Genworth MI – sold to Brookfield Business Partners

The winner of the Genworth MI auction (presumably there were multiple interested partners) was Brookfield Business Partners LP (TSX: BBU.UN) at CAD$48.86 per share, for 57% of Genworth MI shares. Brookfield Asset Management owns about 80% of Brookfield Business Partners. I’m not going to dissect more of Brookfield’s capital structure or even the LP unit, but suffice to say, they have the assets to consummate the transaction, assuming they receive regulatory approval.

The transaction, if approved, will close sometime in the first half of 2020 and apparently will receive regulatory approval by the end of 2019. I had speculated earlier that Genworth would not receive more than CAD$55/share for the unit (and my initial opinion was CAD$50) and this appears to be right on the mark. Genworth MI’s stated book value was $47.17 at the end of Q2-2019, so Brookfield is paying a very modest premium over book.

Here’s the interest part of the release:

Brookfield Business Partners has also agreed, between now and the closing of the transaction, to provide Genworth Financial, Inc. with a bridge loan of up to US$850 million that is intended to be repaid from proceeds of the sale of its interest in Genworth Canada.

Genworth Financial has some solvency matters to deal with.

The other logistical matter for Genworth MI is that they share services with Genworth Financial for some business operations. This will have to be carved out and transitioned over with the takeover. In addition, it is not clear whether the senior staff of Genworth MI will go back to Genworth Financial, or whether they will stay with the MI subsidiary. When businesses are acquired like this, there is always an element of disruption, if not handled carefully!

As for the other 43% of Genworth MI, currently Brookfield indicated they do not wish to repurchase it:

Given the short time frame available to complete this transaction, Brookfield Business Partners has no current intention to make an offer for the balance of the outstanding Shares. Brookfield Business Partners may in the future consider the appropriateness of such an offer after discussion with Genworth Canada’s shareholders and other stakeholders.

This may happen if Genworth MI starts to trade significantly under CAD$48.86. One needs to look no further than the treatment of minority shareholders of Teekay Offshore (NYSE: TOO) which are currently receiving a lowball offer for their shares.

I would suspect very limited upside for the capital value of Genworth MI shares at current market prices.

Create your own Canadian energy index fund

The following is a list of all TSX-traded companies in the energy production sector that have a market capitalization of greater than CAD$1 billion. There are only 20 left. There are only 29 remaining between CAD$100 million and $1 billion. Some of them are not even domestic producers. Included are my VERY pithy notes.

Keep in mind that “profitable” here is a general and not strict description. Accounting (IFRS/GAAP) profitability may vary wildly with the colloquial notion of ‘profitability’, which is “can this company get more cash than it has to dump into its own production?”.

Out of the 20 companies:
* 6 are majority foreign operations (in descending market cap rank order: ECA, VET, PXT, EFR, CNU, FEC)
* 2 are royalty operations (PSK, FRU); similar to gold royalty companies, inherently there is nothing wrong with this, other than that these companies don’t have to directly incur much of the burden facing the rest of the industry at present
* 5 have some foreign operations, including SU (small), CNQ (small), HSE (small), CPG (~25%) and BTE (~40%).

Effectively, this leaves 12 majority-Canadian producers to invest in.

As a side note for Canadian nationalism, the “purest” operating Canadian oil major (no substantive operations outside of Canada) is Imperial Oil, but it is 69.6% owned by Exxon. Husky is majority controlled by Hong Kong finance titan Li Ka-shing. This leaves 10 firms left to invest in if you wish to exclude IMO and HSE because of their majority foreign-held ownership.

TSX Oil/Gas producers over $1 billion market cap

NameTickerMktCap ($Mil)Notes
Suncor Energy Inc.SU64,001Profitable
Canadian Natural Resources LimitedCNQ42,081Profitable
Imperial Oil LimitedIMO27,763Profitable
Cenovus Energy Inc.CVE14,192Profitable
Husky Energy Inc.HSE13,099Profitable; FCF mildly positive
Encana CorporationECA9,714Profitable; Majority USA
Tourmaline Oil Corp.TOU4,538Profitable; FCF mildly positive
Vermilion Energy Inc.VET4,407Profitable; mainly Europe operator
PrairieSky Royalty Ltd.PSK4,299Royalty Company
Parex Resources Inc.PXT3,072Profitable; Colombia operator
Crescent Point Energy Corp.CPG2,370Profitable; FCF mildly positive; 1/4 US ops
Enerplus CorporationERF2,306Mostly USA; FCF neutral
CNOOC LimitedCNU2,299China
Seven Generations Energy Ltd.VII2,269FCF mildly negative
ARC Resources Ltd.ARX2,268FCF negative (neutral w/o dividend)
Whitecap Resources Inc.WCP1,754FCF positive
MEG Energy Corp.MEG1,490FCF positive; fairly high debt
Frontera Energy CorporationFEC1,331LatAm producer
Baytex Energy Corp.BTE1,13040% Texas; FCF positive
Freehold Royalties Ltd.FRU1,003Royalty Company
Market Cap as of June 30, 2019.
 
