Canada’s largest integrated energy company, Suncor Energy Inc. (TSX:SU)(NYSE:SU), has made it clear that it intends to take advantage of distressed asset prices in the patch. The company made an unsolicited all-stock takeover bid for the single largest investor in the Syncrude project, Canadian Oil Sands Ltd. (TSX:COS).
However, despite Suncor’s bid representing an approximate 43% premium to Canadian Oil Sands’s closing share price prior to its announcement, I believe that it significantly undervalued the company.
Now what?
Suncor’s bid valued Canadian Oil Sands’s outstanding shares at $4.3 billion, or about $8.87 per share, giving a total value of $6.6 billion to the bid once its net debt of $2.3 billion was included. Once we consider that Canadian Oil Sands holds a 37% stake in the Syncrude project, it becomes apparent that this offer was opportunistic and inadequate.
Canadian Oil Sands has net oil reserves of 1.4 billion barrels of oil with an estimated production life of over 46 years. Such a long production life is almost unheard of in the oil industry, and is one of the most attractive features of the Syncrude project. This is because it gives a considerable amount of time for oil prices to recover and to pay development costs.
At the end of 2014, these reserves were independently valued at just over $9 billion after income taxes. After deducting Canadian Oil Sands’s net debt of $2.3 billion, this gives them a value of about $14 per share. This is about 60% higher than Suncor’s offer.
While the valuation was conducted using an average price of US$89 per barrel over a 10-year period, all future cash flows were discounted by 10%, and there are a range of indicators that show that oil will appreciate in value over that period.
You see, the International Energy Agency estimates that daily global oil output will drop by 500,000 barrels in 2016, while demand will grow by 1.4 million barrels, thus reducing the global surplus and pushing oil prices higher.
Another indicator that Suncor made a low-ball bid was the recent statements by Canadian billionaire Seymour Schulich, who owns about 5% of Canadian Oil Sands’s outstanding shares. He publicly stated that he would not accept Suncor’s offer and believes that Canadian Oil Sands is worth $20 per share, more than double Suncor’s bid.
Canadian Oil Sands investors also need to consider that the company provides far greater leverage to the price of oil than Suncor. This is because it is a pure upstream, or oil production, play, whereas Suncor is an integrated energy company with operations across oil production, refining, and marketing.
As a result, Suncor offers investors far less leverage to the price of oil because its downstream, or refining operations, actually increase in profitability as oil prices decline. This essentially means that for those investors who remain bullish on the outlook for oil over the long term, Canadian Oil Sands is a far superior bet than Suncor.
So what?
As I explained in an earlier article, the acquisition would certainly be beneficial for Suncor, but it is clear that this was an opportunistic bid that failed to fully appreciate Canadian Oil Sands’s true value and its long-term potential once oil rebounds.
