Two of the companies recommended in my Income Investor newsletter companies are joining forces in a deal that will create one of Canada's largest energy processing, storage, and transportation firms.
Pembina Pipelines Ltd. (TSX: PPL, NYSE: PBA) is buying all the assets of Veresen Inc. (TSX: VSN) in a friendly deal valued at $9.7 billion, including the assumption of Veresen's debt. The transaction is expected to close in the second half of this year.
We first recommended Pembina in June 2009 at $14.77. Veresen was picked in October 2016 at $13.29.
Under the terms of the deal, Veresen shareholders will receive $18.65 in cash for each share they own, or they can convert to Pembina shares at a rate of 0.4287 for each Veresen share. (There is a complex pro-rata formula that will be applied if the cash redemptions exceed $1.523 billion; see the Pembina website for details).
This appears to be a win-win deal for everyone involved. Veresen shareholders saw the stock price jump $2.90 (about 19 per cent) on the day after the deal was announced.
Pembina's price fell 3.3 per cent after the deal was revealed but has since recovered that loss.
Many pluses, few minuses
The combined company has a lot of pluses and very few minuses going for it.
There is very little overlap in their operations. Veresen is engaged in three principal businesses: pipeline transportation that includes interests in the Alliance Pipeline, the Ruby Pipeline and the Alberta Ethane Gathering System; a midstream business which includes a partnership interest in Veresen Midstream Limited Partnership, which owns assets in western Canada; and an ownership interest in Aux Sable, which owns a world-class natural gas liquids (NGL) extraction facility near Chicago and other natural gas and NGL processing energy infrastructure.
Pembina owns and operates an integrated system of pipelines that transport various products derived from natural gas and hydrocarbon liquids produced primarily in western Canada. The company also owns and operates gas gathering and processing facilities and an oil and natural gas liquids infrastructure and logistics business.
What really excites analysts is the strong position the combined company will have in serving the Montney and Duverney regions in Alberta and B.C., which are still in the early stages of development. According to a 2016 report, the Duvernay Formation holds proved plus probable reserves of 395 million barrels of oil equivalent (boe), most of it in the form of natural gas.
The Montney Formation, which straddles the Alberta-B.C. border, is even bigger. A report published last year by the National Energy Board estimates it contains 12,719 billion cubic meters of marketable natural gas, 2,308 million cubic meters (14,521 million barrels) of marketable natural gas liquids, and 179 million cubic feet (1,125 million barrels) of marketable oil.
The combined Pembina-Veresen operation will serve the area with pipelines, storage facilities, and other mid-stream infrastructure. The Alliance pipeline, in which Veresen has a joint interest, originates in northeast British Columbia and transports natural gas products to the Chicago market.
Financially sound companies
Financially, these are very stable businesses. The cash flow from the combined company will be about 85 per cent based on fee-for-service contracts, ensuring steady revenue and a sound balance sheet.
Both companies are already doing very well on a stand-alone basis. Pembina recently reported first-quarter revenue of almost $1.5 billion, up 46 per cent from the same period in 2016. Net earnings were $215 million ($0.49 per share, fully diluted), up from $102 million ($0.23 per share) a year ago.
Veresen, which will continue to trade independently until the deal closes, reported first-quarter net income attributable to common shares of $47 million ($0.15 per share), up from $7 million ($0.02 per share) in 2016. Distributable cash was $104 million ($0.33 per share) compared to $81 million ($0.27 per share) last year.
The deal "represents an ideal opportunity to continue building on our respective low-risk, long-term, fee-for-service business models while growing and substantially diversifying our respective asset bases," said Pembina chairman Randy Findlay. "The combined platform offers compelling customer service offering enhancements, as well as integration and investment potential, exceeding what we could do individually."
He said that once the deal is complete, Pembina would increase its dividend by 5.9 per cent. The stock currently pays $0.17 per quarter ($2.04 per year) to yield 4.7 per cent at the current price.
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