The scenario has been set up for winner-take-all, whereby one interested party with clout and enough resources can scoop in and buy one of the prize assets in the oil patch: the royalty assets held by Canadian Natural Resources.
Canadian Natural (CNQ/TSX) said in February – following the acquisition of Canadian assets of Devon Canada – that after combining the royalty assets of Devon with its own, it would do one of two things: either create a new vehicle to provide steady cash flow to its shareholders or monetize the business through a sale “later in 2014.”
The combined business generates about $150-million a year. Put an attractive multiple on it and the entity is worth a good number. And the chances are the market doesn’t accord that value to CNQ.
CNQ’s plans were announced before PrairieSky Royalty, at one stage 100% owned by Encana, filed documents to go public. (The preliminary prospectus was filed in mid-April though there had been talk for months that Encana was planning such a move.)
And PrairieSky was a bonanza: Encana sold its entire stake, in two deals, less than six months apart, and PrairieSky is now a dividend paying company owned in the market. Investors who bought in the IPO have done well (they paid $28 a share) while those who bought in the recent secondary offering are under water.
The success of Encana’s divestiture has got the analysts talking about potential interest in CNQ’s royalty business, if and when they are put up for sale.
This week Shailender Randhawa, a Calgary-based analyst with RBC Capital Markets, weighed in on the merits of two logical bidders: PrairieSky and Freehold Royalties.
And Randhawa saw the merits of both bidders for what he termed “the prize,” which he believes is worth between $1.2-billion and $1.8-billion. He didn’t see many advantages for a “new vehicle” given the overhead costs of running a stand-alone entity.
“PrairieSky ranks as the clear frontrunner from an accretion standpoint given its larger market capitalization, financial flexibility, and premium valuation compared to Freehold,” he wrote.
By Randhawa’s estimates, buying CNQ’s royalty assets would result in 6%-17% “accretion potential at a target acquisition multiple of 10 – 15 times, which would be very rewarding for PrairieSky shareholders.”
As for Freehold, its smaller size (it has a market cap of about $1.8-billion) and lower valuation “place it at a relative disadvantage to PrairieSky, therefore requiring leverage to stay in the running, in our view.”
If Freehold were required to pay a 10 times multiple, Randhawa estimates that Freehold would experience a 4% “accretion potential.” We think it would be difficult for Freehold to compete at higher acquisition target multiples on an unlevered basis,” he wrote, adding that there is “little overlap between Freehold and CNQ’s royalty lands.”
Negatives aside, Freehold does have two advantages:
• It has a large shareholder, CN Pension Trust Funds, which has owned a stake for many years, at last count it had a 27% stake. CN also has direct ownership of other royalty assets.
• It has done deals with CNQ in the past. In 2005, CNQ acquired a 22% stake when it vended in $345-million of royalty assets.
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