Description

Overview

Gibson Energy (“Gibson”) is a Canadian-listed energy infrastructure c-corp. Its operations are focused around two core terminal assets located in Alberta, Canada, which are the principal hubs for aggregating and exporting oil and refined products out of the Canadian oil sands.

Gibson’s profitability is tied to oil throughput and has no dependence on commodity pricing. Oil throughput is driven by oil sands production. Production from the oil sands is incredibly consistent. In addition to the oil sands being a low marginal cost production geography, based on the current rate of oil sands production, the oil sands have a proven reserve life of >40 years. In turn, Gibson’s profitability is extremely stable, with very strong visibility into the long-term. For example, even during this difficult oil environment, Gibson’s 2020 profitability is expected be unchanged year-over-year.

Despite Gibson’s commodity resilient operating model, its share price is down ~20% YTD on the back of energy-sector outflows. Today, we see Gibson trading at a 10% FCF yield (65% payout for a 6.5% dividend). This valuation is attractive in its own right and believe the share price can make up for lost ground as the business has neither been structurally or cyclically impaired. More compelling however, we believe there is a good chance this entity is acquired over the next 18 months. If we’re right, we believe the total return could be ~40%. If we’re wrong, you get a 6.5% annual dividend while waiting and can move on to the next idea. This is a very attractive risk / reward for an asset with a ~$10mm average daily trading volume and applicable to most funds.  

History of Gibson

To understand the current Gibson situation, history is important for context. Gibson was a hodge-podge of energy infrastructure assets put together by the well known energy-mandated private equity firm Riverstone. Riverstone took the company public in 2011 and fully exited by 2012. From 2012 to 2014, Gibson continued to make acquisitions and was viewed favorably by public market investors given the strength of the oil market. However, once the oil market started turning, so did Gibson as several of the assets it acquired had commodity price exposure.

Upset by the performance of the entity, in 2017, ~20% shareholder M&G Investments press released a public letter to the board, essentially demanding Gibson to sell all of the low-quality commodity businesses that had been acquired and focus on its core storage terminals, referred to in the letter as the “crown jewels”. The M&G letter also outlines that once Gibson is successful in streamlining the portfolio, it should look to sell the business. The letter from M&G can be found here: https://www.newswire.ca/news-releases/mg-investments-requests-initiation-of-strategic-review-process-for-gibson-energy-inc-640325913.html

This letter kick-started a dramatic management refresh which ultimately led to the CEO, along with the top 30 people in the organization being replaced. The new CEO, Steve Spaulding, came from Lone Star NGL and has been instrumental in executing on the Gibson portfolio clean-up and largely achieved the low-hanging fruit the letter demanded. In turn, the market rewarded Gibson’s efforts and by the end of 2019 / beginning of 2020, Gibson regained its cost of equity and traded to the ~$27 / share area. This share re-rating cooled the urgency for a sale and the business was trading closer to fair value. Unfortunately, like every business in the world, Gibson got caught in the COVID drawdown. Unlike every business in the world, being tangential to the energy sector, Gibson has failed to recover its cost of equity and its share price trades 20% lower YTD. Meanwhile, all fundamentals for Gibson appear unchanged or improved. Most notably, interest rates are 100 bps lower and historically Gibson / the sector are interest-rate sensitive (this rate move should be a major positive).    

Why do we think Gibson will be acquired?

On arrival at Gibson, the CEO Spaulding was awarded 1 million options with a strike price of $17 and an expiration date of June 2022. If the share price is unchanged from today, Spaulding will earn ~$4 million. Spaulding did not move from Texas to Alberta for $4 million.

This is the world’s easiest business to underwrite (long-term contracts, investment grade counterparties and visibility on upstream production) at an attractive valuation. Therefore, this should be attractive to a number of strategic or financial sponsors.

The strategic angle would be largely synergy motivated as the entire sector has lost its cost of capital given the energy-related fund outflows. C suite, board and listing fees alone were ~$20m last year. Virtually every Canadian midstream company has some form of storage and marketing business.

The two comparable Canadian midstream acquisitions in the last several years were Veresen in 2017 and Kinder Morgan Canada in 2019. Both were acquired by Pembina (public, Canadian-listed c-corp). The Veresen acquisition was done for ~12x and Kinder Morgan for ~14x EV/EBITDA.  In both cases, WTI was in the ~$50 area and rates were >100 bps higher. In addition, Gibson’s assets are stable and fundamentally more attractive than either acquisition. Therefore, these precedent transaction multiples are not unreasonable.

