Tom Claugus Open Letter from Tom Claugus, President of GMT Capital Corp., for why he Opposes Proposed Acquisition of Pipestone Energy Corp. (TSX: PIPE) by Strathcona Resources Ltd.
September 21, 2023 14:52 ET
| Source: GMT Capital Corp.
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ATLANTA, Sept. 21, 2023 (GLOBE NEWSWIRE) --
After discussions with shareholders and potential suitors for Pipestone I am providing you with my final update before the shareholder vote on the Strathcona Pipestone merger. We remind you that although the shareholder meeting is on Wednesday, September 27th, 2023 the cut-off for providing your proxies to the transfer agent is 10:00 a.m. Mountain Time on Monday, September 25th. Beneficial shareholders may have an earlier cut-off. The Monday deadline is what most shareholders will need to meet. Please feel free to contact our proxy solicitation firm, Morrow Sodali, for assistance with voting logistics at 1-800-607-0088 or 1-289-695-3075. We highly recommend you vote against the proposed merger (preferably by Friday) for the following reasons:
1) The exchange ratio is much too low for Pipestone shareholders. Based on production and cash flow numbers, we believe it represents a minimum 30% dilution, but probably more. We believe the shares will continue to underperform should the deal close.1
a. In our Dissident Circular, we used what we thought was a very generous 5x EV/EBITDA multiple for Strathcona and the combined entity versus a conservative 3.5x EV/EBITDA assumed for Pipestone. Since that time, we have had a number of conversations with other disgruntled shareholders who have convinced us that based on Strathcona’s high levels of debt with a substantial near-term maturity2, and a recent oil sands deal with comparable key metrics to Strathcona3, the multiple could be considerably worse. If the combined company trades at 4x EV/2023 EBITDA, the equity would be valued at $1.804 per share.5 In contrast, Pipestone standalone would be valued at $4.06 per share (assuming 4x EV/2023 EBITDA multiple).5
b. The only way this merger works for the average Pipestone shareholder is if you assume a significantly higher multiple for the combined entity. We think the most relevant comparable companies post-merger would be Crescent Point Energy, which trades at ~3.5x, and NuVista Energy, an adjacent Montney property, which trades at ~4x. We now think the combined entity would likely trade at ~3.5x to ~4x EBITDA.6 We would be happy to share the thought process behind our valuations should you give us a call.
2) The share overhang will be enormous with Strathcona owners and Riverstone holding ~90% of the combined company. We believe post deal closing, both entities are sellers.
3) I believe there are numerous parties interested in bidding for Pipestone, but they are dissuaded by the Riverstone lockup, termination fee and Strathcona’s right to match any superior bids. The Pipestone Circular itself mentions a recent rival offer but disclosed no details about the offer. Ask yourself why that might be? Since this deal was announced, I have personally talked to CEOs of four other companies that are interested in making an offer. All of them have processing assets and producing acreage near Pipestone and significantly more operational synergies and stronger balance sheets/low debt levels than Strathcona. I believe that should this deal be voted down, these companies would emerge as bidders at price levels significantly above the Strathcona deal. Also, three of them expressed a willingness to structure a deal that would be part cash and part stock. The cash portion would eliminate a significant part of the overhang from the Riverstone funds that we believe desire an investment exit. In addition, all four of these companies are publicly traded already, and have significantly more liquidity than Pipestone, so trading in their shares after a deal should be much better.
4) I believe the market for oil and gas deals in Calgary should improve rapidly from here for a few reasons. First, oil prices have rebounded while at the same time multiples have expanded a turn. With the large North American LNG expansion and tightening inventories (coupled with ample demand for LNG abroad), natural gas prices should also rebound in the next year. In addition, recent Montney and Duvernay land sales have come at prices of $1 million to $4 million per section, up materially from just a few months ago. As the availability of drill ready inventory tightens, prices may reach levels of 20% of capital invested. Since Pipestone will probably have capacity for six wells a section with capital of $42 million per section, one could see land values hit $8 million to $14 million per section. With 140 sections that are half undeveloped, the acreage alone could easily be worth half the current deal value.
5) There are a number of value-add initiatives that Pipestone could undergo including delineation of the eastern half of the acreage, finding a way to manage the H2S, and securing more and better priced takeaway capacity. For these reasons and the improving oil and gas market we believe the best strategy is to run Pipestone standalone for a couple years to cleanse the psychology of the low deal price, improve operations, and then sell into a much stronger market. With Pipestone’s strong free cash flow and low debt, it does not need to sell itself to generate returns for shareholders. But to be clear, we would be supportive of a deal to sell the company if a strong offer emerges in the near term.
