Northern Exposure on the Cheap

11/24/2009 10:17 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Canadian energy trusts are ripe for takeovers and mergers capitalizing on huge discounts to the value of their assets, writes Roger Conrad in Canadian Edge.

Canada offers two compelling opportunities for a windfall. And the primary targets are income trusts paying big dividends backed by strong businesses, investments even the most conservative can buy and hold comfortably.

One opportunity is what I call the conversion windfall. Over the next 12 months, virtually all of the 100-plus Canadian income trusts will convert to corporations. As they do, two things will happen.

First, trusts will eliminate the uncertainty that’s depressed their market value since Halloween 2006, when Finance Minister Jim Flaherty issued his infamous proclamation of a new tax in 2011. Second, they’ll almost certainly beat the extremely gloomy expectations still baked into their unit prices. Both factors will lift share prices, as demonstrated by the average gain of 35% for the 23 that have converted from trusts to corporations already.

The other windfall opportunity is from a growing revival of takeover fever, stoked by trusts approaching 2011 decision time, abysmally low valuations, and a global rush to buy Canada. And, based on the results of the last takeover wave—as well as what we’ve seen so far—premiums are likely to range from 35% to 50%, some possibly even higher.

Two possibilities are Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) and Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF). Both sell for less than 60 cents per dollar’s worth of proven oil and gas reserves in the ground. Both also have proven their financial and operating strength by weathering the past year. Penn West Energy Trust and Enerplus Resources Fund are bedrock buys up to US$25 and US$20, respectively.

[Other] oil and gas producer trusts are bets on potential consolidation among the trusts themselves as the larger ones try to bulk before converting to corporations in late 2010.

Almost all of the trust-on-trust takeovers we saw during the 2007 wave were of acquisitions of weaklings at low valuations. In contrast, the majority of those still operating now are battle-hardened. Few, if any, are going to be willing to sell out cheaply for the sake of doing a deal.

That certainly applies to converted corporation Advantage Oil & Gas (TSX: AAV, NYSE; AAV) and four that are still trusts: Bonavista Energy Trust (TSX: BNP-U, OTC: BNPUF), Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF), Pengrowth Energy Trust (TSX: PGF, NYSE: PGH), and Zargon Energy Trust (TSX: ZAR-U, OTC: ZARFF).

Happily, all of them are selling so cheaply now that any offer even approaching the value of their assets in the ground would trigger a windfall gain. Enerplus and Penn West are potential acquirers. So is ARC Energy Trust (TSX: AET-U, OTC: AETUF), which also trades at a discount to NAV and is therefore simultaneously a takeover target as well.

Clearly, there’s no imperative for any of these to join forces. But given the advantages of scale in this business and the fact their favorable tax status is about to go away, there’s also a powerful incentive to do so. And best of all, all of them are compelling buys whether there’s a deal or not.

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