After discussions with shareholders and
potential suitors for Pipestone I am providing you with my final
update before the shareholder vote on the Strathcona Pipestone
merger. We remind you that although the shareholder meeting
is on Wednesday, September 27th,
2023 the cut-off for providing your proxies to the transfer agent
is 10:00 a.m. Mountain Time on Monday, September 25th.
Beneficial shareholders may have an earlier cut-off. The Monday
deadline is what most shareholders will need to meet. Please feel
free to contact our proxy solicitation firm, Morrow Sodali, for
assistance with voting logistics at 1-800-607-0088 or
1-289-695-3075. We highly recommend you vote against the
proposed merger (preferably by Friday) for the following
reasons:
1) The exchange ratio
is much too low for Pipestone shareholders. Based on production and
cash flow numbers, we believe it represents a minimum 30% dilution,
but probably more. We believe the shares will continue to
underperform should the deal close.1
a. In our Dissident
Circular, we used what we thought was a very generous 5x EV/EBITDA
multiple for Strathcona and the combined entity versus a
conservative 3.5x EV/EBITDA assumed for Pipestone. Since that time,
we have had a number of conversations with other disgruntled
shareholders who have convinced us that based on Strathcona’s high
levels of debt with a substantial near-term maturity2, and a recent
oil sands deal with comparable key metrics to Strathcona3, the
multiple could be considerably worse. If the combined company
trades at 4x EV/2023 EBITDA, the equity would be valued at $1.804
per share.5 In contrast, Pipestone standalone would be valued at
$4.06 per share (assuming 4x EV/2023 EBITDA multiple).5
b. The only way this
merger works for the average Pipestone shareholder is if you assume
a significantly higher multiple for the combined entity. We think
the most relevant comparable companies post-merger would be
Crescent Point Energy, which trades at ~3.5x, and NuVista Energy,
an adjacent Montney property, which trades at ~4x. We now think the
combined entity would likely trade at ~3.5x to ~4x EBITDA.6 We
would be happy to share the thought process behind our valuations
should you give us a call.
2) The share overhang
will be enormous with Strathcona owners and Riverstone holding ~90%
of the combined company. We believe post deal closing, both
entities are sellers.
3) I believe there
are numerous parties interested in bidding for Pipestone, but they
are dissuaded by the Riverstone lockup, termination fee and
Strathcona’s right to match any superior bids. The Pipestone
Circular itself mentions a recent rival offer but disclosed no
details about the offer. Ask yourself why that might be? Since this
deal was announced, I have personally talked to CEOs of four other
companies that are interested in making an offer. All of them have
processing assets and producing acreage near Pipestone and
significantly more operational synergies and stronger balance
sheets/low debt levels than Strathcona. I believe that should this
deal be voted down, these companies would emerge as bidders at
price levels significantly above the Strathcona deal. Also, three
of them expressed a willingness to structure a deal that would be
part cash and part stock. The cash portion would eliminate a
significant part of the overhang from the Riverstone funds that we
believe desire an investment exit. In addition, all four of these
companies are publicly traded already, and have significantly more
liquidity than Pipestone, so trading in their shares after a deal
should be much better.
4) I believe the
market for oil and gas deals in Calgary should improve rapidly from
here for a few reasons. First, oil prices have rebounded while at
the same time multiples have expanded a turn. With the large North
American LNG expansion and tightening inventories (coupled with
ample demand for LNG abroad), natural gas prices should also
rebound in the next year. In addition, recent Montney and Duvernay
land sales have come at prices of $1 million to $4 million per
section, up materially from just a few months ago. As the
availability of drill ready inventory tightens, prices may reach
levels of 20% of capital invested. Since Pipestone will probably
have capacity for six wells a section with capital of $42 million
per section, one could see land values hit $8 million to $14
million per section. With 140 sections that are half undeveloped,
the acreage alone could easily be worth half the current deal
value.
5) There are a number
of value-add initiatives that Pipestone could undergo including
delineation of the eastern half of the acreage, finding a way to
manage the H2S, and securing more and better priced takeaway
capacity. For these reasons and the improving oil and gas market we
believe the best strategy is to run Pipestone standalone for a
couple years to cleanse the psychology of the low deal price,
improve operations, and then sell into a much stronger market. With
Pipestone’s strong free cash flow and low debt, it does not need to
sell itself to generate returns for shareholders. But to be clear,
we would be supportive of a deal to sell the company if a strong
offer emerges in the near term.
