Canadian petroleum company acquisitions up, financings down

CANADIAN ENERGY FIRMS SET a record for merger and acquisition (M&A) activity in first half 1998.

The total value of M&A transactions during the period was $10.1 billion (Canadian), an increase of $2.2 billion, or 28%, from the same period last year, and almost double that of first half 1996 (see chart this page).

These are the conclusions of Calgary-based Sayer Securities Ltd.'s quarterly report on Canadian M&A activity.

Meanwhile, first half 1998 treasury financings completed by Canadian oil and gas companies decreased 16% from the same period in 1997. The total value of financings for the period was $2.7 billion from 170 issues, compared with $3.2 billion from 214 issues for the same period last year.

Significant decreases in both equity and royalty trust financing pushed the total down, despite a significant increase in debt financing this year.

"Capital markets are demonstrating the effects of less positive fundamentals," said Sayer, "resulting from lower oil prices, higher interest rates, and reduced investor interest in the oil patch."

M&A transactions

The number of Canadian M&A transactions declined in first half 1998 vs. 1997, said Sayer. The number of deals worth $5 million or more fell to 82 from 113. For both periods, nearly 75% of the transactions were property acquisitions or exchanges, rather than corporate takeovers.

The median price paid for reserves in first half 1998 was down 5% from last year, to $6.34/boe from $6.70/boe.

"With the industry weathering the lowest oil prices seen in years, and stock prices down significantly, we might have expected an even larger drop in acquisition prices to occur," said Sayer. "However, a decrease in prices paid for oil reserves was mitigated by a general shift in buying preference towards natural gas reserves, which commanded a 25% premium relative to oil reserves, on a boe basis, during the first half of 1998."

In the first half of this year, three transactions accounted for about 60% of Canadian M&A deals, says Sayer. These were:

Union Pacific Resources Group Inc.'s $3.7 billion purchase of Norcen Energy Resources Ltd.
Marathon Oil Co.'s $1.1 billion acquisition of Tarragon Oil & Gas Ltd.
Devon Energy Corp.'s $890.3 million purchase of Northstar Energy Corp.

In all three of these transactions, a U.S. buyer acquired a well-established Canadian oil and gas firm.

"Although the American presence in Canada's oil patch isn't new," said Sayer, "there is increased interest lately, given a weak Canadian dollar, relatively underdeveloped natural gas reserve basins, and projections for stronger Canadian gas prices once new pipeline infrastructure is in place."

Despite the partial offsetting of the oil downturn by relatively strong gas fundamentals in the first half, Sayer concludes that, "In generalellipsethe news is not good, and the downward trend in acquisition prices is expected to continue."

The firm also expects some changes in the nature of M&A deals. Its president, Frank Sayer, said, "While most corporate deals completed over the previous 2 years have involved share exchanges, as opposed to cash, we are likely to see a shift towards more cash deals, given the fall in share prices for previous buyers.

"There are also likely to be more financially distressed companies being purchased by companies with strong balance sheets," he predicted.

Financings

In the first 6 months of 1998, equity financings fell significantly, to $1.03 billion from $1.52 billion in first half 1997-a 32% drop.

There has been an across-the-board drop in equity financings this year, regardless of company size, said Sayer. Larger companies have shifted their focus away from equities to the debt market, while the equity market for smaller firms has become "extremely selective."

Sayer says that, although first half 1998 financings reflect a weakened equity market plagued by the lowest oil prices seen in years, relatively strong natural gas prices- and hopes that they will improve by yearend- are playing a part in mitigating the downward trend.

Debt issues in 1998 were the dominant force behind Canadian oil & gas companies' financing trends. This year, $1.53 billion was raised through 20 debt placements, compared with $1.25 billion raised through 13 placements in 1997. In the first half, debt accounted for 56% of the total value of treasury issues, compared with 38% in 1997.

The increase in debt issues is not completely surprising, said Sayer: "Although a portion of the debt raised each year is part of revolving debt programs of major companies, the increase is also a reaction to relatively low interest rates, which make debt a more attractive financing option. Furthermore, the bigger players in the oil industry have, in recent years, enjoyed improved access to larger international debt markets, especially in the U.S."

Royalty trust financings also increased in first half 1998. Last year, six royalty trusts raised $478.6 million in the first half, including three new initial public offerings (IPOs) of trust units worth $376.6 million. But in 1998, there were only three royalty trust issues-by established trust companies-for a combined $169.5 million, and no IPOs.

Financing statistics showed a worsening trend toward the end of the first half.

May and June 1998 had the lowest back-to-back monthly values for treasury issues seen since 1995. These 2 months were down 54% in total value compared with May and June 1997, and were down 79%, based on equity financing exclusively.

Sayer expects the downturn in equity markets to continue until a significant oil price recovery can be realized, or until the Canadian oil industry moves its production weighting further toward natural gas.