The TAQA deal structure uses two corporations, both private, one to lend the funds and the other to own the equity. This permits the entire amount of cash flow to be pulled out of Primewest and directed thru the Canadian corporation to a non-resident entity to eliminate Canadian income tax. Flaherty has just signed an agreement with the US permitting interest payments to leave Canada without withholding taxes. His intention is to extend this agreement with other major tax jurisdictions. The withholding tax removal by Flaherty validates the use of debt by non-residents to purchase Canadian resident businesses.
Primewest - The First of the Majors to Go
The first of the large cap Canadian energy trusts is in process of being acquired by TAQA North Ltd. a subsidiary of Abu Dhabi National Energy Company for $C26.75 per unit. The update reviews the pricing of the deal and provides valuation parameters for Bonterra, Pengrowth, Canetic, Trilogy, Fairborne, Arc, PennWest, Enerplus and Crescent Point.
Our valuation approach has been to establish a lower end value based on the price a purchaser would pay for the proved plus probable reserves. This price is $2.50 per mcf for natural gas and $18 per bbl for conventional oil and $1 for undeveloped oil sands reserves. The Primewest transaction provides an arm’s length actual transaction for the large cap energy trusts to compare and validate our valuations. As an additional benchmark I consider the cash flow that was being used to pay distributions, which is now available to the purchaser to fund the before tax interest cost on borrowings should they decide finance the transaction. The cash flow from distributions is adjusted, if necessary for the potential need for distribution reductions. This number is supported by our revenue and cost per boe analysis which has been the backbone of our valuation methods for 3 years.
The estimated replacement cost values have been listed on a table accessible under Energy Trusts on the front page of IncomeTrustResearch.com. These values have been available since Q4-06 following the release of the income trust taxation legislation.
On a replacement cost approach we valued PWI.UN at $23-$24 including the reserves acquired following the merger with Shiningbank. Just prior to the acquisition announcement units were trading at $20 which makes the offer appear to be at a large premium. Alberta oil and natural gas producer values declined last week following the announcement by the provincial government of a report recommending an substantial increase to crown royalty rates. As are result of the decline from the pending royalty review the offer from TAQA appears somewhat generous and the timing is very interesting.
TAQA is a foreign purchaser with government ownership that could run afoul of Canadian regulators. Primewest has been very active in the Canadian trust lobby with senior executive George Kesteven as the President of the Canadian Association of Income Funds. It was just a matter of time until one of the major Canadian energy trusts would enter into a sale transaction to escape the impact of the trust legislation. It is interesting that Primewest who have been an aggressive advocate against the trust tax are the first to go, giving the appearance they are testing the waters and just before a possible federal election.
On a mcf basis TAQA paid $2.15 or $13.30 per boe. Primewest reserves are 70% natural gas and by this measure they paid less than the $2.50 going rate. The distribution which was being paid to unit holders totals $435M annually and is at risk of a 30% reduction. Even at the reduced amount the distribution would fully pay the interest on a 6%, $5B loan. TAQA is buying Primewest for nothing down should they choose to borrow the funds or they can use the distributions for reinvestment.
By our estimates TAQA paid a 13% premium to our replacement cost value and on a free cash flow basis the deal was priced at a 6% cap rate. As a result of this transaction we are including a free cash flow based value using a 6% loan rate to determine how much debt the purchase price can support. This establishes an upper end value. The TAQA deal structure uses two corporations, both private, one to lend the funds and the other to own the equity. This permits the entire amount of cash flow to be pulled out of Primewest and directed thru the Canadian corporation to a non-resident entity to eliminate Canadian income tax. Flaherty has just signed an agreement with the US permitting interest payments to leave Canada without withholding taxes. His intention is to extend this agreement with other major tax jurisdictions. The withholding tax removal by Flaherty validates the use of debt by non-residents to purchase Canadian resident businesses.
