Strathcona Resources and Cenovus Energy are engaged in a David vs. Goliath struggle for MEG Energy.Chris Bolin/The Globe and Mail
The David-and-Goliath narrative resonates over centuries precisely because it is rare and inspiring for the underdog to prevail against an overwhelming opponent. In many respects, the battle for MEG Energy echoes that story, with Strathcona Resources taking on Cenovus Energy, an industry heavyweight whose market capitalization is five times larger.
In the biblical tale, David relies on ingenuity and decisiveness, armed with nothing more than a sling, to bring down the giant Goliath. Strathcona has far more than a slingshot at its disposal and its actions proved decisive in amassing 14.2 per cent of MEG’s shares – potentially enough, with support from 10 to 15 per cent of fellow MEG shareholders, to block Cenovus’s proposed takeover, which requires approval from two-thirds of votes cast.
Strathcona is not well known to Canadian investors. It was founded in 2017 by Waterous Energy Fund, which currently still owns almost 80 per cent of the company. Waterous Energy Fund is Canada’s largest oil and gas focused private equity firm, centred on value-based investments in the Canadian oil and gas sector.
Earlier this month, the company revised its hostile offer to 0.80 of a Strathcona share for each MEG share it doesn’t already own. Its initial bid this spring combined cash and stock. The revised offer, valued at $30.86 per share, increased from $28.02. Strathcona also plans to pay a $2.14‑billion dividend (non-taxable on election) regardless of whether it acquires MEG.
If shareholders accept Strathcona’s offer they will receive a $5.22 per share payout, or $4.18 per MEG share; otherwise, Strathcona shareholders will get a $10 per share payout.
Cenovus’s bid consists of $20.44 per share in cash and 0.33125 shares, with an implied value of $28.44. It offers a 39 per cent premium to MEG’s mid-May share price but still falls short of Strathcona’s offer.
MEG Energy urges shareholders to reject takeover offer from Strathcona
We will likely know by MEG’s Oct. 9 shareholder meeting whether Strathcona has landed a decisive blow. In the meantime, Cenovus is playing the part of Goliath – mocking Strathcona’s bid in a presentation released last week and insisting in interviews that its offer for MEG is “fair and final.”
Cenovus’s presentation was intended to persuade MEG shareholders, but it makes a better case for Strathcona’s alternative proposal. In the presentation, the company emphasizes that it is paying 7.5 times EBITDA for MEG (equivalent to $28.44 per share), while pro forma Strathcona would trade at 6.8 times EBITDA ($29.58 per MEG share).
The Cenovus Christina Lake oilsands facility southeast of Fort McMurray, Alta.AMBER BRACKEN/The Canadian Press
Put differently, Cenovus has effectively underscored that Strathcona’s bid delivers the bulk of the accretion – in terms of net asset value per share and other financial metrics - to MEG shareholders, which is possible because the synergies represent over 8 per cent of 2025 funds from its combined operations versus less than 2 per cent for Cenovus.
Cenovus’s attempt to highlight Strathcona’s postdeal valuation multiple was meant to underscore potential drawdown risk, noting its chosen peer group trades at 5.8 times EBITDA (or $24.80 per MEG share). Unfortunately, institutions remain highly averse to short-term drawdowns, which was evident when proxy advisor ISS cautiously recommended Friday that shareholders support the Cenovus offer out of concern for a near-term decline. But while pullbacks are always possible, they say nothing about intrinsic value.
Cenovus makes case for MEG Energy bid against rival Strathcona offer
Strategically, Strathcona’s $5.22 per share payout to investors after the deal closes gives shareholders, including the new MEG holders, the flexibility to repurchase at the prevailing price, effectively executing their own buyback. In that sense, any postdeal drawdown is more of an opportunity than a risk.
