(Idea) Strathcona Resources
Note to readers: Dollar references are to Canadian dollars unless otherwise specified.
For years, Strathcona Resources (OTCPK:STHRF) (SCR:CA) has flown under the radar in the Canadian oil patch. It was a private company that pursued rapid growth through an idiosyncratic acquisition strategy, which involved pursuing complex special situations to cobble together a heavy oil giant that is now the fifth-largest E&P in Canada.
Like all Canadian E&Ps, SCR shares have sold off with the recent plunge in oil prices. We believe they represent an attractive long-term buy among E&Ps. We value the shares at $30 and expect that value to grow over time under the stewardship of the Waterous family.
Strathcona’s Idiosyncratic History
Until it came public in October, SCR had been a privately owned E&P investment vehicle for Waterous Energy Fund (WEF), a private equity firm founded in January 2017 by Adam Waterous. SCR is the kind of company where prospective investors have to understand its history to appreciate its current operations, value, and likely future course. However, readers not interested in the corporate history can skip ahead to the next section.
Executive Chairman Adam Waterous is SCR’s architect. After a stint as a McKinsey & Co. consultant, he entered the oil and gas business in 1991 by founding Waterous & Co., an oil and gas mergers and acquisitions advisory boutique, with his brother Jeff.
In 2005, Waterous & Co. was sold to Scotiabank in 2005, at which point Adam became the head of Scotiabank’s global investment banking business. He left the bank in January 2017 to start the WEF.
WEF was founded as a private equity vehicle to acquire oil and gas assets. Waterous believed in the long-term oil bull thesis and viewed the depressed prices after 2014 as an attractive buying opportunity. He got right to work in building WEF’s suite of assets, focusing primarily on low-decline heavy oil assets in Western Canada.
The following is a timeline of the WEF’s acquisitions under Adam Waterous’ leadership.
January 2017: WEF buys condensate-rich natural gas assets producing 5,000 boe/d in the Kakawa area of the Montney out of creditor protection. Waterous names the entity Strath Resources.
April 2017: WEF acquires 67.1% of the common shares of Northern Blizzard Resources for $244 million from U.S. private equity firms Riverstone Holdings and NGP Capital Management. Northern Blizzard produced heavy oil, mostly in Saskatchewan. After the acquisition, WEF changes the company’s name to Cona Resources.
May 2018: WEF acquires the remaining outstanding share of Cona Resources for $85 million.
June 2018: Strath Resources acquires Paramount Resources’ Resthaven/Jayar assets in the Montney for $340 million. Consideration was 50% cash and 50% Strath common shares, as well as warrants to purchase Strath shares. After the transaction, Paramount owned 15.6% of Strath Resources.
June 2018: WEF raises $1.4 billion in its first private equity funding, with a mandate to invest in energy assets either in Canada or the U.S. Investors included pension plans, insurers, family offices, and university endowments. The fund’s potential targets included special situations, including restructurings and distressed energy assets in the range of $300 to $500 million.
January 2020: Cona Resources acquires Pengrowth Energy, a 35,000 boe/d heavy oil producer and owner of the Lindbergh heavy oil project near Cold Lake, for $740 million. The acquisition was funded through $585 million of equity and $155 million of debt.
August 2020: Strath Resources and Cona Resources merge to create a $1 billion enterprise, the largest wholly-owned private equity oil and gas producer in North America. Strathcona becomes the WEF’s sole operating company, producing 60,000 boe/d with 67% liquids with a 40-year reserve life. The rationale behind the tie-up was to have Strath’s condensate production hedge Cona’s heavy oil input costs.
Mid-2020: Acquired a 45% interest in private Osum Production, a troubled owner of Cold Lake oil sands assets, from Blackstone Group (BX), Warburg Pincus, and Singapore’s GIC sovereign wealth fund for an undisclosed sum. Osum produced approximately 20,000 boe/d. Osum’s owners had invested more than $770 million into it since 2008, and the company had acquired the Orion oilsands asset from Shell (SHEL) for $325 million in 2014.