6) Pipestone drilled two wells in the southeastern corner of their acreage that we thought would be connected and producing by now. These are offsetting some extremely prolific Crescent Point Energy wells. We expect they could prove up significant value in the eastern half of the acreage. Why didn’t the Pipestone Board defer the sale to see how these wells perform and why is it taking months to connect them?
7) The carbon intensity that Strathcona has on its heavy and thermal oil assets is massively greater than Pipestone’s Montney assets. This sale would be a large step backwards for Pipestone from an ESG perspective.
8) Lastly, the Pipestone board, in its rebuttal of our Dissident Circular, tried to sell a narrative that essentially everybody supported the deal. I would point out that most of those supporting actors are getting paid cash from the deal, including the underwriters, rating agencies, firms providing fairness opinions, management team, and board members. In particular, I emphasize that the equity incentive awards awarded to management and the board over the years for their service to Pipestone are not being paid out in Strathcona stock under the proposed deal, which is what they are asking Pipestone shareholders to take. The Pipestone Circular indicates the executive management team and board members will receive $10.7 million in cash payments in exchange for their awards and to go along with the change in control.7 Not a bad goodbye kiss. I will leave it to you to infer whether the board and management think the stock in the combined entity would be a good deal for Pipestone shareholders. I would point out that GMT is paying for the costs of our opposition out of our own pocket. We are not activists. Like many of you, we have been long-term Pipestone shareholders. Again, you can conclude what you will about who is more aligned with your interests.
9) Last but not least, as mentioned earlier, Strathcona is highly leveraged at 2.1x Net Debt/TTM Adjusted EBITDA8. As recently as December 2022, their 2026 bonds traded at 74 cents on the dollar9. They have a $675 million term loan due in just five months in February 2024 and since they have $0 cash as of 6/30/2310, we think they will have to borrow to pay it off. Pipestone by contrast has a Net Debt/TTM Adjusted EBITDA of 0.5x11.
In summary, we think there is almost nothing to like about the Strathcona merger terms. The merger would result in a combined entity that trades at a lower valuation, suffers from a huge share overhang, is dangerously levered, and has a poorer ESG profile. I once again recommend that all Pipestone shareholders vote against the proposed merger. I believe we can create much more value in a standalone Pipestone, and if not it appears to us that there will be a number of suitors at much better valuations. Feel free to call us at 770-989-8250 to discuss any aspect of this transaction.
Pipestone shareholders are encouraged to review our Dissident Circular dated September 15, 2023, which is available on Pipestone's profile on SEDAR+ at www.sedarplus.ca.
For further information or to receive a copy of the Dissident Circular please contact:
GMT Capital Corp.
2300 Windy Ridge Parkway
Suite 550 South
Atlanta, GA 30339
_______________
1 At the current proposed exchange ratio of 8.87% for Pipestone shareholders, in order for Pipestone shareholders to “merely maintain” the pre-deal announcement value per Pipestone share of $2.72 on 7/31/23, Pipestone shareholders have to have a lot of faith that Strathcona, a private company with no publicly traded shares, what we believe to be a weak track record of organic growth and $3.2 billion of net debt (or 2.1x net debt/TTM EBITDA, which is among the highest levels among all publicly traded Canadian E&P’s with an average net debt/TTM of 0.6x), will trade at higher multiples than Pipestone and majority of publicly traded companies in more desirable basins in Canada with strong track records of organic growth and much better balance sheets. Pipestone shareholders also have to hope that Strathcona, which had $0 cash as of 6/30/23 and only generated $187.1 million of free cash flow in the first half of 2023, will be able to pay off or refinance $675 million of bank term loans due five months from now in February 2024. Strathcona bondholders also appeared to be concerned as the bonds traded as low as 74% of par value as recently as December of 2022. Sources: (i) Management Information Circular filed by Pipestone on SEDAR+ on August 28, 2023 ("Pipestone Circular"). (ii) Strathcona’s Net Debt is calculated as long-term debt, minus total current assets (excluding risk management assets), plus total current liabilities (excluding lease and other obligations and risk management liabilities) as of 6/30/23, which is in line with Pipestone’s methodology for calculating net debt. (iii) Net Debt/ Trailing Twelve Month ("TTM") Adjusted EBITDA for Strathcona calculated as Net Debt of $3.2 billion as of June 30, 2023, divided by Adjusted EBITDA for trailing twelve months as of June 30, 2023 of $1.5 billion. (iv) Average Net Debt/TTM EBITDA for 31 Canadian publicly traded oil and gas companies with market capitalizations ranging from $500 million to $92 billion calculated based on information available on Bloomberg. (v) Strathcona’s December 2022 bond price based on information available on Bloomberg.
