Daylight Energy Trust (DAY.UN-TSX) bought Highpine Oil and Gas (HPX-TSX) on Sunday, August 23rd for $7/share in stock and cash.
Daylight, like most Canadian trusts, is natural gas weighted and has debt. When your production is 72% natural gas, as Daylight was, you cannot afford to have 72% of your production giving you almost no cash flow to service debt, much less have leftover money for drilling and shareholder distributions.
Daylight’s debt was not onerous, but it could have been an issue should natural gas prices remain low through 2010. There are dozens of Canadian listed energy stocks in the same position – gas weighted, and high debt.
Highpine, which had very low debt and was heavily oil weighted in Alberta, should cushion Daylight investors against any lengthy continued downturn in natural gas prices.
While this deal was accretive for Daylight, I suspect management looked around and saw the Highpine acquisition as the cheapest financing they could do to guarantee their distribution payout, keep their bankers happy and support the stock price with a higher oil weighting.
That may sound negative, but it’s not. That’s what management should do for its investors. But for all the talk about “strategic rationale” there was in press releases and analyst reports, this deal was all about the cash flow; oil weighted cash flow going to help a gas weighted producer in case of a prolonged natural gas price downturn.
It was insurance.
If natural gas prices do stay low, Daylight could finance with a dilutive equity issue, but the Highpine acquisition now is basically an accretive financing. Well done.
Analyst reports on the acquisition today varied on valuation. Analysts said Daylight paid Highpine shareholders between $29,000 per flowing barrel-of-oil-equivalent (boe) to $39,000. Daylight trades at about $56,000 per flowing boe.
Highpine traded at one of the lowest valuations in its peer group despite its good balance sheet (no debt until a small amount was added just recently) and oil weighting (60%). But their spotty exploration record in their core Pembina play in Alberta, and permitting issues surrounding their high sulphur content in their wells, hurt them. (Highpine did not need to do this deal; key shareholders clearly believed they will get better value as part of a larger Daylight.)
As contrast, NuVista paid just over $25,000 per flowing boe for natural gas assets recently, and Petrobank paid just over $110,000 for TriStar’s oil assets in the Bakken. So this price doesn’t value the Highpine assets very highly; but again, this is just good insurance for Daylight. If it was even slightly accretive for Daylight the deal makes sense for them.
This transaction increases Daylight’s oil production from 28% – 42%. Institutional investors will like that increased oil weighting more, and management is obviously hopeful that will give DAY.UN an even higher NAV. The new Daylight will have 38,000 barrels of oil per day of production and an enterprise value of $1.8-billion. And a lower debt-to-cash flow ratio.
So if this gas-trust-buying oil-weighted-producer were a trend, who might be next? West Energy (WTL-TSX) is the other oil weighted producer (80% oil, total production=4100 bopd, with another 1000 bopd ready to come onstream) in Canada that also trades at a low valuation – just over $21,000 per flowing boe – despite having an excellent balance sheet (about $90 million in net CASH). So it would make a very accretive financing for another gas weighted trust, or intermediate gas weighted producer. It also has oil properties in the Pembina of Alberta where Highpine operates.
One Canadian research analyst today said a similar Highpine valuation would mean a $2.75 share price for West. With the WTL stock now at $2.40, that is hardly a premium that investors will jump at. However, might a trust trading at $55,000 – $70,000 per flowing boe themselves be willing to up their buyout valuation? Realistically…only if the deal was friendly or it’s not worth it. The insurance premium would be too high.
Daylight found some cheap insurance. It was a smart move. Especially if natural gas prices remain low for a long time.
I do not own any Highpine, Daylight or West.