Equal Energy & The Theater Of The Absurd
For those who have been following developments at the Canadian O&G producer Equal Energy (EQU), the situation certainly resembles the famous play "Waiting for Godot" by Samuel Beckett; for those who don't know the play, here is the plot summery from Wikipedia:
Waiting for Godot follows a pair of men who divert themselves while waiting expectantly, vainly for someone named Godot to arrive. They claim he's an acquaintance but in fact hardly know him, admitting that they would not recognize him when they do see him. To occupy the time they eat, sleep, converse, argue, sing, play games, exercise, swap hats, and contemplate suicide - anything "to hold the terrible silence at bay"
I would say the description above couldn't be more apt; in the case of Equal Energy, Godot would be the conclusion of the strategic review announced by the company on May 3rd. Just like the two protagonists above, Equal's shareholders hardly know Godot since they have no clear idea how or when Equal Energy will conclude its review, even though the review is well past its 5th month.
Glimpse of Godot?
Unlike the play however, for Equal shareholders there seems to be a ray of light as the company did announce two minor transactions that appear to be the first steps toward a more comprehensive conclusion:
The first transaction was announced on September 24th; it concerned the sale of the company 50% JV interest in its Mississippian acreage to its JV partner Atlas Resource Partners (ARP) along with its Northern Hunton production for a total consideration of $40m.
The second transaction was announced on October 1st; it concerned the sale of the company Viking & Clair oil production along with the transfer of $22m in abandonment liabilities for impaired assets in British Colombia and Saskatchewan for a total consideration of $17.4m.
Both of the above transactions were quite complicated and have certainly not impressed the market, despite the fact that they have significantly strengthened the balance sheet, and most importantly they have positioned the company to achieve a proper conclusion to the review process by eliminating legacy liabilities and further focusing the asset base.
The respective transactions press releases, however, did contain two conflicting messages in regards to the direction of the strategic review. On Sept 24th, the company mentioned that it is retaining its core Central Oklahoma acreage, and it is turning its attention to the Canadian portfolio:
The Strategic Review is ongoing and management and the Special Committee of the board of directors continue to make progress as we turn our focus to Equal's Canadian strategy and potential transactions that we believe will further benefit our shareholders.
On October 1st, along with the announcements of the disposition of some of the Canadian assets, the company had this to say in its press release:
The Asset Disposition is the second step in Equal's ongoing strategic review process. Equal's management and Special Committee of the Board of Directors continue to review opportunities with the Company's portfolio which now consists primarily of the Cardium oil play in the Lochend area of Alberta, certain royalty interests in Canada and the liquids rich natural gas asset in Central Oklahoma.
The above message seems to suggest that the Central Oklahoma asset is back "in play" and investors should expect developments that would have an impact on this asset once the review is concluded. Another difference: the October 1st press release did not include comments or opinions by the company's CEO, Mr. Don Klapko, another positive sign that may indicate that the Special Committee under the leadership of Mr. Dan Botterill is enforcing shareholders demands of a radical outcome at the conclusion of the review process.
Shareholders Letter
Following the Sept 24th press release highlighting the possible retention of the core Hunton acreage, dissident shareholders representing approximately 18.5% of Equal Energy outstanding shares sent a letter to the Chairman requesting the following:
- The full disposal of the company Canadian oil and gas portfolio.
- Subsequent to the disposal, the initiation of a buyback through a "tender offer" of 30%* of the company's outstanding shares.
- The transfer of the company core central Oklahoma Hunton oil & gas assets in a tax efficient mutual fund trust structure, or a Master Limited Partnership.
- The initiation of a cost cutting plan and a cap on executive pay post Trust conversion to bring Equal Energy's "bloated" cost structure in line with its peers.
- The initiation of a dividend reinvestment plan (DRIP).
- The payment of a monthly distribution, subject to increase in the case of continued increase in natural gas and natural gas liquids prices.
*This has been subsequently adjusted to 15% in our models in light of the October 1st press release and the transfer of the impaired assets decommissioning liability.
It was highlighted in the letter that dissident shareholders reserve the right to initiate a formal challenge to the legitimacy of the board of directors should they fail to heed shareholders demands.
The rationale for the letter
In the shareholders' opinion, Equal Energy has pursued a flawed corporate strategy since its decision to convert into a growth E&P company on January 18th 2010, under the leadership of its current CEO, Mr.Don Klapko.
Equal Energy's management has been unable to deliver meaningful growth under its corporate growth strategy, nor have they been able to stipulate a long term vision for the company. Meanwhile its failure to deliver results have caused Equal Energy's shares to decline by 60% since the decision to convert into a growth entity, against a decline of 13% in the S&P Capped Energy Index.
The core Oklahoma Hunton asset, which today presents 94% of the company production, is ideally suited for an income structure, the balanced production profile of the asset (48% Liquids, 52% Natural Gas) and its slow decline profile makes it an excellent candidate to offer steady dividend distributions to the "long suffering" Equal Energy shareholder base.
Equal's oil weighted Canadian assets, while attractive, don't fit with the company's core production base. Meanwhile, a disposition of those assets would permit Equal Energy the financial flexibility to buy back a significant portion of its outstanding shares at a substantial discount to net asset value, thus making such a buyback extremely accretive, while allowing the company to maintain prudent leverage parameters.
Equal's shareholders welcomed the initiation of a strategic review on May 3rd 2012; however, Equal Energy continues to trade at a substantial discount to its Canadian and US listed O&G peers. Efforts to unlock value through the disposition of the company's Mississippian acreage - an acreage position that was the result of a fortuitous discovery and not due to management acumen - was clearly insufficient to unlock shareholder value and falls short of meeting shareholders' expectations.
What's next for Equal Energy?
The October 1st press release seems to have reintroduced the prospect of a corporate transaction for the totality of Equal's assets in cash or in shares once the remaining Canadian assets are divested. Shareholders are generally not opposed to such an outcome, should it take place at a proper valuation. Meanwhile, the company does have a viable option to pursue a trust conversion. The trust model continues to gain ascendance in Canada with the recent IPO of Argent Energy Trust and the recent filing of the 4th such an IPO; Meranex Energy Trust.
In light of the October 1st Viking/Clair disposition, and assuming at least $45m in dispositions for the reminder of the Canadian assets, an Equal Energy Trust can distribute 63c per year based on modest long term energy price assumptions of $87 WTI, NGLs at 40% of WTI and NG at $4 Mcf. Utilizing the trading multiples of Trusts of this nature and this size, such a Trust would likely trade at a 10% yield or $6.3 per share (90% above current levels).
It is highly probable that Equal Energy will conclude its review in the near future by either a disposition of the Canadian assets, the initiation of a substantial buyback and the conversion into an income entity; or the disposition of the Canadian assets followed by a corporate transaction inclusive of the company's remaining US assets. In either scenario Equal Energy will likely trade at a much higher valuation and materially change the future of its asset base.
Godot may show up after all!
Nawar Alsaadi is an independent investor with a background in finance & marketing; his investment philosophy is focused on value growth or special situation investing based on profiting from dislocation in assets prices caused by behavioural factors.
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