6) Pipestone drilled
two wells in the southeastern corner of their acreage that we
thought would be connected and producing by now. These are
offsetting some extremely prolific Crescent Point Energy wells. We
expect they could prove up significant value in the eastern half of
the acreage. Why didn’t the Pipestone Board defer the sale to see
how these wells perform and why is it taking months to connect
them?
7) The carbon
intensity that Strathcona has on its heavy and thermal oil assets
is massively greater than Pipestone’s Montney assets. This sale
would be a large step backwards for Pipestone from an ESG
perspective.
8) Lastly, the
Pipestone board, in its rebuttal of our Dissident Circular, tried
to sell a narrative that essentially everybody supported the deal.
I would point out that most of those supporting actors are getting
paid cash from the deal, including the underwriters, rating
agencies, firms providing fairness opinions, management team, and
board members. In particular, I emphasize that the equity incentive
awards awarded to management and the board over the years for their
service to Pipestone are not being paid out in Strathcona stock
under the proposed deal, which is what they are asking Pipestone
shareholders to take. The Pipestone Circular indicates the
executive management team and board members will receive $10.7
million in cash payments in exchange for their awards and to go
along with the change in control.7 Not a bad goodbye kiss. I will
leave it to you to infer whether the board and management think the
stock in the combined entity would be a good deal for Pipestone
shareholders. I would point out that GMT is paying for the costs of
our opposition out of our own pocket. We are not activists. Like
many of you, we have been long-term Pipestone shareholders. Again,
you can conclude what you will about who is more aligned with your
interests.
9) Last but not
least, as mentioned earlier, Strathcona is highly leveraged at 2.1x
Net Debt/TTM Adjusted EBITDA8. As recently as December 2022, their
2026 bonds traded at 74 cents on the dollar9. They have a $675
million term loan due in just five months in February 2024 and
since they have $0 cash as of 6/30/2310, we think they will have to
borrow to pay it off. Pipestone by contrast has a Net Debt/TTM
Adjusted EBITDA of 0.5x11.
In summary, we think there is almost nothing to
like about the Strathcona merger terms. The merger would result in
a combined entity that trades at a lower valuation, suffers from a
huge share overhang, is dangerously levered, and has a poorer ESG
profile. I once again recommend that all Pipestone shareholders
vote against the proposed merger. I believe we can create much more
value in a standalone Pipestone, and if not it appears to us that
there will be a number of suitors at much better valuations. Feel
free to call us at 770-989-8250 to discuss any
aspect of this transaction.
Pipestone shareholders are encouraged to review
our Dissident Circular dated September 15, 2023, which is available
on Pipestone's profile on SEDAR+ at www.sedarplus.ca.
For further information or to receive a copy of the
Dissident Circular please contact:
GMT Capital Corp. 2300 Windy Ridge
ParkwaySuite 550 SouthAtlanta, GA 30339
_______________1 At the current proposed
exchange ratio of 8.87% for Pipestone shareholders, in order for
Pipestone shareholders to “merely maintain” the pre-deal
announcement value per Pipestone share of $2.72 on 7/31/23,
Pipestone shareholders have to have a lot of faith that Strathcona,
a private company with no publicly traded shares, what we believe
to be a weak track record of organic growth and $3.2 billion of net
debt (or 2.1x net debt/TTM EBITDA, which is among the highest
levels among all publicly traded Canadian E&P’s with an average
net debt/TTM of 0.6x), will trade at higher multiples than
Pipestone and majority of publicly traded companies in more
desirable basins in Canada with strong track records of organic
growth and much better balance sheets. Pipestone shareholders also
have to hope that Strathcona, which had $0 cash as of 6/30/23 and
only generated $187.1 million of free cash flow in the first half
of 2023, will be able to pay off or refinance $675 million of bank
term loans due five months from now in February 2024. Strathcona
bondholders also appeared to be concerned as the bonds traded as
low as 74% of par value as recently as December of 2022. Sources:
(i) Management Information Circular filed by Pipestone on SEDAR+ on
August 28, 2023 ("Pipestone Circular"). (ii) Strathcona’s Net Debt
is calculated as long-term debt, minus total current assets
(excluding risk management assets), plus total current liabilities
(excluding lease and other obligations and risk management
liabilities) as of 6/30/23, which is in line with Pipestone’s
methodology for calculating net debt. (iii) Net Debt/ Trailing
Twelve Month ("TTM") Adjusted EBITDA for Strathcona calculated as
Net Debt of $3.2 billion as of June 30, 2023, divided by Adjusted
EBITDA for trailing twelve months as of June 30, 2023 of $1.5
billion. (iv) Average Net Debt/TTM EBITDA for 31 Canadian publicly
traded oil and gas companies with market capitalizations ranging
from $500 million to $92 billion calculated based on information
available on Bloomberg. (v) Strathcona’s December 2022 bond price
based on information available on Bloomberg.2 Source: Pipestone
Circular.3 To give you an example of just how poorly this deal
could potentially turn out for Pipestone shareholders, consider the
recent valuation datapoints from the Suncor/TotalEnergies Canadian
oil sands deal announced in April 2023 where Suncor announced it
will acquire all of TotalEnergies’ Canadian operations for $5.5
billion in cash and $600 million in contingent payments.
