These are stories Report on Business is following Monday, Oct. 22, 2012.
The 'black box'
Unlike many observers today, I don't necessarily believe the Canadian government did the the wrong thing in spiking the $6-billion takeover of Progress Energy Resources Corp. by Malaysia's state-owned Petronas.
I say "necessarily" because I don't know why it did it. And I wholeheartedly agree with those who warn that Ottawa has left an air of uncertainty that could spook other foreign investors, and that the decision-making process in Ottawa appears to be troubled, to put it mildly.
"Following the rejection of the Potash-BHP Billiton deal, the industry minister at the time, Tony Clement, said that Industry Canada would release a document providing the background to the government’s decision," said Charles St-Arnaud of Nomura Securities in New York.
"This document has yet to be published, which we think suggests the decision process remains a ‘black box’ and is very hard to evaluate."
To recap, at just about midnight last Friday, the government rejected the Petronas-Progress deal as not meeting Canada's "net benefit" test. Petronas has a month to come back, and as The Globe and Mail's Carrie Tait and Shawn McCarthy report today, the Malaysian company says it will meet Industry Canada officials to discuss what went wrong.
Separately, Prime Minister Stephen Harper said foreign investors and Canadians alike will have to wait for clarity on proposed acquisitions, as they've been doing for some time. In the Petronas case, the government also gets to hide behind confidentiality rules.
But lack of clarity is rippling through the markets today, knocking a number of resource stocks, including shares of Nexen Inc., whose own takeover by China's CNOOC Ltd. is under scrutiny by the government.
I agree with Mr. St-Arnaud that things looks kind of messy in Ottawa, not just where foreign takeovers are concerned.
Consider that BCE Inc. says it's appealing to the federal cabinet to overturn a decision by the country's broadcast regulator last week, when it rejected its takeover of Astral Media Inc. Officials have been all over the map on that one, and it's awfully unclear as to what happens next.
Industry Minister Christian Paradis said on Friday that cabinet won't intervene because, legally, it can't, and that the Canadian Radio-television and Telecommunications Commission makes its own decision. But on the weekend, in an interview with CBC, Finance Minister Jim Flaherty said the cabinet will review it because it's obliged to, though intervention would be a big move. And then officials representing Heritage Minister James Moore said the cabinet had no "legal ability" to overturn the regulator's ruling.
So who knows. There's no question, though, that Ottawa needs to do a far better job of broadcasting to the markets just what the heck is going on.
"The transaction may still be resuscitated and the CNOOC/Nexen transaction will be evaluated on its own merits, but in the meantime this paints a negative picture of the openness for foreign investment in Canada," said analysts at CanaccordGenuity.
- Canadian, foreign investors must wait for takeover clarity: Harper
- Petronas move spurs fear of investor chill
Canada right to protect resource companies
Disclosure and clarification aside, we shouldn't get our knickers in a twist over the fact that the Canadian government did what it did. Not yet, anyway.
It may seem like the Canadian government is sending a message to investors, both foreign and domestic, that they’re not keen on big mergers in industries where key resources are at play or where there are consumer concerns to consider.
But that’s simplistic. And it’s wrong to suggest that the Conservatives are robbing shareholders of hefty takeover premiums without sound reasoning, or that foreign suitors need not apply.
The fear is that the government’s opposition to the 2010 takeover of Potash Corp., coupled with its Progress decision late Friday and along with the CRTC’s rejection of BCE Inc.’s takeover of Astral Media last week, is shaping up as a pattern.
But you’ve got to look at each deal on its own.
The BCE-Astral rejection was surprising, but for entirely different reasons, none of which involved foreign suitors.
In the Potash deal, there was a major foreign suitor, but huge concerns over government revenues and future projects, among other things.
I even saw one mention yesterday of how the London Stock Exchange was pushed back in its bid for TMX group Inc. That was, of course, different, in that it was a move by Canada’s banks to control the country’s stock exchanges, which, yes, raises questions, but not where the federal government is concerned.
