You've got to hand it to Bernard Isautier: the Gallic man-about-the-world has overseen one of Canada's best stock runs ever. Five years ago, he guided Calgary-based Hurricane Hydrocarbons out of bankruptcy court and landed the company in Kazakhstan. Renamed PetroKazakhstan (TSX, NYSE: PKZ), it has largely prospered in the former Soviet republic. And this August, as oil prices were breaking records, the fairy tale seemed poised for a happy ending. On Aug. 22, China National Petroleum Corp., China's largest energy company, announced that it submitted a bid to buy PetroKaz for US$55 a share, or US$4.2 billion–an almost $10 premium over its then share price of $45.40. “It's a pretty attractive deal,” said Louis W. MacEachern, a member of PetroKazakhstan's board, which has endorsed the bid. (MacEachern owns 35,700 shares of the company.) “Especially for those who bought six years ago at 26¢.” No kidding: in terms of return, that's well over 21,000%.
So PetroKaz and CNPC were going to live happily ever after, along with shareholders. But PetroKaz's story–and how to play it–are not quite so simple. By the afternoon bell on the first trading day after the announcement, some 15 million PetroKaz shares had already moved on the TSX and NYSE. That's extremely heavy trading. Traders were jockeying for position–even though an investor's first reaction might be to hold on to the stock and just wait for the deal to close. What were the pros doing? Well, when it comes to mergers and acquisitions, a few strategies can help investors squeeze value out of a deal. In the PetroKaz case, as with any M&A, it pays to know them.
The first is getting the price right. According to Kathryn Del Greco, an investment adviser with TD Waterhouse, a general rule is that an acquirer pay at least 10% over market price. “The acquiring company expects to create synergies, but those selling out will be expected to be paid for that,” she says. “That often seems to be around 10%.” With its 21% premium, CNPC's offer clears that threshold easily, and some have speculated the Chinese offered too much. But as MacEachern points out, “There does appear to be a petro shortage looming.”
If that's the case, someone else might be willing to pay an even higher premium. Which raises the question: is the Chinese offer high enough to fend off other (higher) bidders?
One way to answer that is to look at what the market thinks. After a bid has been tabled, the spread between the offer price and the stock price is key to any trading strategy. The day after the CNPC deal was announced, PetroKaz traded at $54.40. Why lower than the offer price? Because the market thought China National Petroleum would be the only bidder. The discount is there because investors were charging for the risk they're taking that the deal won't go through. In the case of a single-bidder acquisition, says Kate Warne, Canadian market strategist for Edward Jones, that risk gap should close as regulatory or market hurdles are cleared. So do you wait for the merger, and risk the deal falling through, or do you cash in now? The conservative approach, says Warne, holds that “if the prices are fairly close [i.e., the risk gap is small], then you might want to take the cash and put it somewhere else.”
That strategy might well have applied for many PetroKaz shareholders. But then, a wrinkle: on Aug. 25, India's Oil and Natural Gas Corp.–which had bid on PetroKaz before the CNPC deal was announced–reported that it had sent an emissary to Russia to talk to oil producer Lukoil about making a combined bid for the Canadian company. That would change PetroKaz's situation from a single-bidder to a multiple-bidder event. And the market immediately registered the new information. In early trading on Aug. 25, PetroKaz stock rose to $55.48–almost half a dollar above bid–by 10 a.m.
Again, the investor has a decision to make–sell now and take the premium, or wait for the new, higher bid. If another bid comes in, that could drive the price above the initial premium; if no other bid appears, the price will slide back toward the offer price. Warne suggests that because second and third bids mean a hostile takeover fight–something many companies like to avoid–investors would be wise to take a conservative approach, cash in and take the premium off the table. “You really have to believe that the second bid is coming,” says Warne. “If not, grab the premium and run.”
Something along those lines seemed to play out quickly on Aug. 25. By 10:40 a.m., PKZ's price, which had been moving steadily higher all morning, had fallen back to US$55.10. Some investors had clearly taken the premium off the table. But the remaining 10¢ premium suggested that the market still expected another bid at that time.
How likely is the bid? Here the story gets complicated. Political and economic ties between Russia and China–would-be rivals for PetroKaz, since Russia controls Lukoil and the Chinese control CNPC–have grown in recent years; both are members of the Shanghai Cooperation Organization, a nascent Central Asian politico-economic club that also includes Tajikistan, Uzbekistan, Kyrgyzstan–and Kazakhstan. Those closer ties may or may not affect the likelihood of a bid coming in from a Lukoil partnership, as might the relative thirst for oil in China and India; the Russian desire to keep its hand in its former Soviet republics; and various domestic concerns in Kazakhstan, which is facing elections soon.
One alluring aspect of CNPC's bid is that it makes provision to spin out from PetroKaz a new company that would search Central Asia for oil–under the leadership of Bernard Isautier. PKZ shareholders would have the option of taking a share of the new firm and US$54 cash. Considering Isautier's record of high returns, that could be a very good deal.