Since highlighting lower crude prices could lead to M&A in the Canadian oil patch, Strathcona (SCR) has been busy, announcing 3 divestitures for $2.8B, a $45M acquisition of a rail terminal, and a $5.9B hostile takeover bid for MEG Energy (MEG).

The series of transactions led by Adam Waterous are, in my view, the best series of strategic moves made by a company this year. Let’s unpack them one by one.

Becoming a pure-play heavy oil producer

The first step in SCR’s strategic shift was the sale of its Montney gas assets for $2.8B in three separate deals including:

• A $1.7B deal to sell its Kakwa asset to ARC Resources

• An $850M deal to sell its Grand Prairie asset to an unknown buyer

• A $290M sale of its Groundbirch asset to Tourmaline

All in, the transactions netted SCR ~33% of its enterprise value in exchange for 12% of its 2024 earnings - a good trade at face value, but one that highlights the market’s appetite for the gas assets they sold, versus the oil assets they kept.

Waterous has an opposing view to the market, though, with a more bullish long-term outlook for oil:

He’s not alone in that view, with global inventories sitting well below the average over the last 5 years…

… rig counts on a steady decline…

… and other prominent energy executives calling for “peak oil” in the U.S.

Hedging risk naturally with rail exposure

Step two was to buy the Hardisty Rail Terminal (HRT) for $45M in order to mitigate the concentration risk that comes with being a pure-play heavy oil producer.

The HRT is the largest crude-by-rail terminal in Western Canada and generated $12M of FCF last year (80% contracted). That’s a >25% FCF yield on top of being a strategic tuck-in, with SCR now owning rail terminals that service 80% of the total crude-by-rail volumes in Western Canada.

Why does that matter? The rail footprint is a natural hedge to a blowout in the WCS differential.

When pipeline capacity is tapped, Canadian producers have to use costlier methods to get their product to market (like crude-by-rail), resulting in huge discounts in Canadian oil (see 2018 below as a great example, where WCS went to $5/bbl).

Today, HRT is only at 19% utilization, but has ran above 80% previously in times of tight pipeline egress. With no unified government push for additional pipeline development, the rail hedge could pay dividends in the not-so-distant future.

Using the war chest to double down

The final step lies in finding an effective use for all that dry powder from the Montney sales, and Waterous feels he has a worthy target in MEG.

Given the two companies are nearly identical in both production and reserve profiles…

… SCR views the combination as a perfect match and expects to unlock $175M of synergies through the usual suspects (lower headcount, interest rates, and CapEx).

It’s clear that Waterous is focused on positioning his company’s stock as a product…

… and in particular, one that stands alone in its category.

Outside of the business benefits, a deal like this would also add more volume to the float (80% of SCR is owned/locked up by the Waterous Energy Fund), which could drive better liquidity and price discovery.

Not past the finish line, but will win either way

The $23.27 per share bid represents a 9% premium to MEG’s pre-deal price, which drew criticism from investors for being too skinny. With MEG shares trading closer to $25 today, the market is clearly expecting a competing bid or a revised offer.

Should the deal escape Strathcona in favour of another bidder, the company will still benefit - having bought nearly 10% of MEG’s outstanding shares prior to the announcement. From where I’m sitting, execution couldn’t have been better.