‘Zombie’ stocks haunt Canada’s oil patch, but buyers aren’t biting in worst bear market in a generation

Last year Michael Binnion considered selling his company’s assets to pay attention to its core play in Alberta, however changed his mind as oil prices kept plumbing new lows.

“In retrospect we actually wished we had sold,” the CEO of Questerre Energy Inc. said last week.

“It’s hard for me to envision many people saying ‘I would like to sell my oil assets at a cost of US$30 per barrel,'” said the Calgary-based Binnion. “So anybody who is selling assets it is because they have looked at other options and decided that’s the right one.”

The amount of wealth that has been destroyed in Calgary is staggering

To sell or otherwise to sell in one of the worst bear oil markets inside a generation has gnawed at management teams across Calgary during the past year.

According to Zachary George, an activist hedge fund manager at FrontFour Capital Group Plc. in Connecticut, a lot more than 500,000 barrels each day of Western Canada production are on the market.

But buyers are biding their time, as valuations are difficult to calculate in the volatile environment.

“The quantity of wealth that has been destroyed in Calgary is staggering,” said George, whose father Rick ran Suncor Energy Inc. for two decades till 2012.

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“In some cases, you see zombie equities that are basically trading at option value with bonds exchanging the fifties. Buyers aren’t stupid – they see the capital structure and also the implied enterprise value. Why should they attribute value towards the equity when the market is telling them there’s none?”

Yet more assets are visiting the market. Last week, Ernst & Young Inc., the court-appointed receiver of bankrupt company Spyglass Resources Corp., place the company’s assets on the market.

LGX Oil & Gas Ltd. has also said it’s considering an outright sale from the company. The little Alberta-based operator joins a list of 22 companies in the Canadian oilpatch publicly looking to sell themselves, according to Sayer Energy Advisors, that is acting as LGX’s adviser. Another 41 companies are selling a portion of their assets, with lots of more informally putting feelers out.

“There are lots of companies looking at alternatives that have not made a public announcement or a formal process,” said Alan Tambosso, president of Sayer Energy Advisors.

But activity remains subdued. Last year, Canadian upstream M&A reached $12.4 billion, down 71 per cent from 2014 levels, based on RBC Capital Markets.

This year may be boosted by Suncor’s $4.3 billion bid for Canadian Oil Sands Ltd. which in fact had turned nasty, but seems set to achieve an amicable closure soon. Regardless of the rise of activism in the usually-congenial oilpatch, there might be few hostile deals, said Chip Johnston, Calgary-based partner at Stikeman Elliott LLP.

“M&A is another manifestation of the great times when the music is pumping and drinks are flowing,” Johnston said. “But when capital isn’t available so when commodity prices are depressed you do not get the same incentive.”

The recent federal and provincial policies related to global warming policies and prolonged reviews of pipelines increases the gust of headwinds facing the Canadian oilpatch.

But many companies’ financial plight might trigger M&A activity. Many firms responded early towards the steep decline in oil prices last year by cutting capex, shedding staff, divesting assets and shelving projects. But 2016 is presenting its very own set of challenges.

Only nine per cent of Canadian companies have hedged with this year, leaving them exposed to the present depressed market prices, energy consultancy IHS Inc. estimates.

“People now understand that the time to hold back for better days may be over,” said Barry Munro, Canadian oil and gas leader at Ernst & Young. “There is a notion of ‘have to, need to or want to’ as driving M&A behaviors. There is a whole couple of people that ‘have to’ transact.”

Canadian banks are also getting nervous, as gas and oil players had drawn $45 billion after October, when compared with $23 billion this year, DBRS Ratings Ltd. data shows.

“The banks – unlike public belief – happen to be forceful and they are getting more forceful,” Tombasso said, noting the 20 installments of receivership – or Companies’ Creditors Arrangement Act (CCAA) – last year, when compared to eight on average in the past years.

Banks may be more motivated to act because they go through the credit redetermination season between February and April and assess their very own rising risk profile.

In addition, the new U.S. Dodd-Frank banking law has specific rules for banks on rolling forward problem loans.

“Everybody kind of skated through within the fall (the final credit review period) and there was a big sigh of relief,” Munro said. “Nobody believes that they can cope with the next cycle in March unscathed. That’s put a lot of pressure on folks.”

If prices recover in the other half of the season, as some analysts predict, banks might even push for transactions as they would prefer to sell inside a stronger market, Munro warns.

With major oil and gas companies and state-owned enterprises struggling to justify new capital commitments to shareholders, the path might be clear for private equity and activist investors which have been prowling around Calgary in the last year.

As much as US$175 billion of non-public equity and pension funds are considering energy opportunities, BMO Capital Markets estimates.

But valuing assets amid price volatility is proving hard for many institutional investors.

“You will see distressed investment opportunities over activist opportunities,” George said. “If you will find the patience and stomach to work through a few of the restructuring and CCAA processes, I believe there are going to be real opportunities.”

yhussain@nationalpost.com
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