Analysts praise Talisman's latest deal
Pays $806M for Petromet: Tax deferral among many advantages of acquisition
Financial Post, April 26
By Claudia Cattaneo, Calgary Bureau Chief
With the acquisition of Petromet Resources Ltd. two weeks ago, Talisman Energy Inc. made its comeback as an acquisitor after an absence of nearly two years.
The $806-million purchase of one of Canada's last available mid-sized natural gas producers has received mostly positive reviews. The purchase allows Talisman to defer taxes at a time when tax bills are escalating across the industry because of fat profits.
The move also builds up natural gas production when commodity prices are strong, is a good fit with existing assets in Alberta and provides a sensible place for cash-rich, low-debt Talisman to deploy its reserves when investment opportunities are getting scarcer because of continuing oilpatch consolidation, analysts said.
Talisman is offering $13.20 a share, or a 26% premium over Petromet's previous closing price. The deal includes the assumption of $45-million in debt.
The deal is seen as pricey for valuing Petromet's natural gas at about $2 per thousand cubic feet in the ground, or top dollar compared with what's been paid for Canadian natural gas assets so far. A concern is that Talisman may be making the purchase at the top of the market, putting itself at risk if there's a commodity price collapse.
Talisman appeased worries by selling forward Petromet's entire production for around $8 per thousand cubic feet until the purchase pays for itself by 2003, with the result that most analysts continue to rate Talisman as one of the sector's top buys.
"However you slice this thing, it's certainly not cheap ... but the win that you don't see directly with the numbers is the tax side of it," said Martin Molyneaux, director of research at FirstEnergy Capital Corp., who rates Talisman a "buy" with an $86 target in 12 months, for a one-year return of about 44%.
By setting up a partnership as the transaction vehicle, Mr. Molyneaux says, Talisman will be able to defer income taxes of around $50-million per quarter until 2003. The acquisition also adds between 120 million and 150 million cubic feet a day of natural gas, and an inventory of drillable prospects of between 180 and 250 locations.
With cash flow mounting because of high oil and gas prices, Mr. Molyneaux estimated the company needs to buy a Petromet every six months on top of its capital spending to put to work all the cash it's generating.
"The bottom line is this deal is accretive to both earnings per share and fully diluted cash flow per share if you are a gas bull, as we are," Mr. Molyneaux said in a recent report. "Even if you are not a gas bull, Talisman's action of selling forward 100% of Petromet's net production will result in a payout of less than two years."
Talisman shares (TLM/TSE) closed at $62.10 yesterday, near their lifetime high of $64.60.
The stock still trades below the valuation accorded to such peers as Alberta Energy Co. and PanCanadian Petroleum Ltd. because a higher proportion of its production is oil, whose price outlook is not as strong as that of natural gas, and because of the so-called "Sudan effect" -- a discount attributed to a divestment campaign orchestrated by human rights organizations opposed to its operations in the war- and famine-ravaged African country.
First quarter results due on May 1 are expected to be exceptional, although not as spectacular as those of peers with a larger natural gas weighting. Analysts polled by First Call expect Talisman to post earnings of $2.31 a share, up from $1.40 in the same period last year.
Steve Calderwood, analyst at Salman Partners Inc., praised the Petromet acquisition for its tax advantages and its good fit with Talisman's other holdings.
Mr. Calderwood rates Talisman a "buy" with a target of $88 in 12 months.
UBS Warburg, which rates Talisman a "top pick," is also positive on the deal and increased the stock's 12-month target to $85 from $80, on cash flow per share rising from $19.35 for this year to $21, and from $16.15 to $20.55 in 2002. UBS says Talisman is trading at about 2.9 times cash flow per share for 2001, compared to 3.5 times for AEC and 4.2 times for PanCanadian.
Talisman's oil production, at 270,000 barrels a day, is the largest of any Canada-based company next to Imperial Oil Ltd. and will exceed Imperial's oil volumes next year. Its natural gas production, at more than a billion cubic feet a day including Petromet, is surpassed only by AEC and PanCanadian.
Talisman's ability to make major acquisitions using its stock has been constrained by its low share price. The Petromet transaction is Talisman's first since its purchase of Rigel Energy Corp. in August, 1999, for $1.2-billion.
Mr. Molyneaux says the Sudan discount has shrunk, although it still depresses Talisman's share price by about 3% to 5%, down from about 12% two years ago. That's because Sudan has been less in the news and the U.S. government seems less preoccupied about singling out the country as a priority to deal with.
But Mr. Calderwood pegs the discount at $15 to $20 a share. Talisman's public relations efforts to improve perception of its Sudanese operations have not changed the valuation, although they may make employees and existing shareholders feel better about themselves, he said. It will take a sale of the asset, or a change in U.S. policy toward the African country, to eliminate the discount, Mr. Calderwood said.
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