For anyone that has been paying attention to the Canadian oil and gas industry recently, there has been a lot of buzz about a hostile takeover of Savanna Energy Services Corp. (OTC:SVGYF) by Total Energy Services Inc. (OTC:TOTZF). In November, Total Energy Services made an unsolicited takeover bid of Savanna Energy Services for .1132 shares of Total Energy; this bid was recently upped to .13 shares in December; and increased again to .13 and $.20 cash for every share of Savanna Energy, as Savanna continued to rally. The plot thickened last week after Western Energy Services Corp. (OTC:WEEEF) announced a bid to acquire Savanna for .85 shares for every share of Western Energy, which was recently upped to .85 plus $.21 cash. As of March 17th, the Total offer values Savanna shares at $1.90, while the Western offer values shares at $2.14.
Savanna Energy Services is currently trading at $2.01, suggesting a slight loss if the Total offer goes through, and a slight gain if the Western merger goes through. However, despite the outcome of acquisition activity, it makes sense to take a position in Savanna Energy Services right now. Either one of these acquisitions would overall be beneficial for Savanna shareholders, so it seems reasonable to buy now, regardless of the outcome of the acquisition.
Savanna Energy Services
Savanna Energy Services is a Canadian Oil and Gas services company that specializes in contract drilling, well servicing, and rentals. The company was once one of the largest oil and gas service companies in Canada, however, it was over-leveraged going into the downturn, and the share price had collapsed to as low as $1.05 per share in 2015. Since then, significant cost cutting and structural reorganization have resulted in an impressive ability to maintain margins and produce positive cash flow, while continuing to pay off debt. I recommended Savanna Energy Services in previous articles written in 2015, which may be helpful to get more of a background about the company.
Total Energy Services
The Total Energy Services hostile takeover bid has been described as opportunistic by Savanna management, and I generally agree. It is very clearly an opportunistic bid. However, that does not necessarily mean it is a bad deal for Savanna shareholders. At the end of the day, Total Energy Services is a fantastic company. I kept my eye on this company closely during the downturn. However, I never took a position in the company simply because the share price never went low enough. This is for good reason, however, as the company was never in any financial danger at any point during the downturn. Cash flow has remained positive over the last two years, the already low debt was lowered further, and costs were effectively cut. An acquisition by Total Energy Services would clearly be a great deal for Savanna shareholders in the long term for a number of reasons. The most obvious reason is that the combined cash flow should allow the new entity to pay off Savanna’s large and soon-to-be-maturing senior debt. Although I posted in previous articles why I believe Savanna Energy Services should be able to pay off its debt without major dilution, it is very reasonable to assume that further dilution will be in the books if no deal is reached.
The reason why I don’t fully support a Total takeover of Savanna Energy Services is simply a matter of the price being a bit too low. I would argue that the dilution effects on Savanna shares could be greater if it was to be acquired by Total, than if it was to dilute its shares itself. I don’t agree with the market opinion that Savanna HAS to be taken over in order to maximize shareholder value, especially at a price this low. The other problem with this offer is that Total and Savanna operate in different markets, and would not provide significant operational synergies. Despite the undervaluation, an acquisition by Total would still create a large diversified energy services company with few balance sheet concerns and significant rebound potential.
Western Energy Services
Over the last couple of years, I have pondered about which companies would be potential buyers of Savanna in the event of a takeover, and Total Energy Services was at the top of the list. Western Energy Services, however, didn’t even make my top 5 potential companies. This is because I can’t understand the rationale for these two companies to merge at this point in time. Savanna and Western Energy Services both operate in similar markets and thus would benefit from certain synergies. However, this does not address the problems with balance sheets. Both companies are in surprisingly similar situations with respect to their finances. I became much more concerned when I read their second offer, which included a cash payout per share of $.20 in addition to the .85 of Western Energy Shares. This is a very dangerous gamble by Western management that, I think, could even make Savanna shareholders worse off in the long term. Western Energy simply does not have the cash nor cash flow to support a cash acquisition, as just like Savanna, it has a very large amount of debt maturing within the next three years. Despite these headwinds, the synergies could allow the combined company to raise margins and lower costs while also dividing up the timing of the debt maturities, thus offering some advantages for the new entity.
