Christopher Edmonds

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Conoco Heads North in Gulf Canada Deal

Christopher Edmonds

Conoco has agreed to acquire Canadian oil and gas concern Gulf Canada (GOU - Cramer's Take - Stockpickr) for $8.02 per share in cash, a total price of nearly $4.3 billion. Conoco will also assume approximately $2 billion in Gulf Canada debt.

The price represents a 35% premium to Gulf Canada's Friday closing price of $5.92 on the New York Stock Exchange. Its stock also trades on the Toronto Stock Exchange.

The purchase of Gulf Canada will be immediately accretive to Conoco's earnings and cash flow, "taking into account normal purchase accounting adjustments for unproved properties, goodwill and anticipated cost savings," according to the company's merger announcement.

Analysts appear mixed in their reactions to the deal. While the rush of integrated oil companies to acquire reserves at a time when proprietary drilling prospects are limited makes sense, there is concern about the price that some may be willing to pay for oil and gas still in the ground.

This deal comes closer to that line. "This is an important strategic deal for Conoco," says Banc of America Securities energy analyst Tyler Dann. "Yet, they are taking on a lot of debt at a time in the cycle where commodity prices are at historical highs." Dann rates Conoco a buy, and his firm has not provided banking services for the company.

However, Dann thinks Conoco did well in pricing Gulf Canada's reserves. "They are paying about $6.21 per barrel of proven reserves, which is pretty reasonable," he says. "If you compare that to what others have paid in recent deals, it is toward the low end of the price range."

According to Canadian analysts, the potential for additional developments from Gulf Canada's prospects is great. "It has enormous undeveloped reserve potential," says Wilf Gobert, managing director of research at Peters & Co., a Calgary energy investment firm. "They are one of the three largest rights-holders in the McKenzie Delta and have the ability to double -- maybe triple -- production from their Indonesia reserves in the next three years."

That is the type of production that integrated oil companies are searching for and the reason more deals may be in the works. "It may be a little early to call it a trend, but certainly some of the larger oil companies are scratching their heads trying to figure out how they grow reserves and production with relatively limited drilling opportunities," says Dann.

As for Gulf Canada shareholders, Gobert thinks the deal looks dandy. "The stock hasn't seen this price since the top of the market in 1997," he says. "It's a significant premium from the recent price, and it's a long way from the $3.33 price at the bottom of the bear market in 1999."

Take Off to the Great White North

With apologies to Bob and Doug McKenzie, that is exactly what a couple of domestic oil and gas producers have done, and the trend may continue. After all, Canada represents a relatively untapped source of production assets for U.S. oil and natural gas companies. In addition to Tuesday's deal, Calpine's (CPN - Cramer's Take - Stockpickr) recent acquisition of Encal highlights the potential for deals north of the border.

And the quest of U.S. companies to acquire Canadian interests becomes even more intriguing when you consider the valuation disparities between the currencies -- both those of the respective nations as well as those of the companies. "Canadian energy companies have become sitting ducks for foreign companies, and it's not just U.S. currency buying Canadian currency," says Peters' Gobert. "What makes it really cheap is if an American company trading near 5 times cash flow or 20 times earnings can buy the Canadian oil patch trading at 3 times cash and under 10 times earnings. Those deals are easily accretive."

Two other potential deals widely discussed in recent months include a possible Shell (RD - Cramer's Take - Stockpickr) bid for Pan Canadian (PCP:Toronto) and Calpine's potential interest in Rio Alto Exploration (RAX:Toronto). None of the companies would comment on merger speculation.

For other ideas, Gobert suggests looking at the attributes of Gulf Canada. "Gulf Canada is geographically diversified with interest both in Canada and Southeast Asia," he says. "That diversity was very attractive to Conoco. And, the company's huge reserves were likely key in the deal. Many of the smaller-cap Canadian companies don't have that kind of potential."

However, Gobert says some companies fit the bill, including Canadian Natural Resources (CED - Cramer's Take - Stockpickr), Talisman (TLM - Cramer's Take - Stockpickr) and Nexen (NXY - Cramer's Take - Stockpickr). He also thinks a number of domestic companies may be looking at Alberta Energy (AOG - Cramer's Take - Stockpickr), although a deal with Alberta has "a slightly lesser probability."

All of those companies are relatively "oily," meaning most of their proven reserves are in oil rather than natural gas. He does think, in addition to Rio Alto, that both Anderson Exploration (AXN - Cramer's Take - Stockpickr) and Canadian Hunter (HTR:Toronto) provide interesting opportunities in the Canadian natural gas markets for the right suitor.

However, the urgency for Canadian gas deals seems to have faded, at least for the time being. "Short-term, the bloom is off the rose on gas prices," Gobert says. "People are wondering how low prices might go now. As it gets hot and steamy this summer, prices should bounce, but there is some doubt creeping in."

Ironically, declining gas prices might make deals for Canadian companies by their U.S. brethren more affordable. A decline in natural gas prices may lower the "asking price" for possible takeovers if sellers think lower prices are sustainable. There is little doubt among domestic analysts that natural gas prices will experience another surge this summer as demand to run new power-generation plants pushes supply.

Even with lower natural gas prices, other analysts think Conoco's interest in Canada should lead to additional interest in Canadian exploration and production companies and better valuations. "This transaction will highlight the inherent value in the remaining Canadian producers, and we expect to see a lift in their share values," Vic Vallance, an analyst with Dundee Securities in Toronto, noted to clients Tuesday morning. In addition to those mentioned by Gobert, Vallance also suggests adding shares of Petro-Canada (PCA:Toronto) and Suncor (SU - Cramer's Take - Stockpickr) to the list of companies that should benefit from a consolidation trend.

And, while Gobert's caution about small-cap Canadian companies and their reserves deserves mention, Banc of America's Dann thinks patience might provide some opportunities down the food chain. "There are a number of smaller Canadian companies that are very interesting at first glance," he says. "The real issue is whether companies have the patience to do that kind of due diligence."

Conoco's deal Tuesday highlights the fact that our neighbors to the north present some very energizing ideas.