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Oct 22, 2018

Prospect of MEG bidding war means bonds still have room to run

MEG rejects Husky takeover offer


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Debt holders of MEG Energy Corp. are betting the Canadian oil-sands developer will accept a sweetened takeover bid from Husky Energy Inc. -- or from another interested bidder.

The Calgary-based oil and natural gas company rejected the unsolicited Husky bid, arguing it significantly undervalues the company, and that it expected superior offers to emerge. If the company manages to get a better bid and accepts it, the bonds are poised to jump by about four cents over the next couple months, according to projections made by analysts and portfolio managers.

MEG’s $1 billion unsecured notes due 2024 have already surged 16 per cent to 99.6 cents on the dollar, according to Trace, the bond price reporting system, after Husky made a $3.3 billion hostile bid for the company on Oct. 1

"We’re good to hold here because in a takeout scenario, we’ll be able to collect that 7 per cent coupon and have an option to the upside through the 101 change of control," said Daniel Cooper, portfolio manager at Mackenzie Financial Corp. in Toronto, referring to the bondholder’s right to sell the bonds back to the company at 101 percent of face value if the change of control is triggered. "Or we could continue to hold the 7 per cent bonds in a higher-rated credit structure," he said.

Husky offered to pay MEG shareholders either $11 in cash or 0.485 Husky shares, subject to pro-ration. Husky Chief Executive Officer Rob Peabody took his cash-and-stock proposal directly to shareholders after MEG’s board spurned an earlier approach. MEG said after reviewing the offer with its financial adviser, Bank of Montreal, it was recommending investors not tender their shares.

Some Risk

While some analysts say MEG could also draw interest from companies including Suncor Energy Inc., Imperial Oil Ltd. and Canadian Natural Resources Ltd., the rejection will likely prompt Husky to boost its offer rather than a white knight coming into play, according to Chris Cox, an equity analyst at Raymond James Ltd. in Toronto.

“We see a deal being consummated here, albeit likely at a higher price than Husky’s current offer,” he wrote in a report.

The pursuit of MEG is happening against a backdrop of plunging Canadian crude prices. Western Canada Select has traded at a record discount to West Texas Intermediate in October as rising oil-sands production bumps up against pipeline bottlenecks and maintenance at U.S. refineries.

“There is still some deal risk, obviously, given the nature of the hostile takeover attempt, so the bonds won’t trade up to fair value for now, unless there is a high degree of certainty that the deal will happen or a bidding war starts and drives the price above the bid," said Cooper at Mackenzie, which manages $44 billion in fixed income.

MEG’s shares closed at $10.92 in Toronto on Oct. 19, close to Husky’s cash offer.

Marc-Andre Gaudreau, a senior portfolio manager at 1832 Asset Management LP in Montreal, warns of asymmetrical risk, as bonds could lose as much as eight cents if the offers don’t come through. If the company’s debt ends up being assumed by an investment-grade buyer, MEG bonds could trade about 25 basis points wider than the buyer’s spreads.

The bonds’ surge on speculation of a takeover makes them too pricey to buy right now, Gaudreau said.

“Also, the probability of a make-whole is there, but there is no rush," he said. A make-whole call provision allows the issuer to pay off remaining debt early. The issuer typically has to make a lump-sum payment to the investor based on the principal and future coupon payments.

--With assistance from Michael Bellusci