Talisman. Wanted: Another Sudan - Well, sort of. Now that it's sold its besieged African stake, Talisman Energy needs to find another that's as profitable but without the bad press.
The Globe & Mail, Friday May 30
By Deborah Yedlin
Just BACK from a trip to Belize, Talisman Energy Inc.'s chief executive officer, Jim Buckee, is sporting a sunburned nose and moving a tad slowly thanks to a sore back.
There's evidently lots on the go in Calgary's Bankers Hall West. Buckee's office on the 36th floor is decorated with scattered piles of papers, a half-eaten sandwich and a magazine open to a photograph of a CEO who happens to head up one of Talisman's primary competitors.
The intense Buckee, one of a handful of CEOs in the world who actually understands rocket science - he holds a PhD in astrophysics from Oxford University - is known for his analytical bent and penchant for challenging convention. He finds there is not enough science in dire global-warming predictions, and continues to believe the people of Sudan were better off when his company was producing oil there.
Talisman's exit from Sudan, Buckee declares, was "the wrong outcome." "We had a voice with the government and a point of access and now that's all gone," he says.
Sudan was Talisman's Faustian bargain. The company's 25% interest in the Greater Nile Petroleum Operating Co. (GNPOC), acquired through the 1998 purchase of Arakis Energy, contributed 22% of Talisman's daily oil production at the enviably low operating cost of about $4 per barrel. But Sudan also put the company on the political hot seat.
The complaint - from aid workers, human-rights groups and churches - was that Sudan's Muslim government was using the oil revenues to fund its military campaign against Christians and animists in the southern part of the country. Talisman was not the only partner in GNPOC, but it was the only one based in the West, so it drew all the heat.
"Relative to the size of the asset, it consumed an inordinate amount of management's time and overshadowed the rest of the company's assets," says Martin Molyneaux, managing director of FirstEnergy Capital Corp., an energy-focused investment dealer based in Calgary. The Sudan controversy even threatened the company's coveted listing on the New York Stock Exchange.
When Talisman's long-rumoured sale of the Sudan stake to ONGC Videsh Ltd., a subsidiary of India's national petroleum company, was finally announced last October, the proceeds were a cool $1.2 billion, meaning Talisman had netted a $340-million after-tax gain on a four-year investment. Yet even though the cheque is in the bank and Talisman's employees are gone from the country, Sudan remained front and centre at the company's annual meeting in Calgary on May 6.
After Buckee went through the highlights of 2002 and discussed the company's first-quarter numbers, which showed substantial increases in earnings and cash flow despite the drop in production, the meeting was opened up for questions...about Sudan. As evenhanded as he was in replying, it was evident that Buckee was anxious to move forward. He must, after all, replace a very prolific asset - as evidenced by the quarter-over-quarter drop in production. And he must re-establish the impressive growth that has characterized Talisman, now Canada's fourth-largest producer of natural gas, almost from the moment it was spun out of the BP umbrella in 1992.
Until then, Talisman was known as BP Canada Inc. At the time of the sale of the 57% stake held by its parent, Talisman's operations were entirely in Western Canada, and production was 51,000 barrels of oil equivalent per day. There was nary a hint the spinoff was going to grow into a company operating in the North Sea, Africa, the Middle East, Southeast Asia, the U.S., the Caribbean and Latin America, altogether boasting production of 445,000 barrels of oil equivalent per day.
The first step in the transformation came in 1993, when Talisman bought Encor Energy, effectively doubling production. The deal also inspired some number-crunching that showed rather vividly that meeting the goal of adding annual production growth of 15% was going to be very tough if Talisman did not look for opportunities outside Canada.
In 1994, a perfect opportunity presented itself in the form of Bow Valley Energy, a purchase that landed Talisman squarely in the North Sea and Indonesia. After that came Goal Petroleum in 1996; the 1998 Arakis deal that put the company in Sudan; Rigel Energy and Highridge Exploration in 1999; and Petromet Resources and Lundin Oil in 2001. There's a pattern to these purchases: natural gas in North America, and oil internationally. The combination of leveraging its strengths in Western Canada, where Talisman continues to boost its natural gas reserves and production, and astute acquisitions that provided international exposure made Talisman into an unusual stock: a big-cap growth story.
The original $12-per-share investment in 1992 yielded an impressive 20% compound annual return over 10 years. Talisman's share price, which consistently trended upward until recently, allowed the company to use its paper to pay for acquisitions.
But Talisman has lost its market-darling status. Its presence in Sudan depressed the company's share price relative to its peer group. Of greater importance was its announcement last October that production for 2003 would be flat instead of growing at the previously forecast 10%.
After a 10-year run, the growth story had stalled. Add to that the impending disappearance of more than 60,000 barrels of oil equivalent per day from Sudan, and Talisman now finds itself on the show-me side of the equation with investors. "The good news is the share price has not dropped, even though the company sold 13% of its total production and its valuation is higher than either Canadian Natural Resources or Nexen," says Brian Prokop of Calgary investment dealer Peters & Co. "But Buckee is still in the penalty box."
How to get back in the game? Another Sudan-type asset obviously would help, but those opportunities are rare, and tend to come up in politically sensitive regions - like Iraq.
Fortunately, the combination of high commodity prices and the $1.2 billion in the kitty from the Sudan sale has put Talisman in the enviable position of having one of the strongest balance sheets in the oil patch. But the cash, along with the fact that Sudan - which effectively acted as a poison pill - is gone, also makes the company a potential takeover target. "When you de-leverage your balance sheet," says Prokop, "you have the balance-sheet strength to take someone over but are also vulnerable to be taken over."
According to one Toronto-based institutional shareholder, the company's weak spot is that it's cheap on a valuation basis: currently trading at three times debt-adjusted 2003 cash flow, while boasting an asset base that would be attractive to a lot of companies with a strong technical team.
