Is Surge Energy Getting a Good Deal?

The energy producer buys a 20% stake in Longview Oil.

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It still pays to be the only buyer in a buyer’s market. Whether it’s gold mining, copper mining, or energy, certain companies have managed to put themselves in that enviable position. And just last week, we saw yet another example.

On Friday, Surge Energy Inc (TSX:SGY) revealed that it owed a 19.8% interest in Longview Oil Corp (TSX:LNV), and planned to pursue a “business combination”. The revelation was the latest in a chain of events that began at the beginning of February. Advantage Oil & Gas Ltd (TSX:AAV) concluded a strategic review – another way of saying the company was looking to sell itself – that “did not result in an acceptable proposal”. Given the state of the Canadian energy market, such a result was not surprising.

But Advantage needed cash, and it owned over 20 million shares of Longview. So it sold those shares to a banking syndicate at $4.45 per share, raising $94 million. The banks then approached Surge about buying those shares. Surge, which had already done due diligence on Longview’s assets, jumped at the opportunity, buying the shares at the same price.

It appears that Surge got a great deal on the shares. The net present value of Longview’s reserves (10% discount rate after tax) is over $500 million, about $11 per share. Longview’s debt takes that number down to $8.50 per share, but still well above what Surge paid. And that does not even include any cost savings that Surge could achieve from combining the two firms’ operations. Any synergies would only make a combination sweeter.

Surge is now in the driver’s seat. The company would like to buy the rest of Longview, but is under no pressure to do so. If Surge decides to wait, then the company will be collecting a dividend yield of over 10% (based on the $4.45 selling price). And those dividends come tax-free.

Foolish bottom line

Of the three companies, Surge has by far the cleanest balance sheet, with debt equal to only 18% of its market capitalization. This compares to 44% for Advantage and 47% for Longview. It’s no wonder that Surge is in the best position of the three companies. In a buyer’s market like Canadian energy, Surge’s flexibility puts it in an enviable position.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Benjamin Sinclair holds no positions in any of the stocks mentioned in this article.

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