Husky to merge with Cenovus Energy
By: Asha Carpenter, Jakub Berkowski and Krzysztof Nosowicz
On 25th October 2020, Cenovus Energy announced its $4.78bn merger with Husky Energy, representing a 21% premium on Husky’s share price, forming the third largest oil and natural gas producer in Canada. The transaction granted Husky shareholders 0.7845 of a Cenovus share in exchange for each Husky common share, in this all-stock deal. The merger represents a horizontal step for Cenovus, with Husky being a competing oil sands company. Both companies are integrated oil and gas companies, differing in their specialisms – Cenovus focuses predominantly on upstream production, whereas Husky Energy focuses more on middle and downstream processes such as refining. The deal will provide an aspect of balance within the pro forma company – leveraging both of these specialisms enables the formation of a more integrated oil and natural gas company; a company which is more likely to have the necessary scale and resources to weather the changes that 2021 brings. The pro-forma entity operates under Cenovus Energy, with Husky being a wholly owned subsidiary, and has its headquarters in Calgary, Alberta, Canada. An amalgamation of the two companies is expected to be completed in due course.
Company Details: Cenovus Energy
Cenovus Energy possesses the right to recover and refine oil in the US and Canada. With major operations in the oil sands plays of Alberta and Saskatchewan, the company has proven and probable reserves of 3.7 billion barrels of oil and 1.1 trillion cu.ft. of natural gas. It also owns stakes in two refineries in Illinois and Texas capable of processing heavy oil that were part of a 50/50 joint venture with ConocoPhillips. That venture provides integration of Cenovus' upstream oil production with downstream refining of such consumer products as diesel, gasoline, and jet fuel.
Founded in 2009, headquartered in Calgary, Alberta, Canada
CEO: Alex Pourbaix
Number of employees: 2,300
Market Cap: $11.92b
LTM Revenue: $20.18b
Company Details: Husky
Husky Energy, Inc. is an international integrated energy company. It operates through two segments: Upstream and Downstream. The Upstream segment includes exploration, development and production of crude oil, natural gas and natural gas liquids. The Downstream segment refers to the upgrading of heavy crude oil feedstock into synthetic crude oil in Canada; and refining of crude oil, marketing of refined petroleum products including gasoline, diesel, ethanol blended fuels, asphalt and ancillary products.
Founded in 1938, headquartered in Calgary, Alberta, Canada
CEO: Rob Peabody
Number of employees: 4,800
Market Cap: $3.2b
LTM Revenue: $14.6b
Despite the worry Cenovus shareholders had prior to the acquisition, it has been made clear that there are many benefits to be drawn from this deal. Combining the two companies has meant production for the pro forma company is now at 750,000 bbls/day, and the refining capacity now stands at 660,000 bbls/day. Cenovus can immediately start to leverage its operating expertise to handle Husky’s oil sands assets, allowing for a more competitive, efficient and profitable business. Prior to the deal, Cenovus produced half a million bbls/day, with 250,000 processed downstream whereas Husky Energy processed 250,000 bbls/day upstream and approximately 400,000 bbls/day in downstream production.
Cenovus Energy’s newly diversified portfolio will enable them to stabilise cash flows even in the unpredictable midst of the pandemic. By utilising Husky’s North American upgrading, refining and transportation network, the future value chain will be shortened, procuring a reduction of costs, including the costs associated with heavy oil transportation. More recently the deal has gained publicity due to the 2000 job cuts Cenovus is enforcing, to realise the $600 million of operational synergies; this is to say roughly 25% of the whole company has or will be facing redundancies in the coming months, due to overlaps when the two companies merge - an often inevitable part of merging organisations.
The concern of Cenovus shareholders was centred around Husky’s focus on refining, as this could potentially hinder the company taking advantage of the rising oil prices. Upon the deal’s announcement, the Cenovus share plummeted 12%, indicating this initial uncertainty – Husky’s on the other hand rose by 6.5%. This may indicate that more benefits are to be felt on Husky’s side compared to Cenovus. Since then however, shareholders voted overwhelmingly in favour of the deal on December 15th, which then closed on January 1st 2021. The transaction is accretive for all shareholders, on the basis of cash flow and free cash flow per share.
The merger will result in $1.2b worth of annual free funds flow synergies, achievable independent of commodity prices, with the integrated company becoming the 3rd largest producer and the 2nd refiner in Canada. This will result in strengthening its position on the domestic market and allowing it to focus on the fast-changing US market. With the US re-entry into the Paris Agreement, there will be an increased demand for green energy solutions ,as well as technologies that could make oil production and refining more efficient. Cenovus’ operations rank amongst the lowest in the context of production emissions intensity compared to its peers, which gives it a competitive edge while competing on the US energy market.
The recent news regarding the Keystone pipeline has affected many oil companies. The oil pipeline, which runs between Alberta and Patoka, Illinois, passing Nebraska and Saskatchewan, should now be in its fourth phase, and would have allowed the transmission of 830,000 bbls/day. This phase, named Keystone XL, met disapproval from Barack Obama, approval from Donald Trump, and rejection once again by the newly inaugurated Joe Biden. The pipeline was commissioned by TC Energy and was supposed to stretch 526km, starting from Alberta and joining pre-existing pipelines in Nebraska. Cenovus should have felt the repercussions of Biden’s decision to cancel the planned works, but has instead been shielded by the merger as it is able to send more of its crude oil to Husky’s refineries in the USA.
With Cenovus share price eroding during the last few years, the merger combined with the increased demand for Energy post-covid could boost the share price in the long term. Lastly, the focus on deleveraging means the company can expect to achieve a net-debt-to-adjusted- EBITDA target of less than 2x in 2022.
Risks and uncertainties
Historically, Cenovus has been a pure play crude producer, apart from owning 50% stakes in a handful of US refineries. Husky’s portfolio is more integrated, with a retail gas business, refining operations, and offshore operations in Asia. While such setup is expected to reduce the combined company’s exposure to volatility in oil prices, the merger's success hinges on a smooth integration of the assets. If setbacks are experienced, synergies, as well as netback improvements may not be fully realised, jeopardising the company’s ability to rebuild the balance sheet, which was strained by excessive debt taken to finance the acquisition of ConocoPhillips’ Canadian assets in 2017.
Key determinants of Cenovus' post-merger performance include correct utilisation of Husky’s know-how and prioritisation of business areas, including potential divestitures. While it is not yet clear which properties will be sold, Cenovus CEO Alex Pourbaix has stressed the firm’s commitment to bolster its financial position by parting with non-core assets. This represents another area of uncertainty surrounding the deal. Determining which assets fit the long-term vision of the firm is always a challenge in M&A. Additionally, finding buyers in the energy industry, which was particularly hit by COVID-19 raises further questions concerning Cenovus’ plan. Nevertheless, the fact that this was an all-stock deal reduces the urgency to strengthen cash balance, as no additional debt was undertaken to finalise the transaction.