There’s a reason why MKM Partners LLC, Oscar Gruss & Son Inc. and GFI Group Inc. say the market is betting the wrong way on the takeover of Nexen Inc. (NXY)
The oil and gas explorer’s shares have lost 2.9 percent through yesterday since Beijing-based Cnooc (883) Ltd.’s offer was announced on July 23, leaving them 8.5 percent below the agreed price. The difference is the second-largest among proposed North American acquisitions valued at $1 billion or more, according to data compiled by Bloomberg. MKM, Oscar Gruss and GFI said arbitrage traders should view this as a chance to make money because the deal will probably close, driving the stock to the $27.50-a-share bid.
While the majority of Canadians in a survey commissioned by Sun News Network want the government to reject the purchase of Calgary-based Nexen by Cnooc, Natural Resources Minister Joe Oliver said Sept. 4 that Canada needs foreign investment to develop and market its raw materials. Nexen’s Gulf of Mexico operations aren’t “national treasures” that would prompt the U.S. to raise obstacles to the deal, according to MKM, which also said the arbitrage spread is so wide that potential earnings will prove alluring even if approval is delayed.
“I would be a buyer,” Alfredo Scialabba, a New York-based special situations analyst for GFI, said in a telephone interview. “The risk-reward is very attractive. The spread and the market are telling you that there is a 75 percent chance the deal goes through, but we think the chances are higher than that, so we would be a holder of this one.”
Pierre Alvarez, a spokesman at Nexen, didn’t respond to a phone call and e-mail requesting comment. Peter Hunt, a Cnooc spokesman who works for Hill & Knowlton Strategies, didn’t comment on the deal’s odds of success or timing.
“We are respectful of the regulatory requirements across all the respective jurisdictions,” Hunt said in an e-mail. “We are working on all the necessary governmental and regulatory filings to comply with the requirements.”
In July, Cnooc agreed to buy Nexen for $15.1 billion in the biggest overseas takeover by a Chinese company. China’s largest offshore oil and natural-gas explorer said it would pay 61 percent more than Nexen’s prior closing price. About 30 percent of Nexen’s production last year came from its Canadian operations. Its oil and gas assets include production platforms in the North Sea, Gulf of Mexico and Nigeria, as well as oil- sands reserves at Long Lake, Alberta, where it already produces crude in a joint venture with Cnooc.
The deal is subject to review under the Investment Canada Act, which requires foreign takeovers provide a “net benefit” to the country. Six factors are considered, including the effects on employment, competition within an industry, the degree of participation by Canadians in the business and Canada’s ability to compete globally. The Committee on Foreign Investment in the United States, which has Treasury Secretary Timothy Geithner as chairman, will also examine the transaction.
Cnooc has applied for Canadian approval, Interior Minister Christian Paradis said on Aug. 29. The process can take 75 days or longer, putting the results at about Nov. 12 or later. Cnooc has already asked CFIUS to review the transaction, according to Hunt, the company spokesman at Hill & Knowlton.
Canadian Prime Minister Stephen Harper said on Aug. 23 that the combination must serve the long-term interests of his nation. He was responding to a poll from Sun News Network that showed a majority of Canadians surveyed want the government to reject the deal. After he spoke to reporters that day, Nexen’s stock price sank to $25.68, or 6.6 percent less than Cnooc’s offer versus 5.9 percent below at the end of the prior session.
When asked if the deal would be allowed given that Canadian companies face limits on investment in China, the prime minister said that should be scrutinized, though he noted Canada has “significant and growing” investments in China. Oliver, the natural resources minister, reiterated the importance of investment reciprocity when speaking with reporters on Sept. 4. U.S. Senator Charles Schumer, a Democrat from New York, has asked Geithner to block the deal until China gives American companies more access to its market.
While Canada doesn’t want to appear like it’s “rubber stamping” the agreement, the nation “needs foreign capital to develop their resources, especially these particular resources,” Keith Moore, an event-driven strategist at MKM in Stamford, Connecticut, said in a phone interview. “In the U.S., you still have headline risk because there will be another politician or two who will try to use this as sort of a wedge. But ultimately it’s not a national treasure. Ultimately this deal gets the approvals.”
Canada rejected Melbourne-based BHP Billiton Ltd.’s hostile $40 billion bid for Potash Corp. of Saskatchewan Inc. in 2010, one of only two acquisitions blocked by the net-benefit rule. To help appease Canadian regulators, Cnooc pledged to locate its North and Central American headquarters in Calgary, retain Nexen’s current employees and management, enhance the company’s planned capital expenditures in Canada, and expand charitable programs.
The acquisition will provide “significant long-term benefits to Canada,” Cnooc said in a July 23 statement. In a conference call that day, Cnooc Chief Executive Officer Li Fanrong said, “Put simply, we are in Canada to invest.”
Nexen slipped to $25.16 a share yesterday, pushing the spread between the stock price and Cnooc’s offer to its widest point since the transaction was announced in July, data compiled by Bloomberg show. The gap is larger than every agreed takeover in North America valued at $1 billion or more, the data show. Only the unsolicited proposal for Best Buy Co. from founder Richard Schulze has a bigger spread.
Today, Nexen shares rose 1.6 percent to $25.50, the biggest increase since the deal was announced.
Harper is mulling Cnooc’s deal as Bank of Nova Scotia continues to await Chinese approval to close its purchase of Bank of Guangzhou. The prime minster raised the issue with China’s Premier Wen Jiabao in February.
The holdup underscores challenges Harper faces as his government reviews the offer for Nexen. His decision may be a pivotal moment in relations between the two countries as Canadian companies look to establish themselves in the world’s second-biggest economy, and as China seeks access to Canada’s natural resources.
“China is a huge market for Canada, and it’s a huge potential partner that can help Canada in a same way that Canadians can help China,” Charlie Fischer, who was Nexen’s CEO until 2008, said in a phone interview. “If we want to be able to exploit those assets, we need to have really large and strong pools of capital to be able to do it.”
Nexen shareholders risk losing money if regulators block the transaction. The stock was valued at $17.06 the day before Cnooc’s offer. GFI’s Scialabba estimates it could fall to $18.20, about $7 less than yesterday’s closing price.
“Whenever you have a Chinese buyer involved, there’s uncertainty,” he said. “Definitely people are kind of scared” that the acquisition could be scuttled.
Still, the market is implying 80 percent odds that the deal will get done, according to Jefferies Group Inc.’s Ted Chen, an event-driven strategist in New York.
“It’s not a bad risk-return to play,” Chen said in a phone interview. “This is a logical deal for Canada to approve.”
Traders can make a 29 percent annualized return if the takeover is completed by year-end, data compiled by Bloomberg show. Even if it’s delayed to the end of March, the gain would be about 16 percent on an annualized basis, the data show.
“If for any reason the closing was delayed to March 2013, then we would still have an attractive return because the spread is so large,” Scialabba said.
Bill Kavaler of Oscar Gruss agreed that Nexen is offering an opportunity that’s too good to pass up.
“It’s a buy,” Kavaler, a New York-based special situations analyst at Oscar Gruss, said in a phone interview. “It’s very complicated in terms of the regulatory issues” he said. Still, Nexen doesn’t “qualify as a national strategic asset, so it will be approved.”