Description

Note: due to the time-sensitive nature of this idea, and the very difficult time I'm having posting my word document and excel spreadsheet into VIC, I'm going to post only what I can right now and will add anything I can't paste in later in the comments section. Unfortunately the main spreadsheet showing that the deal is very accretive for the 4 candidates listed is causing problems... I'll find a way to post it in the comments.

Also, this write-up assumes LNV.TO is at $5 CAD, but it's gone up a bit today.  I still think it's a good bet right now (it's at $5.08 last I checked).

Longview Oil (LNV.TO, LGVWF) is a Canadian high-yield value stock with an intriguing short term catalyst, but if you’re interested you’ll probably want to buy either today or tomorrow to maximize your expected return.

I think there’s at least a 50% chance Longview will be bought out within around 3 months at a price of around $6.50/share (CAD).  There’s also about a 50% chance the deal falls through, in which case I think the stock will go back to where it was trading before the recent secondary offering and buyout proposal announcements, which was around $4.75/share.  Longview pays a $0.04/share monthly dividend, which represents a 9.6% annual dividend yield at $5/share, so you also get paid ~2.4% while you wait those 3 months. 

If you buy LNV at around $5, think of it like a coin flip where you’ve got a 50% chance of earning a +32.4% total return and a 50% chance of earning a -2.6% total return in around 3 months.  It’s a classic “Heads you win big, Tails you don’t lose too much” type of bet (H/T Monish Pabrai).  The geometric mean of these two possibilities is sqrt[(1.324)*(0.974)] - 1 = 13.56% over 3 months, or an expected compound annual return of (1.1356)^4  - 1 = 66%.  So, theoretically, if you flipped a coin like this every 3 months and bet all your money on it each time, you’d eventually become the richest person on earth.  Obviously I’m not suggesting you go all-in on this one stock, since these probabilities and returns are only rough estimates, but I do think the high compound return I’ve calculated is indicative of a very favorable bet.   Furthermore, even if the buyout does fall through you’ll still own a significantly undervalued stock paying a 10.1% sustainable dividend yield at the assumed $4.75 share price.  So in my opinion this investment represents that much sought after but increasingly hard to find combination of very high expected return with very low risk of permanent capital loss.

Background

Longview is a 6,000 boe/d (Q1-Q3 2013 average) dividend-paying Canadian E&P with assets in West Central Alberta, Southeast Saskatchewan, and the Lloydminster area of Saskatchewan.  These oil-weighted assets (79% Oil and NGLs) were previously owned by Advantage Oil and Gas (NYSE: AAV).  Back in early 2011 Advantage wanted to unlock the value of their oil assets and generate cash to develop their Montney Shale gas assets, so they segregated their non-core oil assets into a new company called Longview Oil.  In an April 2011 IPO, Advantage sold 36.9% of Longview at $10/share and retained the remaining 63.1% stake.  They later reduced their ownership stake to 45.2% in an April 2012 secondary offering at $9/share. 

On February 4th, 2014, as part of the conclusion of their strategic review, Advantage announced the final secondary offering of their remaining Longview stake at $4.45/share.  Note: this secondary offering is scheduled to close tomorrow Friday, February 28^th, and if any person or institution buys more than 10% of Longview they’ll need to file a Canadian Insider report within 24 hours.  So Monday March 3^rd is a key date to keep in mind.

On February 10th, Longview issued a press release disclosing an unsolicited non-binding buyout proposal from an unnamed public company ("the Interested Party") that wants to purchase Longview in exchange for shares of the Interested Party.  In response, Longview formed a special committee to consider the proposal and adopted a "shareholder rights plan". 

If Longview were a US-based company this shareholder rights plan might be something to worry about, but in Canada it’s not a big issue because the Canadian poison pill is limited in time.  If the target company receives a public bid, the shareholders rights plan (which acts as a poison pill) offers the company's board a chance to find a better deal (go shop).  The Canadian securities regulator systematically cancels those plans within 45 to 55 days if no alternative is found, in which case the bidder is allowed to submit their bid to a vote.