Potential Outcomes for Savanna
Despite what I believe is the best-case scenario for Savanna shareholders, it is also important to consider the big picture. Right now, Savanna is trading for $2.01 per share, which is much too low considering the two viable offers on the table for the company. If the Western deal is approved then this should offer Savanna shareholders a value of $2.14 per share. If this deal falls through and it is acquired by Total, then this still would offer a breakeven value for Savanna shareholders, as the Total deal would value the shares at $1.90. It is also important to consider that both Western and Total’s share price have fallen considerably since the acquisition news, and why these numbers could likely rise in the future.
Total Energy Services has made it clear that it plans to continue to purchase Savanna shares on the open market, and seems to be buying in the $1.95-2.00 range. This will create a natural floor for the price of Savanna going forward.
I will outline a number of different scenarios that I see as a possibility for Savanna over the next few months. One scenario is that the Western Energy Services offer is rejected by shareholders on the May vote in favor of the Total Energy Services offer. Since Total already has 43% of Savanna shares deposited on the total offer, and since both Total Energy and other significant Savanna shareholders are continuing to add to this stake, it seems reasonable that they could control the vote. In this case, the Total offer would proceed and Savanna would be absorbed by Total at a price slightly lower than the current market value for Savanna. This would not lead to any profit. However, it would give you shares in a company that would have a lot of scale and a great balance sheet going forward. In this scenario, I would simply hold onto the shares for the long term.
Another scenario is that the Western Energy Services offer is accepted in the May vote, and the Western Energy Services merger will take place. This would result in an approximate 5% premium to the current share price. The downside to this scenario, however, is that the new entity will have many similar problems that Savanna has been facing, thus not offering a significant competitive advantage in the long term. In this scenario, I would sell my shares after the merger for the quick profit.
The third scenario is that both offers are rejected. Under this scenario, there are multiple potential outcomes. The absolute worst case scenario is that both offers are rejected, neither Total nor Western increases its offer, and no additional offers are made to acquire Savanna. This would remove the floor for Savanna and would likely send the share price down about 15-20% near the pre-acquisition numbers. Fortunately, I see this scenario as highly unlikely since there are still other potential bidders for the company. It’s also important to consider that if the price of oil were to rise in the near future, the price of Savanna shares could appreciate much more than any of the current offers. A more immediately positive outcome could be that both offers are rejected and instead replaced with a better offer from another corporation. This would, of course, offer at least a 5% premium to the current market value.
Finally, the fourth scenario, which could also be very ugly for Savanna shareholders, is that the Western merger is approved by shareholders but challenged in court by Total. This scenario could lock up a lot of cash flow for both Western and Savanna with legal costs, and put significant delays on any sort of corporate restructuring. This would be the clear worse case scenario for Savanna, especially if it has to pay a break fee to Western.
The Western merger would offer better operational synergies, but would do very little to improve Savanna’s balance sheet. The Total merger would offer little synergies in the combined company, limit the rebound potential for Savanna shareholders, while also undercutting the market price for Savanna. Despite these problems, it would completely remove any financial uncertainty for Savanna. Despite the higher price by Western, both deals, in my opinion, seem almost equal in value when considering the bigger picture. Overall, despite the uncertainty in the future, it is reasonable to take a stake in Savanna at this point in time as it seems that the most likely outcome from this is either a takeover from Western or Total Energy Services, both of which will offer advantages for Savanna shareholders. Even in the event of no merger, Savanna is still reasonably priced when considering historical cash flow, and should continue to be a good investment over the next few years.
Disclosure: I am/we are long SVGYF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own SVY on the TSX.
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