Let's face it: the 61% premium that the China National Offshore Oil Company (CNOOC) is offering to pay for Nexen (NXY) cannot be justified on any of the usual valuation parameters that investors apply to a stock. The Chinese offer is worth a whopping US$15.1 billion which works out to US$27.50 a share. The stock is trading somewhat below that, perhaps on concerns Ottawa will reject the deal. And the vociferous objection of influential U.S. Senator Charles Schumer, who wants the U.S. government to block the deal unless stringent conditions are met, has added to the uncertainty. About 10% of Nexen's assets are in the U.S.
But even at current prices, the shares are being valued at 20.6 times 12-month trailing earnings and 14.4 times projected forward earnings. By comparison, Suncor (SU) has a trailing 12-month p/e ratio of 10.6 and a forward p/e of 9.3. Canadian Oil Sands (TSX: COS) has a trailing 12-month p/e of 8.9 and a forward p/e of 10.2.
Nexen's second-quarter results were disappointing. Despite a small increase in production and an improvement in cash flow from operations, net income fell 57% from the same period last year to $109 million ($0.20 a share) compared to $252 million ($0.46 a share) in the same period of 2011. The share price dropped slightly after the results came out only to surge two days later when the CNOOC bid was revealed.
So have the Chinese lost their marbles by paying so much for Nexen? Not by their parameters. Most of Nexen's current production is outside Canada with operations in the North Sea, offshore Nigeria, Colombia, Yemen, Poland, and the Gulf of Mexico. But it appears the real attraction is Nexen's position in the Alberta oil sands. The company owns 7.23% of Syncrude and is 65% owner and the operator of the Long Lake operation which currently produces 72,000 barrels of bitumen per day. When upgraded, that generates approximately 58,500 barrels of oil per day. Significantly, CNOOC is Nexen's minority partner in Long Lake, so there is some history and familiarity here.
All told, Nexen has an interest in more than 300,000 acres in the Athabasca oil sands region including operated leases at Leismer and Cottonwood and non-operated leases at Meadow Creek, Corner, and Chard. Total estimated contingent recoverable reserves are three to six billion barrels. That's what the Chinese are hungrily eyeing.
As a bonus, Nexen owns large blocks of high-quality acreage in the Horn River Basin located in northeast British Columbia which is considered to be one of the richest gas fields in North America. Including the 2010 purchase in the nearby Cordova and Liard basins, Nexen's total land position is approximately 300,000 acres.
Obviously, the Chinese think this is a good long-term deal for them. Now the question is: what are the implications for other Canadian energy companies going forward? The Conservative government is not going to preside over the wholesale sell-off of our oil and gas sector, that much is obvious. But if the CNOOC bid gets approval, it will be difficult for Ottawa to turn down take-over offers from other foreign countries that are structured in such a way as to benefit Canada.
Japan, which already has some joint venture money invested in the oil sands region and which has become disenchanted with nuclear power following the disaster at Fukushima Daiichi, is one possibility. Energy-poor India and South Korea are others. On the natural gas side, Petronas, Malaysia's state-owned oil company, has raised its offer to buy Progress Energy (TSX: PRQ) to $22 a share. Then there are the U.S. oil giants with billions in cash for acquisitions. They aren't likely to sit idly by while Asian countries grab big chunks of Canada's resources. And, of course, there is always a possibility that some of the bigger Canadian players will make bids for smaller companies if the price looks right.
One big concern for the Asians is delivery of product. Right now, there is only one pipeline connecting Alberta and the Pacific Coast, the Trans-Mountain pipeline operated by Kinder Morgan which runs from Edmonton to Burnaby, near Vancouver. It is operating at capacity and Kinder Morgan has made an application to twin it which, not surprisingly, is coming under fire from environmentalists.
The Northern Gateway pipeline to Kitimat, proposed by Enbridge Inc., has been the target of immense controversy and despite strong support from the Harper government won't be built for many years, if ever. TransCanada Corp. recently announced plans for a natural gas pipeline from the B.C. gas fields, also to Kitimat, but that too is years off.
However, the Chinese are taking the long view and at some point Canada is going to find a way to move more oil to West Coast shipping terminals, even if it has to be done by rail (which some companies are already doing). Other energy-hungry Asian countries will take a similar stance.
So what companies might be targeted next? The immediate speculation focused on Talisman Energy (TLM). On the same day as the CNOOC bid was revealed, Talisman announced it had agreed to sell a 49% equity interest in its North Sea business, Talisman Energy (UK) Limited (TEUK), to Sinopec International Petroleum Exploration and Production Corporation (Sinopec) for $1.5 billion. Sinopec is another major Chinese energy company.
Interestingly, Talisman immediately announced it would use $500 million of the proceeds to buy back its own stock, a clear indication that management believes the market is undervaluing it. Talisman shares moved higher on the news and closed on Friday at C$12.71, US$12.65 but are still well below their 52-week high of C$19.57, US$20.75. (Note that Talisman was recommended by contributing editor Tom Slee in January and is still rated as a Buy.)
Canadian Oil Sands (TSX: COS, OTC: COSWF) is another possibility. The company, which was formerly an income trust, owns 36.74% of Syncrude making it the largest stakeholder in the project. It estimates that its share of 2012 production will be approximately 111,000 barrels per day.
COS stock has never achieved the lofty heights it reached during its income trust heyday when at one point in 2008 it traded at over $50. The closing price on Friday on the TSX was $21, well down from the 52-week high of $28.50. The stock looks cheap at these levels and is widely held, with no majority shareholder.
Talisman and Canadian Oil Sands are only two possibilities and nothing more may happen until after Ottawa rules on the CNOOC bid. But the Chinese offer has stirred the pot and forced everyone to take a fresh look at the way our energy companies are being valued by the stock market. We could be in for some interesting times.