Assuming a typical ~30% “take-out” premium to the current trading price, you get to a $5.25bn enterprise value for Gibson or an implied ~12x EBITDA. This is fair versus recent transaction precedents. Any large-cap (e.g. Enbridge, TransCanada, etc.) has the balance sheet capacity and can more than justify buying this business from a strategic/financial perspective. For a financial buyer, likely a pension, lifeco or energy-infrastructure focused fund (certain Brookfield entities), this asset will hurdle. Our assumed ~30% takeout premium equates to a 6% unlevered pre-tax FCF yield. Assuming 65% LTV and 3.5% all-in cost of debt, a sponsor will be able to get to a high-single-digit levered IRR.

Shareholder dynamics (M&G), management incentives (CEO options) and precedent transactions (Veresen and Kinder Morgan Canada) all point to a transaction making the most sense for Gibson going forward. At today’s share price, the optionality on this is completely free. While you wait, you get an attractive dividend and have the ability to move on if this idea does not play out in short order. I suspect once we see the real economy beginning to normalize, we will see a press release from the company exploring strategic alternatives. Assuming share price unchanged or lower, this could happen within in the next ~6-9 months and would be the first catalyst to unlocking. Given the contractual, infrastructure nature of these assets, this is not an idea where I think the street is modeling or there are opportunities for upside/downside surprises to numbers. Consolidated street numbers are in-line with how we and management view the business. Rather the variant view with this idea comes down to the significant optionality on a takeout.

Additional details on the company

Under the new management team and supervision of M&G, Gibson is a shareholder-oriented company with very good disclosures. I recommend you read the company’s Annual Information Form (can be found on SEDAR) for a full company description (pg 15-20).

For the simple high-level, Gibson has two main operating segments: Infrastructure and Marketing.

     Infrastructure (~80% of EBITDA)

85% of segment of EBITDA comes from its oil terminals (i.e. storage tanks) while the other 15% comes from other assets which include a few small pipelines and a small refinery.

The storage tanks are operationally simple. They represent a minuscule cost in getting barrels to market but play a critical function. These are not the tanks you’d find at a port, these tanks are used almost purely for operational purposes. This means contracts are long, 5+ years, and demand is not impacted by contango/backwardation. 

Gibson’s tanks have three main use cases: i) operational; ii) insurance, and iii) value add. Operationally, the pipelines ship oil in batches of varying specifications. One role of tanks is to allow producers to build their batch while they wait for their shipping window. Second, Gibson’s tanks provide insurance to producers as they provide flexibility in the timing of the sale. Lastly, storage allows for value add services, like blending services which require mixing multiple different grades to produce a named grade.

Gibson’s storage is particularly high quality as far as storage goes because it’s largely contracted to oil sands producers which have very long asset lives. It would also be pretty much impossible to replicate the asset due to land constraints and connections. Gibson is connected to 11 inbound pipes and 8 outbound – more than any other company. The cost to build a connection today can be $50m+ which is about the same cost as to build a new tank.    The cost of storage is ~$1.50 CAD per barrel per month with a small activity fee based on storage turns. This compares to ~$10 USD to ship a barrel to the Gulf. Tanks have turned an average of ~10 times a month since IPO and so the incremental cost on a per-barrel basis is less than $0.20. With volatile markets and pipelines under constant apportionment, the value of storage has only increased.

     Marketing (~20% of EBITDA)

The remaining business operates like any other energy marketing business. It uses the company’s infrastructure to profit off different spreads. The biggest contributor comes from the Moose Jaw refinery which Gibson owns. The refinery uses Canadian heavy oil to produce asphalt, roofing flux, drilling fluid etc. The output products are priced off a Gulf Coast index which allows the company to take advantage of Canadian heavy differentials. In some ways this business acts like a hedge to the terminals business. When differentials are wide and investors worry about oil, the marketing business produces outsized profits. When differentials are narrow and investors get excited for the prospects of volume growth, the marketing business becomes less profitable.

Moose Jaw sits in infrastructure, so Marketing makes an intersegment payment for use of the facility (5% of EBITDA) and then owns the commodity products at the plant gate. Management has guided to mid cycle operating profits of $80 – 120 million.

Putting it together, the Infrastructure segment is producing ~$380 million of operating profit while Marketing has been guided to $80 – 120 million. Corporate G&A of $30m brings EBITDA to ~$450 million. Free cashflow for 2020 will be ~$300 million. The recent volatility in energy has had almost zero impact on the infrastructure segment while marketing is operating at mid cycle. If nothing else, you have an opportunity to buy a long bond yielding ~10% free cash flow backed 90% by investment grade counterparties (55% are A- or better). However, we think there’s a reasonably good chance that the business gets acquired within the next 18 months.

Catalyst

Takeout