NEXEN INC NXY
September 27, 2012 - 4:23pm EST by
clark0225
2012 2013
Price: 25.36 EPS $1.048 $1.604
Shares Out. (in M): 530 P/E 24.2x 15.8x
Market Cap (in $M): 13,440 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Energy
  • Oil and Gas
  • Canada
  • China
  • Acquisition
  • Event-driven
  • Merger Arbitrage

Description

This is an event-driven idea that is relatively straightforward so this write-up will focus on the deal dynamics and includes many links if you want to do additional work/reading.
 
On 7/23/12 CNOOC anounced a definitive agreement to acquire Nexen for $27.50 per share in cash.  The full press release can be read here:
 
http://www.nexeninc.com/en/Investors/NewsPresentations/~/media/C38E0AAB206848D8893EB6F9D112FC85.ashx
 
The circular which includes the full merger agreement can be found here:
 
http://www.nexeninc.com/en/Investors/GeneralInformation/~/media/Files/Governance/SpecialMeeting/Nexen2012SpecialMeeting_Information_Circular.ashx
 
 
Primary conditions for the deal are the Key Regulatory Approvals:
 
1. Court approval (final order obtained 9/21)
2. Shareholder vote of 2/3 (obtained on 9/20 with 99%)
3. Approval in Canada, UK/Europe, US and China
 
Obviously the gating factor to close is #3, the approvals.  Of these, China is virtually assured as per the release "CNOOC has obtained approval from the transaction from its majority stockholder." UK/Europe is not an issue and are more formalities, so I will focus on the US and Canada.
 
In the US the deal will be reviewed under CFIUS ("Committee on Foreign Investment in US) which should not be an issue due to the nature of this review.  This law gives the President the right to block an acquisition of a US business by a foreign person to protect national security interests.  NXY's US operations are limited to Gulf of Mexico properties which are primarily minority-owned assets, where they have proved reserves of 34 mmboe and daily production of 22 mboe/d.  This is obviously de minimis in terms of US energy resources and there is no national security argument.  Of course facts never stop politicians with Schumer weighing in (http://www.schumer.senate.gov/Newsroom/record.cfm?id=337355) as well as the other side of the aisle (http://inhofe.senate.gov/public/index.cfm?FuseAction=PressRoom.PressReleases&ContentRecord_id=c4ee91a4-a96e-cbc5-45f6-fa6db138a713). 
 
Still, I'd note that both letters stop well short of asking for the deal's outright rejection.  Due to the immateriality of the US assets, extensive history of foreign investment in this industry, the lack of any actual national security issues as well as the extreme rarity of CFIUS rejections, I do not view this as a real obstacle to close.  A primer on CFIUS and its history can be found below:
 
http://www.pepperlaw.com/publications_update.aspx?ArticleKey=2198 
 
Canada is the real issue where the deal is subject to review under the Investment Canada Act.  It will be scrutinized by the Industry Minister to determine if it is likely to be of "net benefit" to Canada.  Per the circular linked above the Minister is required to consider:
 
"the effect of the investment on economic activity in Canada (including the effect on employment, resource processing, utilization of Canadian products and services and exports), on participation by Canadians in the acquired business, on productivity, industrial efficiency, technological development, product innovation, product variety and competition in Canada, and the compatibility of the investment with national and provincial industrial, economic and cultural policies, as well as the contribution of the investment to Canada’s ability to compete in world markets. Furthermore, the Ministerhas published guidelines (the Guidelines —Investment by state-owned enterprises — Net benefit assessment) (the ‘‘SOE Guidelines’’) that apply to Reviewable Transactions by non-Canadian state-owned enterprises (‘‘SOEs’’). For the purposes of the SOE Guidelines, an SOE is an enterprise that is owned or controlled directly or indirectly by a foreign government. According to the SOE Guidelines, when determining whether to issue a net benefit ruling, the Minister will assess the corporate governance and reporting structure of the non-Canadian SOE as well as whether the Canadian business will continue to have the ability to operate on a commercial basis" - circular p. 48

Quoting the above deal press release, in order to satisfy this test, CNOOC will: 

- establish Calgary as the head office of its North and Central American operations. This head office will be responsible for operating and growing Nexen’s assets in North and South America, Europe and West Africa and CNOOC Limited’s portfolio in Canada, the U.S. and Central America.