And, of course, Quebec’s bid to declare the Rona Inc. hardware store chain a strategic asset was just plain nutsy.
Once you’ve been through each deal, you’ve then got to ask why the government shouldn’t protect our resources and ensure that each and every proposed takeover is in our interest. Which is not to say that the Petronas-Progress deal isn't - the government won't tell us what's going on - but takeovers such as this one should certainly be given a thorough going-over.
Progress is big in natural gas in British Columbia and Alberta, for example, and Nexen, while global in nature, has huge interests in the oil sands and also B.C.
As The Globe and Mail’s Shawn McCarthy writes, some observers, such as lawyers at Osler Hoskin & Harcourt LLP, worry that Friday’s decision could have “a significant chilling effect” on foreign investors.
“I don’t think this is necessarily protection of the shareholders of the company,” Alan Jochelson, a mergers and acquisitions specialist at Gowling Lafleur Henderson LLP, told The Globe and Mail's Carrie Tait. “It is really looking at ultimately to what extent are we prepared as a country to have foreigners own our assets.”
That’s true, but at the same time the government not only has the right, but also the responsibility to protect, and, yes, at times shelter, Canada’s jewels. That doesn’t mean they can’t change hands, but it does mean we should make certain they fall into the right hands.
As mentioned above, a big problem here is that we don’t know why Ottawa blocked Malaysia’s state-owned Petronas from the takeover of Progress, why it didn’t meet the “net benefit” test.
Was it because the Malaysian company didn’t spell out its plans well enough? Was reciprocity an issue? Were there concerns over the fact that Malaysia is No. 60 in Transparency International’s corruption rankings, a far cry from bottom-ranked Somalia at 182, but also a far cry from Canada’s No. 10 spot? Or, as AltaCorp Capital wondered, was Ottawa troubled by the many “high-profile” acquisitions recently, or tax issues surround repatriation of funds? Or questions over pricing of natural gas that could affect government revenue?
“It could be that the federal government was of the view that Petronas was trying to take advantage of stranded Canadian natural gas and that the deal was structured in a way that would allow them to pay artificially lower costs in terms of taxes and royalties due to a potential disagreement over transfer pricing,” said AltaCorp.
“By owning the full value chain for the delivery of [liquid natural gas], Petronas was in a position that it could dictate what would be assumed in terms of a deemed price for its natural gas – with the bias for this to obviously be lower in order to limit royalty and tax expense on the Canadian side of the business. “
There’s also the issue of reciprocity, though, AltaCorp said, that’s probably a bigger issue in CNOOC’s Nexen takeover.
“There may be some aspect that the government is looking at this deal as an unfavourable opportunity for a NOC (national oil company) to do business in Canada, while Canadian firms are not presented with the same opportunity elsewhere,” the analysts said of the Petronas deal.
“The point is a valid one – do Canadian companies have the same reciprocal rights to doing business in a foreign country? How does a Canadian company compete against an NOC, if they don’t have the same investment opportunities? (Not to mention a higher cost of capital.)”
- How Malaysia's oil patch bid 'came unglued' after Ottawa pressed to extend talks
- B.C. LNG plan at crossroads after Petronas-Progress deal blocked
- Subscribers only: Not sure what 'net benefit' means? That's good
Energy stocks sink
Canadian energy stocks plunged today in the wake of the Petronas ruling.
Shares of Progress Energy Resources Corp. tumbled, as did others, as spooked investors bolted from certain companies.
"Whatever Industry Canada's reasoning, its decision will impose a material cost on Canadian equity investors beyond just the Progress transaction," Raymond James analysts said before the markets opened.
"Canadian energy investors and holders of funds should brace for a material hit on Monday as investors grapple with the prospect that the Nexen and Celtic acquisitions could suffer similar fates."
Indeed, shares of energy giant Nexen Inc. also sank given its takeover by China's CNOOC Ltd. is under scrutiny by authorities, as did those of Celtic Exploration Ltd., the target of a takeover bid by ExxonMobil Corp.
