BAY STREET-Picking the next Nexen is a risky game

Sun Sep 9, 2012 10:29am EDT

* Talisman, Painted Pony among big gainers

* Lull seen if Nexen deal approved or denied

* TSX energy group up 14 pct since Progress deal announced

By Jeffrey Jones

CALGARY, Alberta, Sept 9 (Reuters) - A few Canadian energy companies have China to thank for pushing up their shares this summer even as oil and gas prices languished.

Its state-owned enterprises have racked up more than C$25 billion ($25.59 billion) worth of deals in Canada in less than a decade - the latest being CNOOC Ltd's offer for Nexen Inc - and some investors are handicapping the next targets.

Gainers include Talisman Energy Inc, Celtic Exploration Ltd, MEG Energy Corp and Painted Pony Petroleum Ltd, all with shale gas, oil sands and other holdings deemed as attractive to Chinese and other Asian state-backed enterprises.

It's a risky game, though, and here's why.

The Nexen deal, the largest so far at $15.1 billion, has created a conundrum for Prime Minister Stephen Harper's Conservative government as it begins its review to determine if the transaction will result in a net benefit to Canada.

Some members of his own cabinet are said to be uncomfortable with the Chinese scooping up such a large position in the Alberta oil sands, especially as Canadian companies complain of being denied access to some of China's resources.

In addition, Harper said last week that his government has decided to formulate guidelines for the size and types of future acquisitions it will allow by state-owned enterprises as it vets the Nexen deal. All of this could take 75 days or more.

That, and some opposition in Washington, has certainly given investors the willies, and Nexen's shares are holding well below CNOOC's bid price of $27.50 each. On Friday, they closed at $25.65 on the New York Stock Exchange.

Gains in other stocks started in late June, weeks before CNOOC announced the Nexen deal, when Malaysia's Petronas bid for its partner in a big British Columbia shale gas and LNG development, Progress Energy Resources.

In that time, Talisman has climbed more than 20 percent, Celtic 30 percent and Painted Pony 33 percent. The Toronto Stock Exchange energy subgroup is up just 14 percent since then and is well down from the 2012 peak it hit in February.

Even a green light from Ottawa for the Nexen deal could lead to a lull in deals, Macquarie Capital Markets analyst Chris Feltin said.

"It's tough to see anyone coming in and making a corporate bid for Talisman or Encana with Nexen having just gone out the door, so I think there's a first-mover advantage here for Nexen," Feltin said.

"Secondly, if Nexen isn't approved, I think that will shut the door on any further transactions for our large energy companies on a corporate basis. So I'm actually not expecting anything major until the Nexen deal clears and after a cooling-off period."

The national energy companies have shown a preference for companies and assets with distinct characteristics, like acreage with large reserves of either shale gas, such as the Montney in northeastern British Columbia, or oil sands in Alberta.

They scope out holdings in which they can deploy their cash war chests to quickly accelerate development, said Brook Papau, analyst with ITG Investment Research.

"In general, and there are a few caveats, we've seen that happen with some more distressed companies," he said. Nexen, for example, was among the cheapest stocks in its peer group before the offer due to a record of missed financial targets.

More than once the acquisitors started out as partners in a domestic company's project before deciding to a bid for the entire firm.

CNOOC had become familiar with Nexen as a 35 percent owner of the company's Long Lake oil sands development, and Petronas got to know Progress through the Montney joint venture before eventually agreeing to pay C$5.2 billion for the company.

Papau said it is clear that Ottawa did not view the takeover of Progress as warily as it does that of Nexen, and that deal is all but done.

Some of that might have to do with size.

A producer with a market capitalization of C$1 billion to C$5 billion represents a "sweet spot" for potential acquisitions by Chinese and other state firms, said Martin Pelletier, portfolio manager at TriVest Wealth Counsel Ltd.

"You're not spending too much; it's very reasonable. And there's a high probability that it will get approved," he said.

Takeover bids for companies larger than Nexen, such as Encana Corp and Canadian Natural Resources Ltd are sure to stoke already-smouldering nationalist fears and are doubtful to get done, Pelletier said.

For investors, he recommends buying companies with strong fundamentals rather than for the odds of a takeover by state-owned enterprises, as so many risk factors come into play.

"That said, it's a great time to be investing in the sector as a whole because in many cases companies are trading at levels that transpired in '08 and '09 ... and maybe one or two of them get taken out," he said. "It's happened with us in our fund, and we've been able to benefit from it."

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