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Nexen stock risky despite takeover premium: Morningstar Add to ...

Stock research firm Morningstar is advising investors to take a pass on the takeover play for Nexen Inc., arguing the twists and turns unfolding in the acquisition drama offer limited upside and plenty of downside.

Nexen is awaiting federal government approval for its $15.1-billion takeover by China’s state-owned energy giant CNOOC Ltd.

In the interim, Nexen shares may seem tempting to some investors because the stock is trading around $24.30 while CNOOC is offering $27.50 a share. That suggests intrepid buyers could make a quick profit of more than $3 a share if the deal receives a speedy green light.

But Morningstar worries the buyout won’t be approved. If the deal is blocked, the stock will likely plunge all the way back to around the $17 level it was trading at before the takeover announcement.

“Right now Nexen looks like a sell for everyone but the deep-pocketed Chinese bidder,” Morningstar says in a report. “Unless you believe approval of the takeover is a near-certainty, the downside risk is too great to consider buying shares of Nexen.”

The takeover approval is caught up in Canada’s “net benefits” rule, a political hurdle that Morningstar calls “wishy-washy” and which it says is “far too opaque and provides a level of uncertainty no investor should have to deal with.”

The federal government has extended the timeline for its analysis of whether the deal provides enough benefits to Canada and is now set to make a ruling by Dec. 10.

Nexen shareholders have good reason to be nervous about what might happen if the deal falls apart.

After failed bids, investors have to hope that the underlying value of the company will allow them to eventually recoup any losses sustained when the deal is terminated. Ideally, a company should be undervalued relative to assets or earnings power.

On that score, Morningstar isn’t impressed by Nexen. The firm says Nexen’s trailing price-to-earnings ratio is a relatively lofty 26.3.

Morningstar looked at a peer group of oil patch companies with market capitalizations of more than $1-billion and concluded Nexen’s valuation was “very rich” compared to rivals.

“The upside is just not there to actually put any money down,” says Kirk Paulus, the Morningstar analyst who wrote the Nexen report.

To be sure, not everyone on the Street figures the deal is dead, or else the shares would be trading even lower.

Some observers say that the federal government’s decision to negotiate a Canada-China trade pact makes a favourable ruling on the takeover more likely.

That’s the judgment of Veritas Investment Research. The Toronto-based firm said in a report that the government would be unlikely to launch such an important trade initiative, only to slap down the first big Chinese investment to come along.

“We doubt that a government willing to sign such a comprehensive pact, that is clearly trying to open up China to large-scale Canadian investment (with Manulife and Bank of Nova Scotia rumoured to be the first in line), is looking to scuttle the first major deal that comes across its desk,” it says.

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