Another interesting aspect of the deal is that Primewest is weighted to natural gas where prices have been weakest in comparison to oil. The purchasers have elected to buy the commodity with the weak price trend in expectation of better days ahead, if not this year then within 3-5 years. TAQA has deep enough pockets with $800B in assets to be patient with the $5B purchase of Primewest. There is also the uncertainty about the Alberta government’s review of crown royalties that could increase royalties by up to 50%. This is another risk that TAQA is prepared to accept. Despite reports in the Globe that TAQA is flush with cash and is overpaying for Primewest, the numbers do not support this conclusion. TAQA appears to know exactly what they are doing and have made a very good purchase that includes bargain priced reserves and an excellent management team.
We are in the process of updating the table on energy trust values which reconfirms the lower end value ranges and adds an estimated upper end cash flow based value. The buzz from the Primewest deal will likely fade setting the stage for another possible purchase. If unit prices approach the lower end replacement cost values accumulation is recommended.
Pennwest has agreed to buy Vault Energy Trust paying $14 per boe, $2.33 per mcf including land. Vault is 68% weighted to natural gas. The metrics on this transaction are attractive to Pennwest and supportive of our $2.50 per mcf natural gas value benchmark.
We will be updating the replacement cost and cash flow based values for all energy trusts and advising as updated.
Recommended Prices by Trust
As comparables, replacement cost values for PWT, ERF and CPG are $30, $48 and $17-18 respectively. Our next most favourably priced recommendations are Pennwest Energy (PWT.UN)at $30.25 or lower, Enerplus (ERF.UN) at $48 or lower, Crescent Point Energy Trust $20 or lower.
This also brings into play Peyto Energy (PEY.UN) with a replacement cost of $20 and current price of approx. $18.50
Bonterra Energy Trust (BNE.UN)
Replacement cost value is $25 per unit, and on a cash flow approach using a 6% cap rate they are valued at $30 per unit. Crown royalty costs jumped in Q2 due to retroactive adjustment, however they still have one of the lowest crown royalty rates in the energy trust sector. Recommended at $28 or lower.
Pengrowth Energy Trust (PGF.UN)
At $18 per boe, total enterprise value is $4B net of debt , approx. $17 per unit at replacement cost. On a cash flow distributions should be reduced by 75% which still allows for approx. $250-$300M of free cash flow providing firm support to the $17 per unit replacement cost. Recommended at $18 or less.
Canetic Energy Trust (CNE.UN)
Canetic made a several expensive acquisitions to quickly build reserves during 2004-2006 when reserves were expensive. This has increased their average FD&A to $25 per boe among the most expensive of the energy trusts. On a replacement cost Canetic is worth $10-$11. Free cash flow is thin and we expect up to 80% cut in distributions which is supporting the $15 value. Appreciation above the $15 level is expected to be limited.
Trilogy Energy Trust (TET.UN)
On a replacement cost Trilogy is worth $7.50 per unit and free cash flow provides a value as high as $12 per unit. There appears to be considerable upside appreciation based on the $8 price as of Sept-25-07
Fairborne Energy Trust (FEL.UN)
On a replacement cost Fairborne is worth $6 per unit and free cash flow provides a value of $4 per unit. FEL is expected to cut distributions by up to 80%.
Arc Energy Trust (AET.UN)
Replacement value $20 per unit and cash flow is $26. Cash flow value includes a reduction of distributions by 30%.
PennWest Energy Trust
On a replacement cost for conventional reserves PennWest is worth an estimated $30 plus up to $6 additional for the 1B bbls of potentially recoverable oil sands reserves. On a cash flow basis after reducing distributions by 30% their value is estimated at $40 per unit. The recent acquisition of Vault Energy added 27M boe of reserves at a favourable cost of $14 per boe included land leases and increases total reserves by 5%.
A complete list of energy trust with estimate replacement cost values is accessible from the front page of IncomeTrustResearch.com under Energy Trusts.
Canadian Energy Too Cheap to Ignore - greenfaucet.com
Jim Flaherty's Folly - Diane Francis
The Abu Dhabi Put - The Motley Fool