(MEMO) Memo - A Bittersweet End But A New Beginning
The end of the journey in Gear Energy, but the beginning of a new one.
By: Wilson
For those of you who don't know, I am a large shareholder in Gear Energy (TSE: GXE.TO, GENGF). Today, the company announced a transformational deal that will result in the sale of Gear's heavy oil assets. You can read the press release here.
While I am extremely limited in what I can say publicly, I know that many of you have followed me into Gear back in 2016. It's been a bittersweet road characterized by excitement and a lot of disappointments.
From an investing standpoint, Gear was not the investment I had hoped it would be. Unless your cost basis is in the 10 cents range, it has not been an investment that's made anyone wealthy.
While I can probably write an entire book on the journey so far, I will instead focus this memo on the road ahead.
Details
As stated in the press release:
Gear Energy Ltd. (TSX: GXE) (OTCQX: GENGF) ("Gear" or the "Company"), is pleased to announce that it has entered into an arrangement agreement (the "Agreement") with a large publicly traded company (the "Purchaser") pursuant to which the Purchaser will acquire all of the issued and outstanding common shares of Gear (the "Gear Shares"), excluding its Central Alberta, Southeast Saskatchewan, and Tucker Lake properties (collectively, the "Newco Assets") which will be transferred to a newly formed entity ("Newco"), for $110 million in cash, subject to adjustments as provided for in the Agreement (the "Transaction").
The Transaction will be accomplished by way of a statutory plan of arrangement under the Business Corporations Act (Alberta) (the "Arrangement"). Under the terms of the Arrangement, each holder of Gear Shares (each a "Gear Shareholder" and collectively, the "Gear Shareholders") will receive $0.607 in total consideration per Gear Share, consisting of, at such Gear Shareholder's election: (i) $0.607 in cash per Gear Share; (ii) 0.3035 common shares in Newco ("Newco Shares") per Gear Share; or (iii) a combination thereof, subject to proration and consideration caps set out in the Arrangement.
Under the Arrangement, Gear will transfer the Newco Assets to Newco with the remainder of its properties, consisting of its Lloydminster heavy and medium oil assets (other than the Tucker Lake property) (collectively, the "Gear Assets") remaining with Gear which will be acquired by the Purchaser. Newco will be led by the existing management team and board of directors of Gear.
In essence:
The total consideration of the deal is C$0.607 per share.
Shareholders will be able to choose which one they want more (cash or shares of the newco).
Because this transaction is a sale of the corporate entity, shareholders in Gear will be "paid out" in cash and shares (if that is the result of the vote).
And depending on the vote, it will likely be a combination of the two depending on how many shareholders vote and for what.
Strategic Rationale
As stated in the press release:
The board of directors (the "Gear Board") and management of Gear continuously review options available to the Company to ensure that shareholder value is being maximized and view the Transaction as advantageous for Gear Shareholders.
Key highlights of the Transaction include:
Meaningful Cash Consideration: Gear Shareholders will have the opportunity to receive immediate cash consideration of up to $0.607 per Gear Share, subject to the proration and consideration caps set out in the Agreement.
Creation of Newco: Through ownership of Newco, Gear Shareholders will have the opportunity to unlock significant value by accelerating organic growth and delineating the future potential of the Newco Assets.
To further expand on the Newco strategy (no name has been chosen yet, so it's called Newco for now):
Newco is anticipated to be led by Kevin Johnson as President and CEO and Gear's current management team. Following closing of the Transaction, Newco will focus on the development of the Newco Assets, which have significant, fully funded growth potential.
Newco will retain 31% of Gear's production, equating to approximately 1,700 boe/d (consisting of 1,100 bbl/d of light crude oil, 200 bbl/d of NGLs and 2,000 mcf/d of conventional natural gas) with a liquids weighting of 80% and a deep inventory to grow production and cashflow. Key characteristics of the Newco Assets are summarized below:
Central Alberta: Low decline, light oil production base supported by multiple Belly River waterfloods and stacked light oil growth opportunities analogous to local and regional industry drilling activity.
Southeast Saskatchewan: Established light oil development in the Bakken/Torquay with waterflood potential and on-going evaluation of additional up-hole targets. In place gas conservation reduces the emissions footprint with increasing revenue through gas and NGL sales.
Tucker Lake: 1,920 hectares of undeveloped, heavy oil rights in the Cold Lake oil sands region with up to six prospective zones mapped. Recent offset development of the Mannville Waseca sand highlights the upside potential of this asset.
Newco's 2025 capital program, which is expected to be finalized and communicated to shareholders in the Circular or by press release, will be fully funded, supported by internally generated cash flow and a $35 million new credit facility, to be provided by ATB Financial upon the closing of the Transaction.
From the shareholder perspective, the best way to think about this transaction is that we are refocusing the company into an area that we believe will give us a runway to grow.
From a financial transaction standpoint, the cash portion of the deal allows shareholders to de-risk their investment in Gear while simultaneously participating in a growth company. By selling the 3,700 boe/d of production, Newco has the asset base to grow production quickly.
I think Kevin Johnson and the team are the right people to get this done, and we will continue to focus on asset quality as the most important criterion going forward.
Conclusion
My journey in Gear is coming to a bittersweet ending. But with the conclusion of this deal, a new beginning starts and I hope that the new strategic path we've embarked on will reward shareholders.
As always, please reach out to me if you have any questions.
Analyst's Disclosure: I/we have a beneficial long position in the shares of GXE.TO either through stock ownership, options, or other derivatives.
Wilson Wang is a director for Gear Energy.