Investors bailed out of Husky Energy Inc. shares on Monday after the company announced a $3.3-billion hostile takeover offer for MEG Energy Corp., an oil sands producer that has been hit hard by transportation bottlenecks.
Husky shares were off $1.47 – or 6.5 per cent – to $21.21 as analysts said the acquisition would expose the company to the steep discounts that bitumen producers are forced to accept because of pipeline constraints.
MEG shares soared by 38 per cent to $11.07 – slightly higher than Husky’s $11 cash and share offer – on the expectation that Husky will have to sweeten its bid to conclude the deal. Nearly 20-million MEG shares traded hands on Monday, as some investors opted to cash out while speculators bought in anticipation of a richer offer.
Husky chief executive Rob Peabody defended the deal as good for both companies' shareholders in a conference call on Monday. He said it offered a rich premium for MEG stock owners – 37 per cent from the closing price last Friday – while increasing Husky’s per-share cash flow and bringing new technology and investment opportunities.
The Husky CEO said oil sands producers must have access to processing operations in order to maximize the return on their investments.
“We just believe this is a real compelling offer,” Mr. Peabody said. “This is a real hand-in-glove sort of deal – it just fits together very well.”
MEG issued a statement, telling shareholders it would respond to the Husky offer after the would-be acquirer releases its formal circular on Tuesday. The company produces nearly 100,000 barrels a day of bitumen from steam-assisted, gravity-drainage (SAGD) operations, primarily at its low-cost Christina Lake facility.
MEG’s share price climbed sharply between April and July, but then slumped as investors focused on the growing differential between North America’s benchmark, West Texas intermediate, and Western Canadian Select, the trendsetter for oil sands bitumen. That gap, normally around US$15 a barrel, has widened to US$35 in recent weeks.
In a note on Monday, Royal Bank of Canada analyst Greg Pardy said Husky will likely have to sweeten its bid to close the deal after having been rebuffed by the MEG board.
Mr. Pardy said the acquisition will benefit Husky in the longer run, but will raise investor concerns about its increased exposure to heavy-oil differentials.
MEG shareholders are being offered the option of taking $11 cash, or 0.485 Husky shares, in exchange for their MEG stock, but with a $1-billion limit on the cash component that is meant to limit the debt Husky would have to take on. Given the large share component, Husky will have to readjust its offer if its stock loses value between last Friday and the January, 2019, deadline for tendering into the deal, Mr. Pardy said.
Mr. Peabody said MEG has quality assets but is hampered by too much debt and an inability to process its bitumen, leaving it overly exposed to the light-heavy differential. He said Husky has several strategies to avoid reliance on WCS, including expanding its own heavy-oil refining capacity in the United States, and locking in pipeline space to premium markets.
While the two companies combined would produce 400,000 b/d of heavy crude in 2020, Husky will have processing and transportation capacity for 375,000 b/d.
Husky also expects to be able to save $200-million in annual costs in the combined companies, including $100-million by reducing borrowing costs on MEG’s $3.1-billion in debt. The company would also reduce duplication at corporate head office in Calgary, but Mr. Peabody said he expects that in the medium term, the combined operations would require more people because of growth.
In a note on Monday, Moody’s Investor Services Inc. said the proposed acquisition would raise credit concerns for Husky due to the increased debt load and greater exposure to heavy-oil differentials. However, it said Husky should be able to absorb the debt and Moody’s would likely affirm its credit rating.
Oil sands heavyweights Suncor Energy Inc. and Imperial Oil Ltd. could also have a look at MEG, Phil Skolnick, analyst at Eight Capital, said in a note to clients. However, Mr. Peabody said on Monday that he does not believe other companies would gain the same benefits from an acquisition of MEG.