PEY CKE Merger ? - Major benefits for both. Here is my last take on this subject -this posted to the Peyto board this morning
"So the dividend has been cut - an event much anticipated (and even encouraged) by many on this board. Much blame for this is pointed at pipeline capacity - but this is not the only challenge that Encana faces - its long term problem is the anemic price for dry natural gas. Supply and demand are in a tight balancing act - the slightest change in one can be quickly met with an appropriate response by the other. Dry gas prices could be range bound for years. And there in lies the challenge facing Peyto. It has all its eggs in this single basket. Contrast the pessimism that pervades the Peyto reports to the enthusiasm one can find in the reports of Encana. The difference is simply because Encana has condensate in its basket. Peyto’s Deep Basin production contains about 9% NGL (of which 75% is light oil). Contrast that with Encana Montney operations which have a 25% NGL of which 85% is condensate.
The great thing about condensate is that demand is local - the Canadian oil sands - and that demand far outstrips supply. Canada is an net importer. The current price is $77 a barrel and steadily rising. The present and predicted market is, in fact, so strong that Encanna is focussing it entire Canadian capital expenditure this year on increasing its condensate production in Montney.
The pipeline bottleneck should taper off in 2018 - but the dry natural gas supply/demand problems could endure for years. What Peyto needs right now is some meaningful diversification.
Peyto is not the only woofer in my energy portfolio and not the only gas stock down in the doldrums. There is also a penny stock called Chinook Energy - CKE. I like them both and intend hanging onto each through thick and thin. But the more I look at them - and the unique problems each face - the more certain I become that a merger between this senior and junior producer could be a marriage made in heaven.
Following three years in which it divested itself of some widely dispersed energy interests, CKE, now debt free, settled down to focus the development of its remaining holding - 43,809 acres of multi stack rights on the eastern boundary of the Montney fairway - the condensate rich area. Over the last two years CKE has drilled 13 frac wells and end 2017 production was slated for 6,300 boed. All was going well until processing and shipping problems, which effected the whole of Montney - put the brakes on sales and consequently cash flow.
CKE problems well illustrate the problem beset all small fish in a big pond. Lack of negotiating power. That is where a merger with PEY will score. PEY existing transportation committments for the first quarter and their muscle to secure further capacity in 2018, could ensure the continued expansion of CKE condensate program. Thats not all. Encana has had tremendous sucess using the same multi stack technique, which PEY mastered in the deep basin, in the Montney shallow basin. So add to the benefits of a merger, PEY expertise to more fully exploit the condensate riches of the Montney.
But as Steve Jobs would have said - there is just one more thing. By my calculation a merger could add up to $100 million to PEY cash balances in the first year - sufficient to enhance the share repurchase program or even perhaps reinstate the 11c dividend. Heres how.
PEY has budgeted for first half 2018, $150 million for 20,000 boe/d of added production. CKE could supply 6,300 of that production - a savings of $50 million. Using a net back of $15 boe/d, those 6,300 boe/d could add $34 million to the bottom line in the first year of the merger. Finally CKE has 11 locations that could be drilled off existing tied-in pads. Estimated cost to develop each well is $4.7 million with an anticipated production of 680 boe/d a well. PEY estimates their average cost to develop a new well in the Deep Basin ranges from $7,500 to $10,000 a boe/d. Bottom line, assigning 11 of their proposed 2018 wells to Montney could save them about $11 million and deliver more profitable wells to boot. Finally add to all that economies of scale, added revenues from condensate sales, savings in administration costs - and savings could easily reach $100 million.
The only cost to PEY of the merger would be the additional dividend to CKE shareholders. Based on my suggested merger terms of 1 PEY share for every 22 CKE shares, this would require issuance of roughly 10 million shares. Pricing these at $13.50 a share would put a value on CKE of $135 million and its shares about 0.62c. Added cost of the 6c dividend would $7.2 million. Dilution to PEY stock would only be about 6%.
PEY has earned for itself over the years a very loyal following of investors - me included. What I think most of us like about this stock is the bold, pragmatic, no nonsense and open way management plans its future. Right now PEY is up against a problem not of their own making and endemic to the industry. Peyto in its last announcement recognised the need to diversify. Here hoping they go the whole hog. As a shareholder in both CKE and PEY I, for one, would be right behind them. "