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West Energy (WTL-TSX) Gets To See the Daylight--Tender or Sell?

|Includes: West Energy (WTLFF)

Shareholders in West Energy (WTL-TSX) received a premium buyout offer from Daylight Resources Trust (DAY.UN-TSX) for a combination of cash and stock that essentially works out to $5.30 per share.

For subscribers to Oil & Gas Investments Bulletin, that equates to a 93% profit on a cost base of $2.74 in just six months.

Should investors tender their offer and accept the Daylight stock, or take profits and move on? I am taking profits, but not for the reason you might suspect.


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Analyst reports from the brokerage firms that cover Daylight called the transaction either mildly accretive or mildly dilutive.

From Macquarie:

“..however, at current metrics the deal is neutral to near-term cash flow and 15% dilutive to the current NAV (although when factoring in unbooked Cardium upside, the deal is neutral to our Risked Resource NAV..”

From Canaccord Capital

“After incorporating this acquisition into our model we note that our CFPU estimates increase by approximately 2% while our contingent net asset value estimate increases to $13.45 (from $13.10 previously)..”

From National Bank:

“Overall, our CFPU (FD) estimates increase $0.11 to $1.75 for 2010 and $0.09 to $1.97 for 2011 while our debt-adjusted AFFO (FD) estimates increase $0.14 to $0.76 for 2010 and $0.12 to $0.91 for 2011. Meanwhile, our after-tax blow-down 2010 NAVPU estimate decreases $0.80 to $9.50, including the lower value we ascribe to land and as we defer significant unrisked unbooked Cardium upside as we await further delineation.”

From TD

“We view the transaction as somewhat strategic but at best neutral in terms of accretion…However, in our analysis after accounting for land costs, the economics of the play decline materially (but remain positive) unless IP rates and reserves are higher than our preliminary analysis of the play…While this acquisition provides additional drilling inventory, we believe that much of the future upside has been paid for.”

TD’s comments echo  a similar theme that I heard when Petrobakken bought out both Berens and Result Energy, in January and February respectively.  Were they paying too much?  Were they overcapitalizing these assets to the point where no meaningful return could be delivered to shareholders?

There is still a large group of institutional investors and analysts who are sceptical of the Cardium.  They’re not disbelievers, they just point to the fact that there are very few wells reported from this hot new play, so statistically they’re not yet comfortable saying that the whole Cardium will see the same 200 bopd IP rates that many of the wells have reported to date.

But when investors take in what Daylight paid for 60 prospective sections of Cardium when they bought Highpine Oil & Gas last summer – about $35,000 per flowing barrel (now THAT deal was the steal of 2009 – right before the Cardium mania took off), their cost on 100 net prospective sections is well below current market value. 

Highpine and West were both oil weighted producers in Pembina Nisku trend of Alberta, and many investors thought they should merge.  Now they have – into Daylight.  The synergies of the two similar asset bases made West an obvious choice for Daylight.

And because West’s other production is oil, not gas (like Berens, Vero or Bellatrix), Daylight has also got the cash flow from existing assets to pay for the development of their Cardium lands.

But Daylight is still 55% natural gas weighted after this transaction.  If you’re bearish on natural gas prices, that’s 55% of your production giving you very little cash flow.  However they have hedged 20% of 2010 production at $6.01/mcf (AECO spot price at is now $4.32/mcf)

There is a lot to like about Daylight – their overall Cardium acquisition metrics between Highpine and West is a great deal in this market.   Production is up 75% year over year. 100% success rate in drilling in 2009.  Finding costs under $20/barrel. They were heavily gas weighted, and management nimbly bought themselves out of that tough position in a bearish gas market without blowing the balance sheet  (though keeping the balance sheet steady will likely come before growth if gas prices stay low).

My bearishness on the natural gas market is only part of the reason I’m selling however.  I’m selling because Daylight is converting from a trust into a corporation in May – some 8 weeks from now.  That is generally not a good time to own trusts.

James Keller contributed a column to my site which stated:

“…owning trusts prior to their announcement to convert to a corporation is a one-way ticket to losing “Alpha”.  When it becomes apparent to investors that they face the potential loss of income from a cut in dividends after conversion, the trust begins to underperform its benchmark by roughly 15% in a 6-month period.”

You can read the full article here:

Daylight has a huge drilling inventory – of both oil and gas now, after buying West and Highpine – and a management team that shown they can get financing and get deals done.  But I’m going to wait until after conversion to see how gas prices are faring, and how the market treats the new corporation.

Disclosure: I did own 5000 shares of West; now zero