Other notes

Just by eyeballing the valuations, a very passive investor could do far worse than just sticking their money in an equal-weighted fund of the top-five or top-ten and just sitting on it. Again, my “paper napkin valuation” is just that – a paper napkin take which ignores the quality (or lack thereof) of assets, or hedging portfolios, etc., but a 100,000 foot-above-the-sky valuation metric is instructive:

Looking at Suncor, they have operating earnings, plus depreciation, minus CapEx, minus CASH taxes and interest of $3.9 billion for the half-year. That’s about $2.50/share. It’s not as if they’re over-leveraged either – debt is about $15 billion. Considering they’re trading at CAD$38/share, they look cheap on immediate glance (multiple 7.6x). Management clearly thinks so as well considering they’ve been buying back shares like crazy.

CNQ’s 1H number is $2.9 billion, or $2.45/share. They’re slightly more leveraged ($24 billion in debt) but probably because they scooped up Devon Energy’s assets adjacent next to theirs in Alberta. Stock trades at CAD$32/share and the multiple is 6.5x.

The other top five, relatively speaking, look pretty cheap. CVE generated about $1.1 billion in free cash for the first half of the year (93 cents a share) which in relation to its $11.28 stock price, is a 6.1x multiple – they slashed their dividend earlier and have been using the money to pay down debt, which sits at around $7.1 billion and management has not made it a secret that they want it to get to around $5 billion. This should happen sometime in 2020.

What’s the danger in a broad-based index investment in these names? Commodity prices going down, and a continued hostile government environment for continued production. There’s going to be a lot of money on the sidelines awaiting the result of the upcoming federal election.

Pipelines and Inter-Pipeline

I’m not one to typically invest in pipelines. All of them are quite heavily levered, and in most cases, it is justifiable with the predictable streams of cash flows they generate. As a result, the equity is typically treated like a bond by most investors, plus you add a couple percent to make up for the ‘risk premium’.

In the Canadian retail space, there’s no better example of this than Enbridge, where investors blissfully clip their 74 cent a quarter dividend, with the promise by management that this will grow 10% a year indefinitely. The fact that there’s 65 billion in debt and 8 billion in preferred shares ahead doesn’t matter because of those high cash flows, so one can safely assume you will receive dividends forever. The current headline yield of 6.6% sure looks good and can only go up from here!

This might sound great, but investors of Kinder Morgan (NYSE: KMI) learned their lesson (2015) that some things can go wrong with this model and when corrections are required, shareholders take the hit and not the senior part of the capital structure. Taking equity risk on Enbridge in exchange for very limited capital appreciation upside is not my idea of a good investment, but I’ll digress.

Enbridge and other pipeline companies do have one virtue – because of intense political opposition, it becomes a lot more difficult to develop pipelines, especially in Canada. Thus, there is a huge element of advantage to incumbents. Even if you gave a competent oil major $30 billion, you wouldn’t be able to replicate Line 3 or Line 5 from scratch. Especially with Canada’s Bill C-69, there is really no point – TransCanada learned the tough way (even without C-69) that Energy East is a dead cause because of politics. The only real option these days are avoiding the federal scene entirely and going for intra-provincial pipeline infrastructure. An example of this is the Coastal Gaslink pipeline, connecting the northeastern BC gas formation to Kitimat, BC for LNG export. Even this has received heavy opposition of all sorts, but they were able to miraculously make agreements with all 30 elected First Nations councils and get the thumbs-up from the provincial NDP government (despite having a Green party coalition partner), which has been one of the big political surprises over the past couple years.

Which brings me to another pipeline company – Inter-Pipeline (TSX: IPL). What has been encumbering the company is the construction of their propane to polypropylene refining facility, which needless to say, is very expensive (all of this political talk of being able to refine your own production is completely uninformed about how expensive these facilities are and how much expertise they require to construct and operate – they don’t come up on their own like marijuana!). Their cost estimate of $3.5 billion is probably conservative and looking at the balance sheet, simply put, they have enough debt as it is without constructing this facility.

Now the media has caught wind that somebody wants to take them over, and somebody floated an unsolicited bid for $30 for the whole thing. Management rejected it, but this is starting to get the stock market interested. It’s an interesting valuation when considering that the enterprise value at IPL stock at $30 is 7 times the annualized revenues (1H-2019), while Enbridge’s is currently 3 times.

