What value does Suncor see in Canadian Oil Sands?

One of the most surprising aspects of the current downturn in oil prices has been the lack of major M&A deals thus far. That slow deal flow is largely a result of the spread between bid and ask prices, which in turn is due to a sharp difference of opinion on where oil is going from here. Many current investors in oil stocks are still expecting an imminent recovery in oil prices at least back to the $70 or $80 level. In contrast, parties offering financing either in equity or debt are valuating firms based on a slow recovery of prices that could take years.

As the current share prices in most oil companies show, the market broadly is not siding with the optimists. Yet, investors in oil companies loathe to sell their shares at what many see as a predatory price. The on-going battle between Suncor and Canadian Oil Sands (COS) illustrates this reality. Canadian Oil Sands is a weak company that has consistently missed many quarterly targets and is focused on one of the least attractive areas of the oil patch at current prices. In short, it is exactly the kind of company that is in the most trouble in the current macro environment.

Canadian Oil Sand’s stock reflects this reality. From January 2014 to October 2015, the company’s stock price fell from roughly $17 a share to around $5 a share. Then in October, competitor Suncor announced an interest in taking over COS. The takeover offer along with the lower price of oil has spurred COS’s management to start trying to make improvements at the company like cutting the capex budget and improving efficiency, but the reality is that at this stage in the oil price cycle, companies like COS just need to find a way to hang on if they can.

At this point, COS shareholders are actually lucky to have Suncor’s offer. Without that offer, Canadian Oil Sand’s stock would likely be much lower with little imminent prospect of recovery. The point of contention here is that many COS shareholder’s simply view SU’s offer as opportunistic. They would prefer to wait out the oil price cycle and hope that COS can eventually capitalize on a higher price.
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It’s unclear if that view is realistic or how long it will take before many of COS’ projects are consistently profitable again. Some Canadian Oil Sands shareholders are outspokenly opposed to Suncor’s offer. Canadian businessman Seymour Schulich is one prominent example. The businessman says he owns 5 percent of Canadian Oil Sands but has said consistently that he won’t tender his shares at current prices and is instead holding out for a better offer. It’s unclear if Suncor would be willing to raise its bid though, and the company appears to be confidentit will get the tender numbers it needs by this Friday’s deadline despite some evidence of retail investor opposition.

At this point it’s impossible to say if Suncor’s offer will go through at current prices. While a vocal minority of shareholders are opposed to the deal, institutions clearly own most of the shares and have been largely silent. The broader point though is that the SU-COS fight is a representative microcosm of the entire oil sector, and especially in Canada.

Many oil companies are not making a profit at current prices, and almost all have been forced to dramatically curtail exploration and in some cases cut dividends. If oil prices continue at the current level, there will likely be many bankruptcies in the oil patch in the next two years. Investors in oil companies are essentially betting that the world economy will heat up and that the Saudi-Iranian rivalry will not be enough to continue the current oil glut. Those assumptions are very risky, and investors who are not confident in them should look seriously at any opportunity for efficiency gains at any company they own including synergies related to M&A deals. The world has gotten a lot tougher for oil companies and investors, and there is little evidence that is about to change soon.

By Michael McDonald of Oilprice.com