Ryan Modesto, CFA, is Managing Partner at 5i Research, a conflict-free investment research provider for retail investors offering research reports, model portfolios and investor Q&A. 5i Research provides content under an agreement with The Globe and Mail, which receives royalty compensation. Try it.
There has been a flurry of activity since Suncor announced an unsolicited offer on October 5 to acquire all of the outstanding shares of Canadian Oil Sands (COS) for $4.3 billion. Under the offer, each COS shareholder would receive 0.25 shares of Suncor (SU) for each share of COS held. At the time, the offer represented a 35-per-cent premium to shareholders based on the 30-day weighted average trading price and would also result in dividends that are 45-per-cent higher than what COS shareholders currently receive. With the initial offer expiring December 4, 2015, the Alberta Securities Commission has approved a shareholder rights plan allowing the company more time and Suncor has extended their bid to January 8, 2016. COS has also announced that four credible parties have emerged but there has been no concrete offer from any of them yet. The arguments are interesting because what one views as a positive, the other spins it as a negative. We wanted to try to sift through the marketing and promotional aspects and see what the middle ground is, if any.
Suncor's premium bid/Canadian Oil Sands' undervaluation:
This is an interesting one as it is really a matter of perspective. Looking at the straight numbers, Suncor is offering a premium to what Canadian Oil Sands shares were trading at, during the time of the offer (a 35-per-cent premium). With Suncor shares currently at $36.80, the offer price is actually a ~49-per-cent premium to when the deal was first announced (at the time of writing) but this will change as the price of Suncor shares move. COS essentially counters this by saying it is an opportunistic, lowball offer, and there is some merit to this when you consider the shares are still 57-per-cent lower over a two-year period even after the jump in shares from the offer. It may be worthwhile noting, however, that SU shares are only down 0.41 per cent over the same two-year period. Suncor looks at the offer as the facts are today and views the offer as a generous premium. COS thinks that with any rise in oil prices, investors will quickly see that the offer is unfair. Both arguments are reasonable but we think the main differentiator comes down to the old adage of a bird in the hand versus two in the bush.
Premium dividend:
This is a difficult benefit to argue for COS. To be nice, Canadian Oil Sands has had a volatile dividend. The distribution was as high as $0.5 per quarter in 2010, bounced a little, then stabilized at $0.35 per quarter and was recently cut to $0.05 per quarter in February 2015. Contrast this to Suncor who has grown the dividend from $0.10 in the same period in 2010 to $0.29 per quarter currently, with the most recent increase being in September 2015. When we include the share exchange, COS shareholders would be getting a $0.0725 quarterly dividend compared to the $0.05 one that COS currently offers along with a much stronger dividend growth track record, even through tough times.
Opportunistic/Exploitive:
This is another issue of point of view and framing. COS is accusing SU of being opportunistic given the oil environment but for those that are shareholders of SU, this is exactly what you would want management to be doing: Taking advantage of opportunities as they arise. One might ask why COS is not also looking for these types of opportunities given depressed valuations in the market and their assumption of higher oil prices. The issue of exploiting the potential of Syncrude due to the insider position that Suncor holds is a fair one. This issue has largely been dealt with due to the Alberta Securities Commission extension that was offered.
Can't we all just get along?
We were a little surprised about the intense opposition that has come with this offer. If it were an all cash deal and current COS shareholders had no chance to benefit in the upside, we think it would be a different story. However, given that it is a share exchange, owners of COS shares are essentially given two options: They can take a quick 'gain' from a sector that has been decimated in the past year or they can continue to hold for longer-term potential and benefit from the strengths of both companies. Yes, COS investors are likely to experience a significant rise in shares with any rise in oil prices, but as many of these investors know, this can work both ways and also result in a 50-per-cent haircut in share value in a short amount of time. The share exchange allows investors to benefit from the company that is being opportunistic and getting a 'steal' while still indirectly holding the original entity. As indicated by the chart below showing SU, COS and Light Sweet Crude over a two-year period, a case could be made that Suncor actually has an ability to withstand oil downturns while still participating in strengthening oil prices.
Risks on the rise:
Canadian Oil Sands has now effectively been pushed in a corner with the extension from the ASC. If another offer/deal does not surface, COS will have egg on their face. This can have even larger negative consequences as it may pressure management to find ANY kind of offer over the next thirty days, just to have an alternative to the Suncor bid. It may also lead to COS looking at other alternatives such as restructuring (adding debt) to make COS less attractive to SU. While it is hard to speculate how any such restructuring would look, this type of move would likely create less value for shareholders over the long-term, as it would be more likened to a defensive move over a strategic one. Finally, if Suncor gets frustrated and walks, COS is likely to face a falling share price and angry shareholders, so simply letting the deal fail is less of an option and COS will have to show some way to create value over the long term, above and beyond referencing that oil prices will go higher. It will be exciting to watch the developments but as these types of battles linger on, emotions tend to start colouring management teams and non-optimal decisions can be made. The losers in these scenarios usually end up being shareholders, so we only hope that cool heads prevail and that the best interests of the owners of the company, the shareholders, are kept in mind.
The writer does not hold a position in any companies mentioned. To remain conflict-free, employees of 5i Research do not own any individual Canadian securities.