- retain Nexen’s current management team and employees.

- Implement and enhance Nexen’s current planned capital expenditure program, thereby investing significant capital in Canada and in Nexen’s other international assets. CNOOC Limited brings greater financial capacity to better realize the full potential of Nexen’s significant resource base.

- list its common shares on the TSX.

- build upon Nexen’s existing and highly regarded community and charitable programs, particularly with respect to First Nations and local communities.

- Additionally, CNOOC Limited will continue to support oil sands research at Alberta universities and participate in the Canada’s Oil Sands Innovation Alliance ("COSIA").

More information on CNOOC Limited’s global commitments to social responsibility can be found at http://www.cnoocltd.com/encnoocltd/default.shtml" 

 
 
CNOOC submitted their application to Industry Minister Paradis on 8/29.  Under the Investment Act, this triggered a 45 day initial review, which he may unilaterally extend for a further 30 days.  It can be extended an additional 30 days by mutual agreement.
 
NXY stock is currently trading at $25.36 with a gross spread of $2.14 or 8.4%.  This is an unusally wide spread for a friendly deal as "safe" transactions are trading with ANNUALIZED spreads to close in the mid to high single digits at most (equivalent to north of 30% annualized here even in the most conservative estimate to close here). 
 
There are 2 primary concerns regarding approval that seem to account for the wide spread and I believe present the opportunity.  The first is that while only two deals have been rejected, one was recent, very surprising, and in the resource sector (BHP's bid for Potash, further described here http://online.wsj.com/article/SB10001424052748703506904575592870406638644.html).  The second is the history of CNOOC's last attempt to purchase a public company in North America (Unocal in 2005) which failed.  I think neither precedent is applicable to this deal.
 
Both deals were hostile unlike this transaction, a crucial difference.  In the case of Potash, it was a strategic natural resource controlling greater than 1/5 of the entire world's potash reserves.  The same can simply not be said for NXY with a small fraction of Canada's reserves and production.  Secondly, there was broad political opposition to the POT bid with the premier of the local province campaigning against it under any circumstances and highlighting the costs and harm to his province.  He made clear throughout that there was no remedy that would garner his support.  In this case, the Alberta premier where Nexen is headquartered is actually on record as in favor of the deal (http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/alberta-backs-foreign-oil-deals/article4544070/).
 
As far as Unocal, it was a clumsy attempt by CNOOC where they actually went hostile to break up an existing friendly deal between two US companies (CVX had agreement to buy Unocal).  Representative of the polical furor, the House voted 398-15 to demand the administration review the deal before CNOOC even had an agreement w/ Unocal.  CNOOC quickly dropped the bid without ever even applying for approval.  So it was never actually rejected but CNOOC did learn lessons (http://online.wsj.com/article/SB112295744495102393.html). 
 
There have been literally thousands of articles written about this deal in the US and Canada media since its announcement, here are a few recent ones for additional perspective:
 
http://www.theglobeandmail.com/report-on-business/international-business/asian-pacific-business/chinas-cnooc-confident-on-nexen-deal-report/article4571335/
 
http://www.businessweek.com/news/2012-09-25/cnooc-seeking-100-percent-of-nexen-hinders-approval-says-chee
 
http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/alberta-backs-foreign-oil-deals/article4544070/
 
http://in.reuters.com/article/2012/09/27/cnooc-nexen-talks-idINT9E8I907C20120927
 
http://www.ottawacitizen.com/business/Chinese+envoy+warns+Canada+against+politicizing+Nexen+deal/7286328/story.html
 
http://www.bloomberg.com/news/2012-07-23/cnooc-studies-history-to-plot-nexen-strategy.html
 
 
Part of my confidence regarding this review comes from Canada's strategic interests and the importance of China to those aims.  PM Harper has made trade with China a priority for his admistration, as well as securing additional markets for their resources.  Following the Keystone rejection, Harper was adamant about their needs to diversify away from being a captive supplier to the US:
 
