Capricorn Energy’s LSE:CNE proposed GBP657m merger with Tullow Oil LSE:TLW was thrown into more doubt, as Palliser Capital, one of Capricorn’s biggest investors, wrote a letter to the board objecting to the transaction.
In the letter, Palliser Capital – which holds over 5% of Capricorn’s stock – said: “…rather than the touted ‘merger of equals’, the proposed merger appears to us to be a poorly disguised nil-premium takeover of Capricorn by Tullow…”
Palliser claimed that the proposed merger was purely a cash-grab by Tullow Oil to pay off the significant debts it had built up in its exploration forays in Africa and South America. The letter said that Tullow was intending to use: “Capricorn’s substantial net cash balance, available after years of arbitration, […] towards repaying Tullow’s junk-rated creditors, with zero value attributed to Capricorn’s remaining high-quality and unencumbered assets.”
The proposed merger is an all-share transaction whereby shareholders of Capricorn, will receive 3.8068 of new Tullow shares for each share held. Upon completion of the transaction, Tullow shareholders will hold around 53% of the combined entity while Capricorn shareholders will own the remaining 47% interest. The proposal claims that post-merger the company will have a combined production of around 100 million barrels of oil per day.
Capricorn Energy undervalued
However, Palliser claimed that: “The proposed merger materially undervalues Capricorn and its straightforward asset base, which includes a substantial net cash position, low-risk contingent receivables and a high-quality, opportunity-rich Egyptian portfolio.”
Palliser said: “Based on our own in-depth analysis and with the benefit of extensive third-party input, we strongly believe that Capricorn Energy can realise value of at least 330p per share, representing a 50% upside to the current share price and a 67% upside to the terms of the proposed merger.”
Palliser thought that the terms of the deal were “an illogical exchange of low-risk assets for speculative paper.”
Palliser joins investors Legal & General Investment Management and Kite Lake in criticizing the deal and called for a strategic review at Capricorn. Palliser holds a stake of more than 5% in Capricorn, L&G holds around 4%, while hedge fund, Kite Lake has interests worth 6.7%.
Palliser first expressed its concerns to Capricorn on 1st July in discussions with top executives, something that it alluded to in the letter, but found the Capricorn board unsympathetic. Both Tullow and Capricorn have recommended the deal to their shareholders.
Palliser’s main objections were that the transaction would surrender shareholder value as the merger did not take into account the value of Capricorn’s non-cash assets. The transaction valued Capricorn’s Western Desert assets at zero, something that the company paid USD323m for in net cash less than a year ago. The transaction, they say, would in effect give away two-thirds of the company’s market cap.
Backward step
The fund manager also said that Capricorn was swapping relative stability, probity and sustainability to become part of one of the worst performing and riskiest companies in the EMEA oil & gas sector. Fundamentally, the deal, said Capricorn, would just be bailing-out Tullow from a very uncomfortable place “allowing it to de-lever its stressed balance sheet via what [Palliser saw] as a backdoor rights issue, at a premium to its current share price.” It would also be a backward step in ESG terms.
Palliser poured scorn on Tullow’s claim that the merger would create “a leading African energy company”, calling it “…little more than a marketing ploy” lacking in genuine synergies, noting that Tullow only last year warned shareholders of a significant risk that it may not survive as a going concern, following chronic underperformance of its flagship deep-water fields in Ghana, the abrupt departure of its senior management team and a subsequent fire sale of assets to avoid insolvency.
Tullow, said Palliser, is highly indebted, has no distributable reserves, has a portfolio of riskier, longer-dated assets and is facing acute funding challenges, including a need to refinance high yield debt carrying an onerous 10.25% coupon.
The deal also, thought Palliser, would go back on promised capital allocation, depriving shareholders of a promised and long-overdue return or accretive deployment of hard-fought cash recovered through the settlement of the Indian tax arbitration.
The letter concluded that there was no deal worth pursuing, and fired a warning shot across the bow of Capricorn management highlighting Capricorn’s “bloated administrative function” and “the close relationships between the Tullow and Capricorn executive teams, management fatigue and/or other factors unrelated to enhancing shareholder value,” providing the momentum behind the deal.
Neither Tullow nor Capricorn have made any public response to Palliser’s objections.
Uncompelling
Ashley Kelty, an analyst at Panmure Gordon said that any synergies were relatively paltry, throwing shade at there being any link between Capricorn’s onshore Egyptian assets and Tullow’s offshore West African assets, apart from the fact they were on the same geographical continent. He said in a note: “it doesn’t seem a particularly compelling tie-up in my view.” Capricorn shareholders will get a “modest premium” of 4.7%, and they are hardly getting value from their recently acquired Egyptian assets. However, he thought, Tullow would be able to use the transaction to service its large debts.
Capricorn shares were trading at 221.8p mid-morning today (10th August), down from 225.9p at close of play on 9th August valuing the company at GBP713.9m. The shares have offered a year-to-date return of 17.79% with a one-year return of 29.33%, ranging between 166.8p and 238.8p over 52-weeks.
Tullow shares were trading at 51.35p, down from 52.55p the day previously, with a market capitalisation of GBP755.9m. The company offered a one-year return of 9.34% and over the year was up by 9.8%. Tullow’s shares ranged from 39.3p to 63.5p over a 52-week period.
