In a somewhat unexpected move, integrated energy major Husky Energy (TSX:HSE) has made an unsolicited offer to acquire rival oil sands producer MEG Energy (TSX:MEG), which, when including debt, is valued at $6.4 billion. This caused MEG’s stock to soar, gaining 35% over the last week as markets digested the news.
It is easy to understand why MEG’s stock surged. Husky’s proposal values the company at $11 per share, which represents a 37% premium to its pre-offer market price. At this time, MEG’s management has issued a cautious statement, saying that they will establish a special committee to evaluate the deal, but at this stage no formal offer had been made. The question for investors is whether there is more upside ahead.
Now what?
Typically, when a company makes an unsolicited offer to acquire a rival, it is prepared to sweeten the agreement by increasing the initial offer if that is what is required to complete the deal. Now that a baseline market value has been established, there is also every chance that an opposing energy company could swoop in and make a higher offer.
Clearly, in either case, that would bolster MEG’s market value. The deal would — if completed — be beneficial for both oil companies and accretive for Husky’s earnings as well as free cash flow. It is anticipated that it would unlock annual synergies of up to around $200 million while creating further long-term synergies from a combined capital-spending program. The acquisition of MEG would add its considerable net oil reserves of over two billion barrels to Husky’s 1.6 billion barrels, giving the combined entity reserves totaling an impressive 3.8 billion barrels. Based on 2018 guidance, the addition of MEG’s forecast production of 88,000 barrels daily to Husky’s expected output would expand the new entity’s production to over 420,000 barrels daily.
A key aspect of the deal is that MEG would be able to access Husky’s infrastructure and expertise, which would help to ease the burden of the deep discount applied to the bitumen produced at its Christina Lake SAGD asset. The significant differential between Canadian heavy oil known as Western Canadian Select (WCS) and the North American benchmark West Texas Intermediate (WTI) has been weighing on oil sands companies like MEG for some time. In recent months, the price of WCS has diverged substantially from WTI to see it trading at a hefty discount of around a 44%. Any initiatives that ease this disadvantage will help to boost MEG’s value.
The combined company will be a low-cost operator with a forecast breakeven price of US$40 per barrel, underscoring its profitability in an environment where crude has risen to well over US$70 per barrel.
A key benefit of the deal that should not be overlooked is that the combined entity will have a rock-solid balance sheet with net debt expected to be less than one times forecast 2019 EBITDA. This is crucial to note when it is considered that MEG has battled to rein in debt since the oil slump began because the company was initially built on the optimistic assumption of US$100-a-barrel crude.
So what?
Husky’s bid to take over MEG is likely the start of the next wave of consolidation in the energy patch. While oil has risen sharply since the start of 2018, many Canadian oil stocks have failed to keep pace, which, coupled with the increasingly optimistic outlook for crude, has created an opportunity for cashed-up companies like Husky to opportunistically acquire quality assets. If Husky’s acquisition is successful, it would be a boon for MEG’s shareholders, because there would finally be sufficient resources available to fully develop MEG’s flagship Christina Lake asset.
Fool contributor Matt Smith has no position in any stocks mentioned.