“Look, the very fact that a ‘no’ could even be said underscores to our country that we must diversify our energy export markets....We have taken a significant price hit by virtue of the fact that we are a captive supplier and that just does not make sense in terms of the broader interests of the Canadian economy. We’re still going to be a major supplier of the United States. It will be a long time, if ever, before the United States isn’t our number one export market, but for us the United States cannot be our only export market. That is not in our interest, either commercially or in terms of pricing. We cannot be, as a country, in a situation where our one and, in many cases, only energy partner could say no to our energy products. We just cannot be in that position.” http://www.wilsoncenter.org/event/director%E2%80%99s-forum-the-right-honourable-stephen-harper-prime-minister-canada-0
 
China is the logical alternative customer for this oil, and further having the ability to play the US against China would give Canada more leverage with both.  There is also tremendous need for investment in the oil sands and infrastructure generally, which China has been happy to provide.  A rejection of this deal would be absolutely chilling for all of these initiatives and really would be against Canada's self-interest. 
 
For all these reasons, the deal highly likely to close and I find the spread attractive.  My expected close is mid-December as Canada will likely take the maximum possible time for the review and any negotiations with CNOOC.  In the last review I saw this year (Viterra/Glencore), Paradis took the full amount of time (submitted on 4/3, approved 7/15).  That timing would imply a decision on Nexen by 12/12/12. 
 
In terms of strategy, you can obviously play it via the common, but there are also options with significant open interest.  I am long the stock as well as March 2013 options (in case the timing drags), and 25/27 December call spreads. 
 
As with all merger arb spreads, there is significant downside should the deal fail to close.  NXY closed at $17.06 on 7/20 the last trading day prior to announcement.  While there has been a significant rally in the market and sector since then (10% for Suncor, 7%ish for group), NXY would likely trade to the high teens on a break.

Catalyst

Approvals
Closing
 
Risks....
Investment Act of Canada rejection
CFIUS (highly unlikely)
Exogenous event such as China hard landing, or crash in the price of oil makes CNOOC try to find a way to walk
    sort by    

    Description

    This is an event-driven idea that is relatively straightforward so this write-up will focus on the deal dynamics and includes many links if you want to do additional work/reading.
     
    On 7/23/12 CNOOC anounced a definitive agreement to acquire Nexen for $27.50 per share in cash.  The full press release can be read here:
     
    http://www.nexeninc.com/en/Investors/NewsPresentations/~/media/C38E0AAB206848D8893EB6F9D112FC85.ashx
     
    The circular which includes the full merger agreement can be found here:
     
    http://www.nexeninc.com/en/Investors/GeneralInformation/~/media/Files/Governance/SpecialMeeting/Nexen2012SpecialMeeting_Information_Circular.ashx
     
     
    Primary conditions for the deal are the Key Regulatory Approvals:
     
    1. Court approval (final order obtained 9/21)
    2. Shareholder vote of 2/3 (obtained on 9/20 with 99%)
    3. Approval in Canada, UK/Europe, US and China
     
    Obviously the gating factor to close is #3, the approvals.  Of these, China is virtually assured as per the release "CNOOC has obtained approval from the transaction from its majority stockholder." UK/Europe is not an issue and are more formalities, so I will focus on the US and Canada.
     
    In the US the deal will be reviewed under CFIUS ("Committee on Foreign Investment in US) which should not be an issue due to the nature of this review.  This law gives the President the right to block an acquisition of a US business by a foreign person to protect national security interests.  NXY's US operations are limited to Gulf of Mexico properties which are primarily minority-owned assets, where they have proved reserves of 34 mmboe and daily production of 22 mboe/d.  This is obviously de minimis in terms of US energy resources and there is no national security argument.  Of course facts never stop politicians with Schumer weighing in (http://www.schumer.senate.gov/Newsroom/record.cfm?id=337355) as well as the other side of the aisle (http://inhofe.senate.gov/public/index.cfm?FuseAction=PressRoom.PressReleases&ContentRecord_id=c4ee91a4-a96e-cbc5-45f6-fa6db138a713). 
     