Also sideswiped were Encana Corp. and Talisman Energy Inc., among others as investors looked past the deal in question, along with those of ARC Resources Ltd., Bonavista Energy Corp., Paramount Resources Ltd. and NuVista Energy Ltd.
“We expect that initial market reaction will be universally negative, although we believe that [exploration and production] stocks buoyed by speculation on acquisition activity on behalf of non-SOES will be gradually differentiated in the market,” said analysts at FirstEnergy Capital, referring to state-owned enterprises such as Petronas.
“There is a very good chance that this could be an opportunity to establish/complement positions for those with a higher risk tolerance, believing that this is a policy/process issue and that ultimately many transactions will observe approval,” they said in a research note.
“No question however, it will be difficult to overcome emotion through what will be severe market pressure this week.”
Analysts, of course, began slashing their price targets on Progress shares in the wake of the Friday midnight decision.
“We attach a 25-per-cent probability that the deal is saved, and a 50-per-cent chance that a multinational oil company comes in as a bidder if the Petronas deal fails,” said Andrew Potter of CIBC World Markets, who cut his target on Progress shares to $19 from $22.
“We note that we see a buying opportunity on the stock below $17.”
Like many other observers, Mr. Potter warned of the reaction globally to the Canadian decision.
“After the disastrous royal review and trust legislation, the last thing investors needed was a reminder that Canada does have political risk – and that will likely prompt many global investors to continue to deploy capital outside of Canada in the short-term (at least),” he said.
Celtic is in a separate class as Exxon is not a state-owned company.
“We believe that Industry Canada’s denial of Petronas’ proposed takeover of Progress Energy will be perceived in the short term as negative to Celtic, given the recent offer from Exxon Mobil,” said Toronto-Dominion Bank analyst Roger Serin.
“We believe that the Celtic/Exxon transaction will ultimately move forward. We note that a comparable transaction by a multinational oil company (not a state-owned enterprise) was Shell’s successful acquisition of Duvernay Oil Corp. in the summer of 2008,” he said, though he cut his price target on Celtic shares to $24.50 from $26.25 on “newly perceived deal execution risk.”
- Follow our Inside the Market blog
- Mike Moffatt's Economy Lab: With 163 words on Petronas, $2.3-billion in wealth disappears
- Market braces for Petronas fallout
- Subscribers only: Where is the floor for Progress after Petronas rejection?
Caterpillar cuts forecasts
Caterpillar Inc. has slashed its outlook for the year in yet another sign of the troubles dogging the global economy.
“As we've moved through the year, we've seen continued economic weakening and uncertainty,” said chief executive officer Doug Oberhelman.
“It's definitely impacting our business with dealers intending to lower inventories and mining customers delaying some projects and reducing orders,” Mr. Oberhelman added in a statement.
“We're focused on being very nimble and taking actions to respond to the current environment while at the same time keeping our 2015 goals and expectations in mind. It requires a pragmatic and steady approach as we balance our actions in the short term with what we need to do to be prepared for better growth when the world economy improves.”
The giant equipment company cut its projections for revenue this year to about $66-billion (U.S.), down from a range of $68-billion to $70-billion earlier.
It also expects earnings per share of $9 to $9.25, down from its previous projection of $9.60.
“The decline in the sales and revenues outlook reflects global economic conditions that are weaker than we had previously expected,” the company said.
“In addition, Cat dealers have lowered order rates well below end-user demand to reduce their inventories. Production across much of the company has been lowered, resulting in temporary shutdowns and layoffs. Lower production will continue until inventories and dealer order rates move back in line with dealer deliveries to end users.”
It does have a “slightly” better view of 2013, with “modest improvement in the United States, China and most of the developing world, but continuing difficulty in Europe.” It said it does not forecast a global recession.
