Cenovus Drops Most Ever as $13.3 Billion Deal Ramps Up Risks (1)

(Bloomberg) -- Cenovus Energy Inc. fell the most since its trading debut more than seven years ago after agreeing to buy Canadian oil assets from ConocoPhillips for C$17.7 billion ($13.3 billion) in a deal that increases its risks at a time of uncertain oil prices.

Cenovus is paying Conoco C$14.1 billion in cash and 208 million shares for its 50 percent stake in their Foster Creek and Christina Lake oil-sands venture, plus most of its conventional assets in the Deep Basin of Alberta and British Columbia. The deal is the latest sale of energy assets in Canada by international companies gravitating toward higher-profit drilling in U.S. shale basins.

While the acquisition will double the Calgary-based producer’s reserves and production, it ties it heavily to one of the costliest methods of producing oil after prices sank below $30 a barrel just last year. The deal also weakens its balance sheet, with Cenovus funding the cash portion of the deal by tapping its credit line, taking on a C$10.5 billion bridge loan and selling C$3 billion of shares at a discount to recent prices.

“Cenovus’ risk profile has drastically changed with this deal,” Chris Cox, an analyst at Raymond James in Toronto, said in an interview. “The company had one of the strongest balance sheets in its peer group, to now unequivocally having the highest-risk profile of the Canadian large caps.”

Cenovus limited its upside on the acquisition by agreeing to make contingent payments to Conoco over the next five years if Western Canadian Select prices rise above C$52 a barrel. Also weighing on Cenovus shares was Conoco’s statement that it plans to start liquidating its holdings in the stock after a six-month lockup period.

Shares Tumble

Cenovus shares slid as much as 13 percent to C$15.24 in Toronto, the biggest intraday decline since it was spun off from Encana Corp. in November 2009. The shares already were down 14 percent this year through yesterday. Meanwhile, Houston-based Conoco had its best day in four months, rising as much as 9.7 percent to $50.41 in New York.

The sale comes two weeks after Canadian Natural Resources Ltd. agreed to spend C$12.7 billion to buy assets in Alberta from Royal Dutch Shell Plc and Marathon Oil Corp. It follows by a month Conoco’s announcement that its reserves fell to a 15-year low after removing oil-sands barrels that were uneconomic as crude prices sat below $50 a barrel.

The new assets allow Cenovus “to take full control of our best-in-class oil sands projects and to add a second growth platform across the prolific Deep Basin that provides complementary short-cycle development opportunities,” said Brian Ferguson, Cenovus chief executive officer.

Largest Shareholder

Combined, the holdings in the agreement can produce 298,000 barrels of oil equivalent a day in 2017. The transaction, expected to close in the second quarter, will make Conoco into Cenovus’s largest shareholder, with about a 25 percent stake.

With about 440,000 barrels a day of capacity after the acquisitions, Cenovus will be the third-largest oil-sands producer by the end of the decade, behind Suncor Energy Inc. and Canadian Natural, according to company statements.

In a separate statement, Conoco said it would use the proceeds to reduce debt to $20 billion in 2017, and to double a share repurchase program to $6 billion. The company plans to triple its buybacks this year to $3 billion, with the remaining $3 billion spent in the next two years.

“We were just looking for the maximum value that we could get for the assets, and that happened to come from a combination of cash and equity and the contingent payment," Chief Financial Officer Don Wallette Jr. told analysts on a conference call Wednesday.

Conoco doesn’t plan to remain a shareholder in Cenovus for the long-term and will sell its position “over time and do it in an orderly way,” he said.

Maximum Value

The transaction will be Cenovus’s biggest since it was separated from Encana Corp. in 2009. In that split, Encana retained most of the previous company’s natural gas assets, while Cenovus held the oil assets. The current deal is the largest in the Canadian oil patch since CNOOC Corp. bought Nexen Energy for $17 billion in 2012.

The industry has long been hampered by a lack of adequate transport options to move its crude to market. A series of proposed pipelines -- and renewed support in the U.S. for the Keystone XL project -- may help to ease a bottleneck that has kept Western Canadian oil prices below global benchmarks.

Canadian Natural, Cenovus and MEG Energy Corp. have announced expansion projects in the past five months that will add a total of 110,000 barrels a day of capacity when completed in 2019.

Despite the risks, Cenovus’ purchase of the Conoco assets makes strategic sense, said Benny Wong, an analyst for Morgan Stanley. The deal gives Cenovus full strategic control of the oil-sands project and will allow it to provide increased clarity about its long-term outlook, he said in a note Thursday.

“Acquiring producing assets that are familiar and top-tier is a much more welcome scenario for the market rather than accelerating spend to develop new projects and have to wait several years before seeing cash flow,” Wong said.

(Updates with analyst’s comment in fourth paragraph.)

--With assistance from Michael Bellusci

To contact the reporters on this story: Alex Nussbaum in New York at anussbaum1@bloomberg.net, Kevin Orland in Calgary at korland@bloomberg.net, Robert Tuttle in Calgary at rtuttle@bloomberg.net.

To contact the editors responsible for this story: Reg Gale at rgale5@bloomberg.net, Tina Davis at tinadavis@bloomberg.net, Susan Warren

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