    Still, I'd note that both letters stop well short of asking for the deal's outright rejection.  Due to the immateriality of the US assets, extensive history of foreign investment in this industry, the lack of any actual national security issues as well as the extreme rarity of CFIUS rejections, I do not view this as a real obstacle to close.  A primer on CFIUS and its history can be found below:
     
    http://www.pepperlaw.com/publications_update.aspx?ArticleKey=2198 
     
    Canada is the real issue where the deal is subject to review under the Investment Canada Act.  It will be scrutinized by the Industry Minister to determine if it is likely to be of "net benefit" to Canada.  Per the circular linked above the Minister is required to consider:
     
    "the effect of the investment on economic activity in Canada (including the effect on employment, resource processing, utilization of Canadian products and services and exports), on participation by Canadians in the acquired business, on productivity, industrial efficiency, technological development, product innovation, product variety and competition in Canada, and the compatibility of the investment with national and provincial industrial, economic and cultural policies, as well as the contribution of the investment to Canada’s ability to compete in world markets. Furthermore, the Ministerhas published guidelines (the Guidelines —Investment by state-owned enterprises — Net benefit assessment) (the ‘‘SOE Guidelines’’) that apply to Reviewable Transactions by non-Canadian state-owned enterprises (‘‘SOEs’’). For the purposes of the SOE Guidelines, an SOE is an enterprise that is owned or controlled directly or indirectly by a foreign government. According to the SOE Guidelines, when determining whether to issue a net benefit ruling, the Minister will assess the corporate governance and reporting structure of the non-Canadian SOE as well as whether the Canadian business will continue to have the ability to operate on a commercial basis" - circular p. 48

    Quoting the above deal press release, in order to satisfy this test, CNOOC will: 

    - establish Calgary as the head office of its North and Central American operations. This head office will be responsible for operating and growing Nexen’s assets in North and South America, Europe and West Africa and CNOOC Limited’s portfolio in Canada, the U.S. and Central America.

    - retain Nexen’s current management team and employees.

    - Implement and enhance Nexen’s current planned capital expenditure program, thereby investing significant capital in Canada and in Nexen’s other international assets. CNOOC Limited brings greater financial capacity to better realize the full potential of Nexen’s significant resource base.

    - list its common shares on the TSX.

    - build upon Nexen’s existing and highly regarded community and charitable programs, particularly with respect to First Nations and local communities.

    - Additionally, CNOOC Limited will continue to support oil sands research at Alberta universities and participate in the Canada’s Oil Sands Innovation Alliance ("COSIA").

    More information on CNOOC Limited’s global commitments to social responsibility can be found at http://www.cnoocltd.com/encnoocltd/default.shtml" 

     
     
    CNOOC submitted their application to Industry Minister Paradis on 8/29.  Under the Investment Act, this triggered a 45 day initial review, which he may unilaterally extend for a further 30 days.  It can be extended an additional 30 days by mutual agreement.
     
    NXY stock is currently trading at $25.36 with a gross spread of $2.14 or 8.4%.  This is an unusally wide spread for a friendly deal as "safe" transactions are trading with ANNUALIZED spreads to close in the mid to high single digits at most (equivalent to north of 30% annualized here even in the most conservative estimate to close here). 
     
    There are 2 primary concerns regarding approval that seem to account for the wide spread and I believe present the opportunity.  The first is that while only two deals have been rejected, one was recent, very surprising, and in the resource sector (BHP's bid for Potash, further described here http://online.wsj.com/article/SB10001424052748703506904575592870406638644.html).  The second is the history of CNOOC's last attempt to purchase a public company in North America (Unocal in 2005) which failed.  I think neither precedent is applicable to this deal.
     