Caterpillar sales rose 5 per cent in the third quarter to $16.45-billion from a year earlier, while profit surged to $1.7-billion, or $2.54 a share, from $1.14-billion or $1.71.
Agrium boosts dividend
Canada’s Agrium Inc. is doubling its dividend after buying back almost 9 million shares, good news for shareholders amid a weaker outlook for potash-related stocks.
Agrium said its dividend would climb to $2 (U.S.) on an annualized basis, or a quarterly payout of 50 cents beginning in January.
“This is the third significant increase to our dividend since December of last year,” said chief executive officer Mike Wilson.
“The increased dividend and $900-million substantial issuer bid are an indication of our confidence that our integrated business model will continue to deliver strong results for the benefit of shareholders.”
What to watch for this week
The Bank of Canada and its U.S. counterpart take centre stage this week, with questions surrounding the message the Canadian central bank wants to send.
Governor Mark Carney and his colleagues announce their policy decision tomorrow. And while they won't change their benchmark overnight rate from its current 1 per cent, analysts wonder whether they will change a key line in their statement. That key line has, for now, been a signal that the next move in rates will be up. But given that Mr. Carney omitted that statement in a speech earlier this week, economists expect he could change it tomorrow.
"There remains some chance the bias is left intact, though this says more about its conditional nature rather than confidence in the medium-term outlook," said Mark Chandler and Ian Pollick of RBC Dominion Securities.
"Instead, the BoC may choose a 'third way,' outlining various economic scenarios in an uncertain forecasting environment and the associated policy responses that might be expected."
For those reasons, there's heightened speculation surrounding tomorrow's decision.
"Many took the Governor's remarks this past week as a sign that the bank was about to drop its very soft-pedaled warning of rate hikes to come," said chief economist Avery Shenfeld of CIBC World Markets, though he believes Mr. Carney won't change his message.
"In its most recent incarnation, there has been no sense of urgency in terms of the timing of when those hikes would take place, and very specific conditions under which they would happen at all. If the bank dropped that message in its entirety, it would leave investors guessing whether the next move was even a hike, would rally the short end a bit, and take some of the wind of the Canadian dollar's sails. So in this case, words do count."
A day after the rate decision, the Bank of Canada will release its widely watched Monetary Policy Report, and could well trim its outlook for economic growth.
"In the July edition of the MPR, the BoC expected growth to be 2.1 per cent in 2012 and 2.3 per cent in 2013," said Charles St-Arnaud of Nomura Securities in New York.
"Based on the level of uncertainty and the recent data, we believe that growth in 2012 could be revised to 2 per cent and for 2013 to 2.2 per cent for 2013. This should still see the output gap closing in the second half of 2013."
While Canada's central bank is unveiling that report, the U.S. Federal Reserve will be preparing to release its policy announcement that afternoon.
"After pressing harder on the monetary gas pedal in September, the Fed will likely stay in cruise control for a few months to monitor the effectiveness of recent policies," said Sal Guatieri of BMO Nesbitt Burns.
"With the unemployment rate trending lower and the expansion picking up some, there is little urgency for additional monetary fuel. ... The statement should also repeat that policy makers will take additional action 'if the outlook for the labour market does not improve substantially and retain a super-easy stance 'for a considerable time after the economic recovery strengthens.'"
For shareholders, several major companies are scheduled to report quarterly results, including Canada’s two major railways, Apple Inc., Yahoo Inc., Potash Corp. of Saskatchewan, Cenovus Energy Inc., Nexen Inc., Precision Drilling Corp., Caterpillar Inc., Facebook Inc., Xerox Corp., AT&T Inc., Encana Corp., Rogers Communications Inc. and Teck Resources Ltd.
- Kevin Carmichael's Economy Lab: Canada's credit bubble a central banker's dilemma
- Mike Moffatt's Economy Lab: Why Carney needs to lower interest rates
- Barrie McKenna: Don't expect Canada's housing market to have U.S.-style meltdown
- Martin Mittelstaedt's At The Bell: Carney's track record not as good as one might think