Burlington Looks North, Buys Canadian Hunter

The Hunter has been hunted.

In a continuing trend of Canadian natural gas mergers, Burlington Resources (BR Quote) agreed Tuesday to acquire natural gas producer Canadian Hunter Exploration (HTR:Toronto) for $2.1 billion (C$3.3 billion). Hunter was originally profiled as a merger candidate about a month ago in my Under the Radar column.

The deal, which nearly doubles Burlington's position in Canada, calls for Burlington to pay C$53 for each share of Hunter, a 36% premium over Monday's closing price of C$39.01.

Tuesday's announcement is another in a growing list of north-of-the-border transactions by U.S. energy companies. Last month, Devon Energy (DVN Quote) announced its acquisition of Anderson Exploration (AXN Quote), and Duke Energy (DUK Quote) purchased Westcoast Energy (W:Toronto). Earlier this year, Conoco(COC.A Quote) acquired Gulf Canada Resources, and Calpine (CPN Quote) purchased Encal Energy.

The continued acquisition trend, even as natural gas prices continue to fall, suggests natural gas producers believe demand will return as supplies remain tight. Some believe now is the right time to grow through acquisitions.

"The pullback in natural gas prices and share prices is a good time to strike," says Raymond James energy analyst Wayne Andrews. "The energy crisis has not been fixed. We have an interim lull here. You can pick up good-quality assets where they can grow production at a reasonable cost."

Canada continues to be a prime hunting ground for merger candidates as a result of solid natural gas production trends there. "Burlington has been very happy with Canada," Andrews says. "U.S. producers just aren't finding areas domestically where they can grow production. The only areas that are really providing production growth are Canada and the Rockies. And maybe deepwater Gulf of Mexico, but we haven't gotten there yet."

If Canada remains the focus, only a few pure natural gas plays are left. First, Rio Alto Exploration (RAX:Toronto) looks attractive to one Canadian pundit who has been quite accurate in his guidance this year.

Scott Walters of Toronto's Research Capital was right in his calls on both Anderson and Hunter. Now, he believes Rio Alto deserves a look. "Rio Alto is the last man standing," he says of the midsize Canadian natural gas exploration-and-production company. "And if you apply the same pricing of recent deals, take-out valuation should be around C$30." The stock closed Monday at $20.50.

Raymond James' Andrews also thinks investors should look at a larger Canadian play, Alberta Energy (AOG Quote).

"Alberta is the best company in Canada," Andrews says. "They have a great story and solid management. Investors should be buying these shares. If you don't see an increase in the price, somebody should come in and buy the company."

Using recent pricing as a guide, Andrews says Alberta Energy could receive C$80 a share in an acquisition offer. The stock currently trades around C$57. Andrews rates Alberta Energy a strong buy, and his firm has not provided banking services to the company.

A number of possible bidders for Canadian assets come to mind. Apache (APA Quote) has been looking to expand its Canadian presence for some time. Royal Dutch Shell (RD Quote) is also said to be seeking a Canadian partner. Neither would comment on acquisition plans or speculation.

"Shell should be all over Alberta Energy if they are serious about expanding their North American natural gas presence," says one analyst who wished not to be identified.

Any company that's interested in Canada should get busy now, though. "If Canada is part of your strategic plan, you better act," says Mark Meyer, E&P analyst at Simmons & Co., a Houston energy investment firm. "The available assets in Canada are dwindling."

Full Price, Fair Price

In the short term, analysts believe Burlington's premium bid will put pressure on its stock. However, the deal suggests the longer-term thesis of a tight North American natural gas market will remain intact.

"It's on the full-price end of the spectrum if you are looking at the short term," Meyer says. "It's a tough time to be paying a full price for natural gas assets."

Meyer believes Burlington shares will feel some short-term pressure as a result of the deal, although he thinks an all-cash deal makes sense because the cost of borrowing is "cheap and getting cheaper." In early Tuesday trading, Burlington was down $1.40, or 3.8%, to $35.10.

Yet the deal looks like it will help Burlington shore up its long-term growth strategy. "The deal gives Burlington a 3% to 8% growth rate, and Hunter will represent 20% of the new company," Andrews notes. "With Hunter, they go from no growth to decent growth. They are paying a healthy price, but it is a reasonable price given the longer-term outlook." Andrews rates Burlington a buy, and his firm has not provided banking services to the company.

In the deal, Burlington gets Hunter's 1.2 trillion cubic feet of proven natural gas reserves, 6.2 million barrels of oil and about 2 million undeveloped acres in Western Canada. The deal increases Burlington's reserves by 12%. Burlington's cost is about $1.27 per thousand cubic feet equivalent (Mcfe) of proved natural gas reserves.

The pursuit of reserves at such a high price, given current gas prices, suggests that Burlington -- as well as other producers -- believes in the future of natural gas.

"The deal is yet another affirmation of belief in the North American natural gas story," Meyer says. "That is tight supply and demand and an equilibrium price above the mid-$2 range."