Penn West Breakup Seen Returning $3.7 Billion: Real M&A

Penn West Petroleum Ltd., the Canadian oil producer that recently overhauled management, is poised to boost a valuation that’s more depressed than 99 percent of peers by breaking up.

Penn West named a new chief executive officer and board leadership and last week said it will explore options to increase returns after a two-year stock plunge left the energy company trading at a 42 percent discount to book value. The C$5.1 billion ($5 billion) company’s assets should be valued at as much as C$18.20 a share, 73 percent more than its closing price yesterday, according to three analyst and investor estimates compiled by Bloomberg.

To boost its languishing shares, Calgary-based Penn West could split into two companies -- one focused on assets with greater growth potential and another that could entice investors with its dividend payouts, Stifel Financial Corp. said. Asset sales or joint ventures may be more likely, according to Macquarie Group Ltd., while shareholder Leon Frazer & Associates said the company could even be a takeover target.

“They’re going to have to do something because standing still is not going to work for them,” Cristina Lopez, a Calgary-based analyst at Macquarie, said in a telephone interview. Penn West “has a wide-ranging grouping of assets. There are so many possible and plausible scenarios.”

New Management

Penn West said last week it would cut staff by 10 percent and trim its dividend as it seeks to reverse stock losses that wiped out C$5.7 billion in market value in two years. The company is also replacing retiring CEO Murray Nunns with David Roberts, the former chief operating officer of Marathon Oil Corp., and exploring alternatives including asset sales, joint ventures and other business combinations.

“Penn West has many high-quality assets, but the company has yet to unlock their complete value,” Rick George, the former head of Suncor Energy Inc. who was named Penn West’s chairman last month, said in a June 4 statement.

“We’re going to look at every single option,” George said a day later after the company’s annual meeting, when asked whether Penn West is for sale.

Clayton Paradis, a spokesman for Penn West, declined yesterday to comment on the review beyond George’s statements.

Losing Streak

The energy company has reported three consecutive unprofitable quarters, the worst streak of losses since at least 1992, according to data compiled by Bloomberg. Free cash flow has been negative in nine of the last 10 quarters.

Penn West is burdened with almost C$3 billion of debt and production “is actually declining,” Dirk Lever, a Calgary-based analyst at AltaCorp Capital Inc., said in a phone interview. “That’s a problem.”

After its stock drop, the company is trading at 0.58 times its book value, according to data compiled by Bloomberg. Among North American exploration and production companies valued at more than $1 billion, only Lightstream Resources Ltd. has a lower multiple, the data show.

Today, Penn West rose 3.7 percent to C$10.90, the most in more than a month. It was the biggest gain in the S&P/TSX Energy Index and the second-biggest advance among stocks in the broader S&P/Toronto Stock Exchange Composite Index.

Penn West should be valued at as much as C$18.20 a share, based on the average of three analyst and investor estimates for net asset value. That would equate to C$8.8 billion, which is C$3.7 billion ($3.7 billion) more than yesterday’s market capitalization.

Restructuring the company by selling or spinning off assets should unlock some of that value for shareholders, said Gordon Tait, a Calgary-based analyst at BMO Capital Markets, a division of Bank of Montreal.

Refocusing Efforts

“The parts are worth more than the sum at this point,” Tait said in a phone interview. There are “some assets in the company that Penn West realistically wouldn’t be able to add a lot of value to that maybe someone else could. That way, they can focus their attention and their efforts on the properties where they have some kind of a comparative advantage.”

Separating Penn West into two businesses, with one focused on assets with growth potential and the other on properties whose predictable production would allow for an attractive dividend “would be a good idea,” according to Michael Zuk of Stifel.

The dividend-driven division could include stable developments such as the Viking and Spearfish formations, while Penn West’s acreage in the Cardium formation, where the company is using enhanced oil-recovery technology to boost production, would fit into a growth-oriented business, Zuk said.

“If they did do that type of split, that would be received well,” the Calgary-based analyst said in a phone interview.

Debt Complication

Still, Penn West’s debt would need to be allocated among the businesses in a breakup, and that might complicate a split, said Sam La Bell, a Toronto-based analyst at Veritas Investment Research Corp. Selling assets or forming a joint venture may offer simpler ways to boost shareholder value, he said.

Penn West’s resources in the Cardium region could potentially be sold, La Bell said in a phone interview.

Acreage in the Duvernay shale development in Alberta also could be attractive to a buyer, according to Jim Hall, chief investment officer at Calgary-based Mawer Investment Management Ltd., which oversees more than C$16 billion, including Penn West shares.

“Penn West has a big portfolio, so there are lots of pieces that might be better off in someone else’s hands,” Hall wrote in an e-mail. “I don’t think Penn West gets any value for its Duvernay assets.”

Possible Proceeds

Assets including the Duvernay shale position and half of Penn West’s acreage in the Cardium region could be valued at about C$1.2 billion in a sale, Greg Pardy, a Toronto-based analyst at Royal Bank of Canada, estimated in a June 6 note to clients.

The company has already been shopping its 155,000 net acres in the Duvernay, with TD Securities handling the process, said Paradis, the Penn West spokesman. He declined to comment on whether the company had received any interest in the asset from potential buyers.

Penn West could attract bidders for the whole company, according to Ryan Bushell, who helps oversee C$2.1 billion, including Penn West shares, at Leon Frazer & Associates.

“It’s not necessarily the strong players that get taken out,” the Toronto-based money manager said in a phone interview. “Would we be surprised to see someone step in? We probably wouldn’t be.”

Asset Glut

Still, as energy companies flood the market with assets following a decline in natural-gas prices to a 10-year low last year, there may not be sufficient appetite for the entire company, according to Macquarie’s Lopez. Asset sales or joint ventures “may actually end up being the only step that they can undertake,” she said.

Even so, just slimming down the company -- whether by spinning off units or divesting assets -- should benefit shareholders, said Tait of BMO.

“There’s more value in selling off some pieces and concentrating on the areas where you think you really do have economies of scale or some knowledge that you can bring that makes you a top-notch operator,” he said. “At the end of the day, I would like to think that they will leave themselves some good assets that have lots of upside.”

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