TotalEnergies disclosed in a September 2022 presentation that these
operations were expected to generate more than $2.0 billion in
operating cash flows in 2022. This compares to Strathcona who
generated $1.8 billion in Adjusted EBITDA in 2022 (Adjusted EBITDA
is generally comparable to operating cash flows except for G&A
– which was $68.8 million for Strathcona in 2022). Other key
metrics are very similar – TotalEnergies’ Canadian operations
produces 135 MBOED and has 2.1 billion BOE of proved and probable
(“2P”) reserves compared to Strathcona’s 144 MBOED of production
and 1.7 billion BOE of 2P reserves. Assuming the combined company
trades at the multiples of key metrics implied by the recent
Suncor/TotalEnergies deal, Pipestone shareholders could see as
little as $0.56 to $1.51 per share should this deal with Strathcona
go through at the proposed exchange ratio of 8.87% for Pipestone
shareholders. Sources: (i) April 26, 2023 press release
from the Suncor Energy company website at
https://www.suncor.com/en-ca/, (ii) “Investor Day: 2022 Strategy
and Outlook, 2022 Strategy and Outlook” presentation dated 9/28/22
from the TotalEnergies company website at
https://totalenergies.com/, values converted from USD to CAD for
ease of comparison, and (iii) GMT Capital estimate, see footnote
5.4 Unless otherwise indicated, all references to $ set forth in
this document are to Canadian dollars and all references to US$ set
forth in this document are to US dollars.5 Source GMT Capital
estimates: equity value calculated as enterprise value less net
debt, based on September 14, 2023 NYMEX strip prices for oil and
gas; equity value per share for Strathcona standalone calculated as
equity value of Strathcona standalone divided by 2,872,345,233
shares (which is calculated by dividing Pipestone’s current share
count of 279,638,000 by 0.0887, and multiplying the resulting
number by 0.9113); equity value per share for Pipestone standalone
calculated as equity value of Pipestone standalone divided by the
current Pipestone’s share count of 279,638,000 shares; equity value
per share for the combined company calculated as equity value of
combined company, divided by 3,151,983,233 shares (which is
calculated by dividing Pipestone’s current share count of
279,638,000 by 0.0887). We have done this calculation to make
equity values per share for the deal easier to compare from the
perspective of Pipestone shareholders.6 Source: Bloomberg.7 Source:
Based on information provided in the Pipestone Circular. See
Section “Pipestone Incentive Securities” on page 61. Calculated by
adding $7.8 million in cash consideration to be paid to the
executive management team and the board members for Pipestone
Incentive Securities and $2.9 million of Pipestone Change of
Control Payments to be paid to the Pipestone executive officers.8
Strathcona’s Net Debt is calculated as long-term debt, minus total
current assets (excluding risk management assets), plus total
current liabilities (excluding lease and other obligations and risk
management liabilities) as of 6/30/23, which is in line with
Pipestone’s methodology for calculating net debt. Net Debt/TTM
Adjusted EBITDA for Strathcona calculated as Net Debt of $3.2
billion as of June 30, 2023, divided by Adjusted EBITDA for
trailing twelve months as of June 30, 2023 of $1.5 billion.9
Source: Bloomberg.10 Source: Pipestone Circular, see Condensed
Consolidated Interim Financial Statements for the Three and Six
Months June 30, 2023 and 2022.11 Net Debt/TTM Adjusted EBITDA for
Pipestone calculated as Net Debt of $172.394 million as of June 30,
2023, divided by Adjusted EBITDA for trailing twelve months as of
June 30, 2023 of $344.0 million (which is calculated as Adjusted
EBITDA for the full year 2022, less Adjusted EBITDA for the first
six months of 2022, plus Adjusted EBITDA for the first six months
of 2023). Sources: (i) Pipestone August 9 Press Release; (ii) Press
Release filed by Pipestone on SEDAR+ on March 8, 2023.
Or Morrow Sodali at:
North America Toll-Free Phone: 1-800-607-0088
Banks, Brokers and Collect Calls: 1-289-695-3075
Email: assistance@morrowsodali.com
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