Tag: PIPE

Pipestone Energy – Strathcona Resources

Shareholders of Pipestone Energy last Wednesday approved (with a 67/33% yes/no vote) a reverse merger with Strathcona Resources. Strathcona (substantially owned by a private fund) will own 91% of the remaining entity, while Pipestone shareholders will own 9%.

Needless to say the valuation received by Pipestone shareholders was lacklustre (hence describing the minority protest vote). On August 1st, when the reverse merger was announced, the stock traded down 10% to close at $2.42. After the deal with approved, the stock is now at $2.14. It has dramatically unperformed as almost every other oil and gas equity has appreciated considerably since then. Next week they will complete the acquisition and there will be a share consolidation.

Strathcona has assembled a bunch of relatively interesting assets over the past decade. Considering I have owned debt securities of some of the entrails they have devoured, it is something I still keep track of once in awhile, but now they are public I can continue taking a more relevant look at them.

One of them was the acquisition of Pengrowth Energy for $0.05 a share (and the assumption of their not-inconsiderable at the time debt of about $700 million). I had owned Pengrowth’s convertible debentures ages ago (and they were matured at par, pretty much just before the company was running into liquidity issues). An interesting asset was the SAGD heavy project near Lindbergh, but it was relatively inefficient (recently reported steam to oil ratio was around 4), producing around 20k boe/d.

The total estimated production of Strathcona and Pipestone is 185,000 barrels/day, at apparently a $735 million sustained capital spend (this estimate seems a little bit low in my estimation). At US$80 WTI the estimated EBITDA is $2.5 billion. The metrics at the current commodity price structure is relatively favourable. The market cap, at $2.14/share, will be about $6.8 billion and the debt that will get added on will be in excess of $3 billion. Relatively speaking, the valuation is roughly in the ballpark of (a small number of) peers, so paying attention to asset quality and management’s intentions on how to best work with their capital remain to be seen.

One thing is undeniable – Waterous Energy Fund (the private owner of Strathcona Resources) is going to make a fortune on their investment in Pengrowth Energy made back in 2019. They timed the low nearly perfectly (I do not think they could be faulted for not foreseeing Covid-19). That said, there are other companies out there that have proven shareholder-friendly policies and are trading at even better valuations.

A few miscellaneous observations

The quarterly earnings cycle is behind us. Here are some quick notes:

1. There is a lot more stress in the exchange-traded debenture market. Many more companies (ones which had dubious histories to start with) are trading well below par value. I’ve also noticed a lack of new issues over the past six months (compared to the previous 12 months) and issues that are approaching imminent maturity are not getting rolled over – clearly unsecured credit in this domain is tightening. There’s a few entities on the list which clearly are on the “anytime expect the CCAA announcement” list.

Despite this increasing stress in the exchange traded debenture space, when carefully examining the list, I do not find anything too compelling at present.

2. Commodity-land is no longer a one-way trade, or perhaps “costs matter”. I look at companies like Pipestone Energy (TSX: PIPE) and how they got hammered 20% after their quarterly release. Also many gold mining companies are having huge struggles with keeping capital costs under control. Even majors like Teck are having over-runs on their developments, but this especially affects junior companies that have significantly less pools of financial resources to work with (e.g. Copper Mountain).

3. This is why smaller capitalization commodity companies are disproportionately risky at this point in the market cycle – we are well beyond the point where throwing money at the entire space will yield returns. As a result, larger, established players are likely the sweet spot on the efficient frontier for capital and I am positioned accordingly. I note that Cenovus (TSX: CVE) appears to have a very well regulated capital return policy, namely that I noticed that they suspended their share buybacks above CAD$25/share. The cash they do not spend on the buyback will get dumped to shareholders in the form of a variable dividend. While they did not explicitly state that CAD$25 is their price threshold, it is very apparent to me their buyback is price-sensitive. This is great capital management as most managements I see, when they perform share buybacks, are price insensitive!

4. Last week on Thursday, the Nasdaq had a huge up-day, going up about 7.3% for the day. The amount of negative sentiment baked into the market over the past couple months has been extreme, and it should be noted that upward volatility in bear markets can be extreme. This is quite common – the process is almost ecological in nature to flush out negative sentiment in the market – stress gets added on to put buyers and short sellers and their conviction is tested. Simply put, when the sentiment supports one side of a trade, it creates a vacuum on the other side and when there is a trigger point, it is like the water coming out of a dam that has burst and last Thursday resembled one of these days. In the short-term it will look like that the markets are recovering and we are entering into some sort of trading range, but always keep in mind that the overall monetary policy environment is not supportive and continues to be like a vice that tightens harder and harder on asset values – and demands a relatively higher return on capital.

I suspect we are nowhere close to being finished to this liquidity purge and hence remain very cautiously positioned. My previous posting about how to survive a high interest rate environment is still salient.