2 Source: Pipestone Circular.
3 To give you an example of just how poorly this deal could potentially turn out for Pipestone shareholders, consider the recent valuation datapoints from the Suncor/TotalEnergies Canadian oil sands deal announced in April 2023 where Suncor announced it will acquire all of TotalEnergies’ Canadian operations for $5.5 billion in cash and $600 million in contingent payments. TotalEnergies disclosed in a September 2022 presentation that these operations were expected to generate more than $2.0 billion in operating cash flows in 2022. This compares to Strathcona who generated $1.8 billion in Adjusted EBITDA in 2022 (Adjusted EBITDA is generally comparable to operating cash flows except for G&A – which was $68.8 million for Strathcona in 2022). Other key metrics are very similar – TotalEnergies’ Canadian operations produces 135 MBOED and has 2.1 billion BOE of proved and probable (“2P”) reserves compared to Strathcona’s 144 MBOED of production and 1.7 billion BOE of 2P reserves. Assuming the combined company trades at the multiples of key metrics implied by the recent Suncor/TotalEnergies deal, Pipestone shareholders could see as little as $0.56 to $1.51 per share should this deal with Strathcona go through at the proposed exchange ratio of 8.87% for Pipestone shareholders. Sources: (i) April 26, 2023 press release from the Suncor Energy company website at https://www.suncor.com/en-ca/, (ii) “Investor Day: 2022 Strategy and Outlook, 2022 Strategy and Outlook” presentation dated 9/28/22 from the TotalEnergies company website at https://totalenergies.com/, values converted from USD to CAD for ease of comparison, and (iii) GMT Capital estimate, see footnote 5.
4 Unless otherwise indicated, all references to $ set forth in this document are to Canadian dollars and all references to US$ set forth in this document are to US dollars.
5 Source GMT Capital estimates: equity value calculated as enterprise value less net debt, based on September 14, 2023 NYMEX strip prices for oil and gas; equity value per share for Strathcona standalone calculated as equity value of Strathcona standalone divided by 2,872,345,233 shares (which is calculated by dividing Pipestone’s current share count of 279,638,000 by 0.0887, and multiplying the resulting number by 0.9113); equity value per share for Pipestone standalone calculated as equity value of Pipestone standalone divided by the current Pipestone’s share count of 279,638,000 shares; equity value per share for the combined company calculated as equity value of combined company, divided by 3,151,983,233 shares (which is calculated by dividing Pipestone’s current share count of 279,638,000 by 0.0887). We have done this calculation to make equity values per share for the deal easier to compare from the perspective of Pipestone shareholders.
6 Source: Bloomberg.
7 Source: Based on information provided in the Pipestone Circular. See Section “Pipestone Incentive Securities” on page 61. Calculated by adding $7.8 million in cash consideration to be paid to the executive management team and the board members for Pipestone Incentive Securities and $2.9 million of Pipestone Change of Control Payments to be paid to the Pipestone executive officers.
8 Strathcona’s Net Debt is calculated as long-term debt, minus total current assets (excluding risk management assets), plus total current liabilities (excluding lease and other obligations and risk management liabilities) as of 6/30/23, which is in line with Pipestone’s methodology for calculating net debt. Net Debt/TTM Adjusted EBITDA for Strathcona calculated as Net Debt of $3.2 billion as of June 30, 2023, divided by Adjusted EBITDA for trailing twelve months as of June 30, 2023 of $1.5 billion.
9 Source: Bloomberg.
10 Source: Pipestone Circular, see Condensed Consolidated Interim Financial Statements for the Three and Six Months June 30, 2023 and 2022.
11 Net Debt/TTM Adjusted EBITDA for Pipestone calculated as Net Debt of $172.394 million as of June 30, 2023, divided by Adjusted EBITDA for trailing twelve months as of June 30, 2023 of $344.0 million (which is calculated as Adjusted EBITDA for the full year 2022, less Adjusted EBITDA for the first six months of 2022, plus Adjusted EBITDA for the first six months of 2023). Sources: (i) Pipestone August 9 Press Release; (ii) Press Release filed by Pipestone on SEDAR+ on March 8, 2023.