CALGARY -- The pipeline for initial public offerings for business trusts might well be full -- with an estimated $5.5-billion ready to be sold to yield-hungry investors -- but that's not likely to be the case in the energy sector.
In fact, the consensus is that consolidation, not proliferation, will characterize 2006 in the oil patch trust world.
One of the key reasons many analysts are calling for a healthy round of merger activity relates to the simple fact there are too many such companies with not much differentiating one from the next. It's a fairly generic business, after all: Produce and sell oil and natural gas in a manner that generates as much cash flow as possible so that unitholders continue to receive their monthly distributions.
While most of the trusts are still following the original model, a number of the younger trusts -- Peyto Energy included -- are adding a traditional exploration and development component to their strategy. That's because high commodities prices have made it considerably cheaper to develop reserves from existing prospects than going out and buying new production and reserves.
As it stands, there are 36 publicly traded energy trusts needing research coverage from the investment firms, with the majority of these trusts falling into the large or intermediate category.
Conventional wisdom suggests the more a company is covered by analysts, the higher their valuation in the market, but given the dearth of sell-side analysts coupled with too many companies to follow, the likely outcome is that the quality of analysis is ultimately compromised.
The need to get bigger could also be motivated by the recent inclusion of the energy trusts in the S&P/TSX composite index. Size does matter when it comes to being included in the index, and there is a certain amount of status that goes along with that because it opens the doors to a wider range of institutional investors who will now consider buying a company's units.
Size is just as important for listing on the New York Stock Exchange -- something a growing number of energy trusts have been doing simply because there are 20 times more investors looking for yield in the United States than in Canada. And, as the law of supply and demand dictates, more investors translates into a higher unit price. Being of a certain size from a market capitalization standpoint also means a company doesn't get lost in the clutter, and guarantees a big enough float to make the shares easy to buy and sell. In capital markets terms, this is called liquidity.
If the stars align as they are supposed to, a bigger company enjoys better research coverage, stronger trading volumes and higher market valuations -- and this makes it easier to raise money down the road, should the need arise.
On the operational side, there are other reasons in favour of mergers among energy trusts.
Chief among them is the issue of replacing reserves in order to maintain production levels. As commodity prices continue their fantastic run and show no signs of backing off, asset prices continue to be very dear.
The same holds true for the junior end of the conventional oil and gas segment because the companies are trading at rich price-to-cash-flow multiples, which makes it hard for a trust to strike a deal that adds value from the day the transaction closes.
"A company either has to develop or acquire; development is hard because the risks are higher and acquiring is getting expensive," said Leslie Lundquist, who is the lead manager for the Bissett Income Trust Fund.
Add to this the lack of asset packages for sale these days, the rising costs for oil field services and hot competition for people, and it all points in one compelling direction: consolidation.
There was a wee taste last year of things to come, with Harvest Energy Trust buying Viking Energy Trust in November and Acclaim Energy Trust merging with StarPoint Energy Trust in September to form the third-largest conventional trust -- Canetic Resources Trust, which started trading yesterday on the Toronto Stock Exchange.
The betting is that these deals were only the appetizer in what is likely to be a smorgasbord of energy trust deals in the coming months.
© The Globe and Mail
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