November 2020: WEF launches a takeover bid to acquire 40% of Osum Oil Sands’ outstanding common shares. Osum had remained a private company. Some Osum shareholders had sought an exit and supported the deal, though others considered the offer too low and fought it. The deal closed in June 2021 after WEF increased its offer price. WEF’s acquisition price per Osum share was less than a quarter of the price implied by previous funding rounds.
June 2021: WEF combines Strathcona Resources and Osum Oil Sands Corp. The combined entity continued under the name Strathcona Resources. Strathcona remained 100% owned by the WEF, its investors, and Strathcona employees. At the time, it produced 80,000 boe/d of 75% liquids and had a proved and probable reserve life of 60 years. In the deal, Strathcona secured a $1 billion credit facility from a syndicate of Canadian and international banks to facilitate additional expansion. This is the point at which SCR begins to look like it does today. The company had its three operating segments intact. These included its Cold Lake thermal, Montey condensate-rich natural gas, and Saskatchewan heavy oil segments.
January 2022: Strathcona acquires Tucker thermal oilfield assets from Cenovus Energy (CVE) through a company called Stickney Resources for $800 million. Tucker produced approximately 20,000 boe/d.
March 2022: WEF closes on its fourth equity capital raise, raising $345 million to fund the acquisition of Caltex Resources, a producer of 13,000 boe/d of heavy oil in Alberta and Saskatchewan using enhanced oil recovery techniques. After the acquisition, WEF merges Caltex with Strathcona and increases the combined entity’s credit facility to $1.5 billion.
August 2022: Strathcona acquires private-equity-backed Serafina Energy for $2.3 billion, funding the deal mainly through borrowings on its revolving credit facility. Serafina produced 40,000 boe/d in Saskatchewan. The deal brought Strathcona’s total production to approximately 115,000 boe/d.
Pipestone Deal Brings Strathcona Public
On August 1, 2023, Strathcona and publicly-listed Pipestone Energy announced a deal in which Strathcona would exchange 9% of its equity for all Pipestone common shares. Pipestone produced approximately 37,000 boe/d of light oil and condensate. A large part of Pipestone’s value was that one-third of its production was condensate, which had tended to trade at a premium to WTI. Condensate is particularly valuable as a diluent for bitumen, which comprises a large part of SCR’s production. The competition between oil sands operators for condensate supply has pushed up its price, increasing production costs for major oil sands producers.
SCR’s all-stock offer valued Pipestone at around $2.70 per Pipestone share. Since this was only a small premium to Pipestone shares, which had been trading in the mid-$2 range.
Many Pipestone shareholders believed the offer significantly undervalued the company due to its large reserve value, premium condensate pricing, and growth prospects. Some voiced their concerns in public, making the deal contentious on the Pipestone side. Still, SCR had already won the support of Pipestone's management and board, making the deal likely to occur.
The Pipestone shareholders had a point. Valued on a per-flowing-barrel of oil equivalent basis, SCR's offer came at $26,000, well below other recent Montney deals, most of which were made at $40,000 to $60,000. Other Pipestone shareholders believed Pipestone’s assets were better suited for a large operator. They were also glad to participate in Strathcona’s upside, as Pipestone provides SCR with condensate to hedge its heavy oil production.
Ultimately, SCR’s bid carried the day. The price SCR paid was very attractive for its shareholders. The deal closed on October 3, after the end of the third quarter. Consequently, it has yet to publish quarterly financial documents on the combined entity.
With the Pipestone deal complete, Strathcona became the fifth largest oil producer in Canada, producing 185,000 boe/d with a market cap of $8.6 billion and an enterprise value of $11.5 billion.
We should touch upon a final incident in SCR's timeline that isn’t company-related but could sway investor opinion of SCR and its leadership nonetheless. In late October 2023, Adam Waterous became the target of an apparent smear campaign sparked by a backlash over his efforts to reform the board of the Banff Centre for Arts and Sciences. We investigated the incident and believe the allegations against him are false and ridiculous. The incident does nothing to change our positive view of Adam Waterous.