Oil M&A's False Positives: Liam Denning

In a wounded market, M&A can be a healing balm. The sight of battered predators feasting on even more battered rivals warms the coldest of hearts on Wall Street. After all, if insiders have decided it is the right time to buy, then surely the worst is over.

That is one way of reading Suncor Energy’s hostile bid for compatriot Canadian Oil Sands. It just happens to be the optimistic way of reading it.

For one thing, mistiming mergers is something of a specialty in the cyclical commodities sector: Just ask Freeport McMoRan, which on Tuesday re-announced its intention to offload the oil and gas business it largely acquired when crude traded at triple-digit prices.

In Suncor’s case, the timing doesn’t look bad: Canadian Oil Sands’ stock is down by more than 50 percent in the past year, and that includes the bump it got Monday on news of the offer.

The slump in Canadian Oil Sands has sure made it cheap.

That said, Suncor’s rationale for preying on the company now, and the means involved, make it a stretch to argue that the bid signals the bottom in the oil market has been definitively called in Calgary.

Suncor is trying to buy more of an asset that it already knows well. Canadian Oil Sands owns a 37 percent stake in the Syncrude joint venture, where Suncor owns 12 percent.

And Suncor is clearly taking advantage of its partner’s weakness. Its offer of 0.25 of its own shares per Canadian Oil Sands share is the lowest of low balls, and not merely because it was cut from an earlier proposed exchange ratio of 0.32.

Canadian Oil Sands’ existing shareholders would end up owning less than 8 percent of the combined company. That compares with a pro-forma contribution of 15 percent of production, based on the average of the past three years, according to data compiled by Bloomberg. On the same basis, Canadian Oil Sands would have contributed 11 percent of Ebitda, 15 percent of net income, and 10 percent of free cash flow.

The problem for Canadian Oil Sands is its balance sheet: High leverage there leaves it with little at the negotiating table. Net debt north of 2.8 times trailing Ebitda isn’t good with oil prices so low and a recovery uncertain at best.

Suncor is at least paying with stock, so Canadian Oil Sands’ investors would still have exposure to that recovery if and when it happens -- and via a company with a pro-forma ratio of net debt to Ebitda of just 1.2 times.

Equally, though, this offers another reason as to why oil investors shouldn’t read too much into the hostile bid. Suncor’s stock is presumably held already by those banking on an oil price recovery. Oil sands production is among the most expensive forms of supply in the world, so owning shares in those operators is a leveraged bet on crude rallying.

That one set of these investors might now get together with another set proves little beyond the fact that it makes sense for consolidation in this part of the oil patch when prices are so low. So even if another partner in the Syncrude joint venture jumps in with a competing bid, such as Exxon Mobil-controlled Imperial Oil, the potential takeaway for oil watchers still looks limited.

A new entrant would be a different story. But it would be a brave company indeed that decided to play the white knight. Another M&A story on Monday got less attention but arguably had a more significant message for investors.

Bloomberg News reported that Saudi Aramco may be in talks to buy refining and marketing assets from China National Petroleum Corp. This comes just as Saudi Arabia widened significantly the discounts it offers to Asian buyers of its oil. If a deal is in the works, it suggests that Saudi Arabia is escalating its campaign to protect its share of the critical Chinese market from the likes of Nigeria, Iran and Iraq. Even if the Canadians are reshuffling in the sands, the wider context remains a global oil market where heightened competition weighs on prices.

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