Appendix – Bill C-69

Here is a snippet of the new requirements that the environmental impact (now “impact assessment”) agency must consider:

Factors — impact assessment
22 (1) The impact assessment of a designated project, whether it is conducted by the Agency or a review panel, must take into account the following factors:
(a) the changes to the environment or to health, social or economic conditions and the positive and negative consequences of these changes that are likely to be caused by the carrying out of the designated project, including
(i) the effects of malfunctions or accidents that may occur in connection with the designated project,
(ii) any cumulative effects that are likely to result from the designated project in combination with other physical activities that have been or will be carried out, and
(iii) the result of any interaction between those effects;
(b) mitigation measures that are technically and economically feasible and that would mitigate any adverse effects of the designated project;
(c) the impact that the designated project may have on any Indigenous group and any adverse impact that the designated project may have on the rights of the Indigenous peoples of Canada recognized and affirmed by section 35 of the Constitution Act, 1982;
(d) the purpose of and need for the designated project;
(e) alternative means of carrying out the designated project that are technically and economically feasible, including through the use of best available technologies, and the effects of those means;
(f) any alternatives to the designated project that are technically and economically feasible and are directly related to the designated project;
(g) Indigenous knowledge provided with respect to the designated project;
(h) the extent to which the designated project contributes to sustainability;
(i) the extent to which the effects of the designated project hinder or contribute to the Government of Canada’s ability to meet its environmental obligations and its commitments in respect of climate change;
(j) any change to the designated project that may be caused by the environment;
(k) the requirements of the follow-up program in respect of the designated project;
(l) considerations related to Indigenous cultures raised with respect to the designated project;
(m) community knowledge provided with respect to the designated project;
(n) comments received from the public;
(o) comments from a jurisdiction that are received in the course of consultations conducted under section 21;
(p) any relevant assessment referred to in section 92, 93 or 95;
(q) any assessment of the effects of the designated project that is conducted by or on behalf of an Indigenous governing body and that is provided with respect to the designated project;
(r) any study or plan that is conducted or prepared by a jurisdiction — or an Indigenous governing body not referred to in paragraph (f) or (g) of the definition jurisdiction in section 2 — that is in respect of a region related to the designated project and that has been provided with respect to the project;
(s) the intersection of sex and gender with other identity factors; and
(t) any other matter relevant to the impact assessment that the Agency requires to be taken into account.

My comments: Good luck! Especially with the very quantifiable “intersection of sex and gender with other identity factors” criterion.

Gran Colombia Gold Notes – Part 2

Since gold is going crazy, I’ll just follow up from my previous post on Gran Colombia Gold’s senior secured notes (TSX: GCM.NT.U).

With gold at US$1,475/Oz, and assuming a call date on May 1, 2021, the notes at a purchase price of 104 will have a 13% YTM if gold continues at that price.

Unfortunately since the notes are amortized quarterly, it is very doubtful you can fully realize this, but as a buy-to-maturity investment, it gives you an equity-like return for a first-priority bond that is linked to a hot commodity. Only real risk is that the income you are being paid with is mostly derived from a single mine in Colombia – just hope for no earthquake in the next two years. Fortunately the only earthquakes presently are financial.

My notes were purchased near par and this one is looking like to be around a 15%er on debt. Not bad. Don’t think we will be seeing this again for a long time.

Book Review: The Outsiders – and outsized returns

The Outsiders: Eight unconventional CEOs and their radically rational blueprint for success – by William Thorndike.

I’ll recommend this book. Although it is becoming somewhat dated (copyright date was 2012), it gives the reader a 50,000 foot above the skies satellite view of some hand-picked CEOs that were able to strongly defeat the GE Jack Welch / S&P 500 record during multi-decade periods. They shared a single characteristic – they were able to allocate capital with discipline and ruthless efficiency. Operationally they were able to delegate to competent individuals and decentralization to the point of abdication was another theme.

If this book was written today and for Canadian CEOs, I would think Mark Leonard of Constellation Software (TSX: CSU) is an obvious candidate. He has delivered 42% compounded annual returns over the past decade, and 38% since going public in May of 2006 – notably still earning this return through the 2008-2009 economic crisis.

Reading (mostly written by) Mark Leonard’s Shareholder Q&A letters is fascinating insight on the company and how management thinks. It is indeed a shame that I never heard of this company until it was far, far too late. Sadly they are looking at future returns in the upper teens from their current size.

I have also taken great pleasure of reading Tyler’s compilation of quotations by TransForce’s (TSX: TFII) CEO Alain Bedard, which is a trucking and logistics company. TFII has performed at 22% compounded annually over the past decade, and about 13% since going public in October 2002 (in both cases dividend-adjusted). For a low margin business such as trucking, this is needless to say impressive.

There is a bit of retrospective bias in this book, however. Most individuals would probably regard Prem Watsa of Fairfax (TSX: FFH) as being a very good CEO, but his dividend-adjusted CAGR over the past decade has been 9%, and over the past 20 years has been 6%. Compare this with CEO Duncan Jackman of E-L Financial (TSX: ELF), which has been approx. 9% over both the past 10 and 20 year period. E-L Financial, in my opinion, is the least attention-seeking publicly traded corporation with a market cap of over a billion dollars.

For the sake of comparison, the TSX’s performance (dividends reinvested) over the past 10 years has been 6.6%. The main index (dividends not reinvested) over the past 17.7 years (which is how far the data goes back when they did a major change to the index) is 4.5% – adding in dividends would be another 3% or so. So a 9% CAGR performance is a slightly overperformance over the TSX, but posting returns into the teens and better is clear outperformance.