Petro-Canada / Suncor Merge Offers Interesting Arbitrage Play

Monday, March 23, Petro-Canada (PCZ) and Suncor (SU) agreed to "merge" in an all stock transaction making the merged company the second largest Canadian company (by market capitalization) after Royal Bank of Canada (RY). Shareholders of Petro-Canada will receive 1.28 shares of the merged company for every Petro-Canada share held, while Suncor shareholders exchange one for one. The deal is estimated to close in the third quarter of this year.

Here’s the opportunity: Suncor’s closing price on the NYSE of $23.25 places Petro-Canada’s share value just shy of $30. Petro-Canada ended trading at $27.50, creating an arbitrage spread of about 9%. Buying shares of Petro-Canada and selling the June 30 calls (premium of $2.20) can yield a 17% return plus a dividend payment in 3 months' time, assuming Suncor shares simply remain unchanged.

How certain is that deal completed? Nearly 100%! Canada’s government views the deal as good for Canadian business by reducing the risk of yet another giant Canadian company falling into foreign hands.

The risk, of course, is that the deal is an all stock transaction and depends on Suncor shares not declining in the next 3 months. In addition, an archaic Canadian law prevents any company from owning more than 20% of a company previously owned by the federal government, which Petro-Canada was until the final piece was privatized in 2004.

Would the resulting merged company be worthwhile owning? In the United States, there are better long term prospects than a merged Petro-Canada/Suncor. To take advantage of the current depressed oil stock prices and the positive long term prospects in the energy market, companies such as Exxon Mobil (XOM) and Chevron (CVX) - for integrated oil exposure, and Devon Energy (DVN) - a riskier play more leveraged to natural gas and crude prices, will better serve the investor.

But for now, the opportunity to make a 17% return in a difficult market environment seems appealing.

Disclosure: Author owns a covered call position in PCA.TO and DVN

Comments

[Gravity404:]

Very good observations for both plays. I think oil has seen its lows for a long time. DVN is a acquisition target and has an excellent balance sheet.

Mar 27 09:28 AM

[DrT:]

Good article. There are way too many political interests aligned here in Canada for this deal for it to not go through. Plus Petrocanada finally get to shed their awful management. One of the rare true win-win mergers. You could even get more aggressive and go long Petrocanada and short Suncor.

Mar 28 06:39 PM