It is worth noting that companies which participated in Advantage’s strategic review also had the option to review Longview’s assets since Longview was still consolidated into Advantage’s financials.  Therefore, it’s highly likely that the bidder is one of the companies that participated in Advantage’s strategic review.  We suspect Advantage would only accept payment in cash, however, and that may be why this deal didn’t get done at the conclusion of their strategic review.

The next day, February 11th, Longview issued a press release stating "... Longview has been advised that the Interested Party has submitted an expression of interest to the underwriters (the "Underwriters") for the secondary offering of Longview Shares held by Advantage Oil & Gas Ltd. (the "Secondary Offering"), to purchase, and the Underwriters have allocated to the Interested Party, 9.3 million Longview Shares under the Secondary Offering, representing approximately 19.8% of the issued and outstanding Longview Shares."  The press release goes on to mention "There is no assurance that the Interested Party will acquire any Longview Shares under the Secondary Offering".

On February 19^th, Longview issued a press release stating “After careful consideration of the matter, and upon receiving the advice of its financial and legal advisors, the Special Committee determined that it could not properly evaluate the transaction outlined in the Proposal without an exchange and review of confidential information by both parties. Longview and the Interested Party engaged in negotiations with respect to a confidentiality and standstill agreement in order to facilitate an exchange of confidential information. Although the parties finalized the terms of the confidentiality and standstill agreement, the Interested Party was unwilling to execute it. The Proposal has now expired and the parties are not currently in discussions.”

Now we come to a truly bizarre part of this whole story: On February 24^th , Longview issued a press release stating that Kelly Drader, Longview’s CEO, passed away suddenly over the weekend while cross-country skiing.  What can one say?  This is obviously tragic for him, his family and his friends, but in my opinion this event increased the likelihood of the deal getting done.  The normal reaction of a CEO in his position would have been to resist losing his job, but obviously that won’t be an issue in this case.

My investment colleague Nawar Alsaadi , a 3.4% holder in Longview, has consulted with other major shareholders about the affairs of the company and its outstanding buyout offer.  He sensed widespread support for a deal.  In addition, a number of Canadian based activist hedge funds expressed an interest in getting involved for the purpose of unlocking shareholder value, but with the passing of the CEO and the increased likelihood of a transaction, Nawar believes such action may be unnecessary.  

Relative Valuation

The table below shows how Longview compares to its dividend paying Canadian peers with respect to the standard valuation metrics used in the industry.  I think it’s self-evident that Longview is significantly undervalued at its current share price of ~$5.

Source: CIBC Oil and Gas Weekly, Feb. 17^th, 2014.  Note: P/NAV numbers came from RBC’s Jan. 6^th note on Canadian Energy since CIBC no longer covers Longview.

Acquirer Candidates

We believe there are at least 4 good candidates to be this mystery buyer: Cardinal Energy (CJ), Whitecap (WCP), Surge (SGY), and TORC (TOG). This is by no means an exhaustive list of possibilities, but it's useful to run the numbers on the most obvious choices. The following table shows various valuation metrics for each of these companies, both standalone and after an all-stock merger with Longview. Longview's share price is shown $6.09, which was computed using the formula $6.09 = 0.802*$6.50 + 0.198*$4.45. We assume the buyer follows through with its proposed purchase of 19.8% of Longview at the secondary offering price of $4.45 and that the remaining 80.2% is purchased at the stated deal price of $6.50. As you can see, this deal would be highly accretive to all 4 of these under most valuation metrics listed. The one exception is Surge Energy, which was recently downgraded and is now trading at a higher dividend yield than Longview would be at $6.09. However, the deal would still be accretive for Surge with respect to the other valuation metrics listed.

Risks

* We noticed that the Decommissioning Liability listed on Longview's balance sheet is significantly larger than what's assumed by the third-party reserve engineers in the 2012 reserve report (AIF). To be honest I haven't had the time to track this down and see if a similar disconnect exists for the peer group, but I thought I should at least flag this as a risk item.

* The Directors have a very small ownership stake in the company, so there may be a lack of alignment with shareholder interests in getting a deal done.

* Canadian oil differentials are volatile, so obviously if Canadian oil prices decline significantly that would be a negative.

Catalyst