet the net benefit test may differ for NOCs versus IOCs and may encompass a broader array of policy considerations.
While the analysts noted that large caps have not generally been the topic of take-over speculation by investors, they warned that the group may still pull back in the wake of the Progress announcement. RBC recommended adding to positions in Cenovus, Suncor, Canadian Natural Resources and Talisman in that scenario.
RBC also highlighted EnCana as the stock potentially most impacted by the market uncertainty.
?We do not expect any impact on Encana?s ability to consummate its JV initiatives. Nonetheless, following ExxonMobil Canada?s proposed bid for Celtic Exploration, market speculation regarding a take-over of Encana has fuelled its share price performance,? RBC said.
They analysts highlighted the intermediate producing group as highly exposed to the outcome of the Progress/Petronas decision given the inclusion of a large number of Montney-focused natural gas producers, which is the formation of interest in the deal.
?In sympathy with both the prior Progress and recently announced Celtic/ExxonMobil transactions (and in conjunction with increased commodity prices), we have seen a substantial run-up in the price of shares within the group which have benefited from ongoing takeover speculation by investors,? RBC said. ?While we do not expect this M&A premium to disappear, it is likely to be eroded in the coming days.?
The analysts highlighted NuVista Energy Ltd. and Painted Pony Petroleum Ltd. as names currently pricing in M&A premiums of more than 25% as a result of their recent outperformance.
They also noted the significant bump Delphi Energy Corp. saw following the Celtic/Exxon announcement, as the company capitalized on the share price move? to complete a bought deal financing last week. As a result, RBC believes it may be one of the harder hit by the announcement.
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