    Both deals were hostile unlike this transaction, a crucial difference.  In the case of Potash, it was a strategic natural resource controlling greater than 1/5 of the entire world's potash reserves.  The same can simply not be said for NXY with a small fraction of Canada's reserves and production.  Secondly, there was broad political opposition to the POT bid with the premier of the local province campaigning against it under any circumstances and highlighting the costs and harm to his province.  He made clear throughout that there was no remedy that would garner his support.  In this case, the Alberta premier where Nexen is headquartered is actually on record as in favor of the deal (http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/alberta-backs-foreign-oil-deals/article4544070/).
     
    As far as Unocal, it was a clumsy attempt by CNOOC where they actually went hostile to break up an existing friendly deal between two US companies (CVX had agreement to buy Unocal).  Representative of the polical furor, the House voted 398-15 to demand the administration review the deal before CNOOC even had an agreement w/ Unocal.  CNOOC quickly dropped the bid without ever even applying for approval.  So it was never actually rejected but CNOOC did learn lessons (http://online.wsj.com/article/SB112295744495102393.html). 
     
    There have been literally thousands of articles written about this deal in the US and Canada media since its announcement, here are a few recent ones for additional perspective:
     
    http://www.theglobeandmail.com/report-on-business/international-business/asian-pacific-business/chinas-cnooc-confident-on-nexen-deal-report/article4571335/
     
    http://www.businessweek.com/news/2012-09-25/cnooc-seeking-100-percent-of-nexen-hinders-approval-says-chee
     
    http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/alberta-backs-foreign-oil-deals/article4544070/
     
    http://in.reuters.com/article/2012/09/27/cnooc-nexen-talks-idINT9E8I907C20120927
     
    http://www.ottawacitizen.com/business/Chinese+envoy+warns+Canada+against+politicizing+Nexen+deal/7286328/story.html
     
    http://www.bloomberg.com/news/2012-07-23/cnooc-studies-history-to-plot-nexen-strategy.html
     
     
    Part of my confidence regarding this review comes from Canada's strategic interests and the importance of China to those aims.  PM Harper has made trade with China a priority for his admistration, as well as securing additional markets for their resources.  Following the Keystone rejection, Harper was adamant about their needs to diversify away from being a captive supplier to the US:
     
    “Look, the very fact that a ‘no’ could even be said underscores to our country that we must diversify our energy export markets....We have taken a significant price hit by virtue of the fact that we are a captive supplier and that just does not make sense in terms of the broader interests of the Canadian economy. We’re still going to be a major supplier of the United States. It will be a long time, if ever, before the United States isn’t our number one export market, but for us the United States cannot be our only export market. That is not in our interest, either commercially or in terms of pricing. We cannot be, as a country, in a situation where our one and, in many cases, only energy partner could say no to our energy products. We just cannot be in that position.” http://www.wilsoncenter.org/event/director%E2%80%99s-forum-the-right-honourable-stephen-harper-prime-minister-canada-0
     
    China is the logical alternative customer for this oil, and further having the ability to play the US against China would give Canada more leverage with both.  There is also tremendous need for investment in the oil sands and infrastructure generally, which China has been happy to provide.  A rejection of this deal would be absolutely chilling for all of these initiatives and really would be against Canada's self-interest. 
     
    For all these reasons, the deal highly likely to close and I find the spread attractive.  My expected close is mid-December as Canada will likely take the maximum possible time for the review and any negotiations with CNOOC.  In the last review I saw this year (Viterra/Glencore), Paradis took the full amount of time (submitted on 4/3, approved 7/15).  That timing would imply a decision on Nexen by 12/12/12. 
     
    In terms of strategy, you can obviously play it via the common, but there are also options with significant open interest.  I am long the stock as well as March 2013 options (in case the timing drags), and 25/27 December call spreads. 
     
    As with all merger arb spreads, there is significant downside should the deal fail to close.  NXY closed at $17.06 on 7/20 the last trading day prior to announcement.  While there has been a significant rally in the market and sector since then (10% for Suncor, 7%ish for group), NXY would likely trade to the high teens on a break.

    Catalyst

    Approvals
    Closing
     
    Risks....
    Investment Act of Canada rejection
    CFIUS (highly unlikely)
    Exogenous event such as China hard landing, or crash in the price of oil makes CNOOC try to find a way to walk
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