Faced with a market that refuses to give its shares full value, Talisman has been actively buying back stock in the open market. It repurchased 5.9 million shares (or 5% of the total) in 2002 and early 2003 at an average cost of $57, and has renewed the program. Apart from signalling to investors that management has faith in Talisman's prospects, the buyback decreases the number of shares outstanding and therefore boosts earnings, cash flow and production per share.
Ultimately, of course, growth has to come from adding production, not decreasing the number of shares.
Given Talisman's broad asset base, there is no shortage of opportunities to boost reserves and production; it's simply a matter of cost and time. Alternatively, the company could go back to its old playbook of growth by acquisition. But Buckee doesn't appear eager to start buying companies again - perhaps because of his concern for Talisman's share price, but also because he expects there will be plenty of opportunity to make meaningful acquisitions of individual assets, which don't come with the headache of dealing with a different corporate culture.
One area where Talisman will not be going is to the oil sands. While the company made a play in that direction in 1997 with its aggressive bid for Wascana Energy, Buckee now feels Talisman's capital is best deployed in areas where the fixed costs aren't as onerous. "When your all-in costs are $25 a barrel, there never is going to be huge upside," he says. The conventional Western Canadian sedimentary basin, meanwhile, isn't being overly generous in yielding new discoveries or adding gobs of new production. Half of Talisman's $2.2-billion capital-expenditure budget for 2003 is being plowed back into North America - for a hoped-for 5% growth in production.
There are some promising spots on the continent, it's true. "Talisman's deeper foothills plays in Western Canada are very attractive but they are not a panacea for growth because you are working very hard to stay flat," says FirstEnergy's Molyneaux. Talisman scored a big find in 2002 that could unlock one trillion cubic feet of natural gas at its Monkman play in northeast B.C., but some of the wells required are $10 million a pop and take six months to drill. Meanwhile, the company has forked out about $500 million to gain a foothold in upstate New York, close to the lucrative northeastern U.S. market. And there are high hopes for an unexploited deep gas play in Appalachia that looks a lot like the deep foothills.
But for all this, Buckee views the opportunities in North America as not especially compelling, thanks to the intense competition for assets and the maturity of the basin. "The only option left is to go elsewhere, and we are rapidly going elsewhere."
Of course, with 49% of its production outside North America, Talisman already is elsewhere: in the North Sea, Southeast Asia, Africa, Latin America. It is also venturing into the Middle East by way of Qatar. The company counts on expanding its overseas reach by capitalizing on the expected wave of asset rationalization by the super-majors like Exxon Mobil, ChevronTexaco and BP.
Still, even without expanding beyond its existing areas, Talisman is well-positioned abroad; its old workhorse of the North Sea continues to be the company's most lucrative core area, despite its high operating costs. Not only did Talisman net $25.93 on average per barrel of oil produced out of the North Sea in 2002, but a successful new well could yield reserves of as much as five million barrels, compared with the average size in Canada of 150,000 barrels. While fragmentation of ownership requires companies to do a lot of horse-trading and asset swapping in order to build meaningful positions and economies of scale, the North Sea also has more than 200 undeveloped fields that could yield significant discoveries. According to Molyneaux, there is further upside in the North Sea for Talisman, but it's tied to the pace of rationalization by the super-majors.
Another workhorse on the international front is Indonesia, where Talisman has contracts to sell 7.5 trillion cubic feet of natural gas over the next 20 years. But that number could go much higher.
There are also high hopes for Algeria, which is expected to produce 17,000 barrels of oil per day by year-end. But the project has been 10 years in the making, and Talisman's partner, U.S.-based Burlington Resources, is "sticky" as to how much it wants to commit to the area, according to Molyneaux. Talisman would rather get involved in projects that are on stream within three years, not 10.
It's the natural gas opportunities in Malaysia and Vietnam that Buckee appears most excited about. Talisman has been active in the area since 2001, when it bought Sweden's Lundin Oil. The area is expected to see net production volumes of 100 million cubic feet per day by year-end.
"We think Malaysia and Vietnam could turn into a hidden gem, much like when Talisman first went into the North Sea eight years ago," says Molyneaux.
It's a project where Talisman has been able to apply its Sudan experience. Sudan taught Talisman how to start from scratch in a new region; it gave the company valuable connections with its partners, Malaysia's Petronas and the China National Petroleum Co., both of which are also anxious to capitalize on the super-majors' rationalization; and it led to the development of corporate social-responsibility policies. Perhaps more than other companies scouring the globe for opportunities, Talisman is now aware of the need to balance political risk against growth objectives. Such risk is front and centre with many investors, and a perception of heightened exposure could do a number on a company's trading multiple.
But all this might be moot if, as some believe, it is only a matter of time before Talisman is bought or finds a suitable merger candidate.
For the past six months, rumours have circulated that EnCana Corp., the uber-independent company created out of the merger of Alberta Energy and PanCanadian Energy last year, might be interested. So great is the competition between the two companies that one Calgary real estate player, trying to land a lead tenant for his proposed office tower, suggested to EnCana CEO Gwyn Morgan that if he signed on the dotted line he'd get a windfall benefit: The new structure will obscure most of Buckee's view. But rivalry aside, Morgan continues to insist that another big acquisition is not on his radar screen.
The other scenario is that Talisman will strike a pre-emptive deal with Canadian Natural Resources in order to fend off a bid from EnCana. Such an alliance would offer synergies, since Canadian Natural also has a big presence in the North Sea; is active in Africa; and has a strong presence in Western Canada.
Whatever future unfolds, Buckee has to reclaim Talisman's title as a big-cap growth story. The name of the company, after all, promises unusual results.
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