Ultimately, share prices are driven by supply and demand. Beyond the potential inflows from reinvestment of Strathcona’s planned $2.14-billion distribution, the company also stands to benefit from passive demand: Its larger float will be combined with MEG’s in the benchmarks where MEG is already included, and it may qualify for additional benchmarks given the much larger market capitalization.
Passive demand should only grow over time as Waterous Energy Fund distributes shares from its funds to limited partners over the next three years. This provides steady and growing support for the shares incentivizing long term investors to position themselves early to be ahead of the flows.
Despite the clear passive flow benefits of the transaction, many energy sector specialists remain opposed, advising portfolio managers not to tender their shares to Strathcona’s offer. Their main argument is that Strathcona owns lower-quality assets that deserve a discounted multiple. But their case falls flat in several ways.
Most notably, after the deal closes, Strathcona will retain the option of selling the acquired assets to Cenovus at a time of its choosing for more than $8.2-billion in cash. This would be the equivalent of selling equity at almost $42 per Strathcona share or over $33 in MEG share terms, creating a considerable margin of safety.
Equally important, Strathcona takes a very different approach to capital allocation – one that has more in common with Constellation Software than with traditional energy peers. Both companies focus on maximizing portfolio returns and uses a decentralized approach to manage operations while still benefiting from scale and sharing best practices.
For Constellation investors, that mindset is second nature. For energy sector specialists, it is almost the opposite of their framework, which optimizes for output from individual operations while overlooking the portfolio effect on company wide returns. In part due to the synergies, netbacks at Strathcona will be higher than MEG on a stand-alone basis, increasing returns.
Strathcona shares other traits with Constellation, including its approach to compensation. Constellation avoids traditional stock-based compensation and funds all acquisitions with cash, which keeps its float exceptionally tight. Employees are required to buy shares in the open market, a structure that helps explain the stock performance.
Because Strathcona shares are tightly held, passive demand from increases in its float may have a larger than normal impact on its stock price. At the same time, employees are paid cash bonuses but must meet minimum ownership requirements, ensuring they are likely to be providing support when prices are low.
Alignment extends to the boardroom. Unlike MEG’s current directors, most of Strathcona’s board members have the bulk of their net worth invested in the stock. The compensation structure reinforces that ownership culture: Strathcona plans to pay a $2.14‑billion distribution regardless of whether its bid for MEG succeeds.
In either outcome, if the share price were to fall by more than the payout, employees would likely use the added liquidity to increase their positions – and be able to do so without triggering tax consequences.
Pumpjacks draw oil out of the ground near Olds, Alta.Jeff McIntosh/The Canadian Press
MEG shareholders are right to argue that their core asset deserves to trade at a premium – and Strathcona is offering exactly that through its all‑equity tender. Like-minded investors have the chance to help Strathcona close the deal by buying MEG shares and tendering them, effectively creating Strathcona stock at a discount based on the 0.8 times proposed exchange ratio.
Portfolio managers that gravitate toward quality businesses are the most likely to recognize Waterous Energy Fund’s capital allocation record, and are also likely to be underweight commodity exposure while overweight high quality companies with sky high multiples. Diversifying into Strathcona should increase margin of safety and provide diversification in their portfolios.
Unlike most commodity exposure, oil sands stand apart for their high margins, high returns on incremental capital and long reserve lives. Unlike the peer group, the combined company is 100 per cent oil exposure with no refining or mining operations which should demand a premium.
When paired with Strathcona’s disciplined yet opportunistic approach to capital allocation, that durability creates the potential floor returns similar to quality stocks but at much lower valuations providing margin of safety.
Berczy Park Capital owns both Strathcona and MEG, collectively representing nearly 10 per cent of net assets. We are confident that – regardless of whether MEG is acquired – Strathcona should deliver a compound annual return exceeding 15 per cent over the next five years, even if the subdued oil price environment continues.
Asheef Lalani, CFA, is chief investment officer at Toronto-based family office Berczy Park Capital. He was previously a portfolio manager for UBS Securities and auditor at PricewaterhouseCoopers.