DBRS Comments on Husky Energy’s Unsolicited Offer to Acquire MEG Energy Corp for $6.4 Billion

DBRS Limited (DBRS) notes that on September 30, 2018, Husky Energy Inc. (Husky or the Company; rated A (low) with a Stable Trend by DBRS)) announced an unsolicited offer to acquire all of the outstanding shares of MEG Energy Corp. (MEG) for an implied total equity consideration of approximately $3.3 billion and an implied total enterprise value of $6.4 billion, including the assumption of approximately $3.1 billion of net debt (gross debt of approximately $3.6 billion). Under the terms of Husky’s proposal, each MEG shareholder will have the option to choose to receive consideration of $11 in cash or 0.485 Husky shares per MEG share, subject to maximum aggregate cash consideration of $1 billion and a maximum aggregate number of approximately 107 million Husky common shares issued. The total consideration for the common share component of the offer at the current share price is approximately $2.2 billion.

MEG Energy is primarily a single producing asset company with approximately 98,000 barrels per day (bbls/d) of bitumen production in July 2018 from the Christina Lake in-situ thermal oil development in the Athabasca oil sands region of Northern Alberta. MEG’s Christina Lake development is considered one of the most efficient and highest netback in-situ thermal developments in Canada. On a combined basis (assuming Husky is successful with its offer), the Company expects to have total upstream production of more than 410,000 barrels of oil equivalent per day (a greater than 30% increase from the midpoint of Husky’s 2018 production guidance) and downstream refining and upgrading capacity of approximately 400,000 bbls/d.

Husky’s unsolicited offer has not been endorsed by MEG’s Board of Directors (Board). With the absence of Board support, Husky intends to commence an offer directly to MEG common shareholders by way of a takeover bid, which requires 66 2/3% of the total fully diluted shares tendered to Husky’s offer. DBRS notes the uncertainty in that Husky may not be successful with its proposal in the current form. DBRS also notes uncertainty as to (1) the time necessary to complete a successful offer and (2) the possibility that Husky may have to alter its offer to secure approval from MEG’s Board and/or common shareholders. Because of the uncertainties regarding the outcome of Husky’s offer, DBRS plans no rating action at the current time. However, should Husky be successful with its offer either in its current form or a modified form, DBRS may be compelled to take a rating action.

Nevertheless, DBRS notes that if Husky’s offer is successful in its current form, the addition of MEG’s assets would be mildly positive for Husky’s business risk profile. The inclusion of MEG’s assets (1) adds to Husky’s size, (2) improves the Company’s proven reserve life index, (3) complements Husky’s other thermal oil developments in Western Canada and (4) enhances Husky’s heavy oil integration plans. Tempering the improvement in the business risk profile is a higher level of asset concentration in Western Canada and a higher proportion of thermal oil in the Company’s production mix.

DBRS notes that Husky’s credit metrics (assuming Husky’s offer is successful in its current form) are modestly negatively affected initially due to the sizable amount of MEG debt that the Company would incur. On a pro forma basis (last 12 months ended June 30, 2018), Husky’s lease-adjusted debt-to-cash flow ratio rises from approximately 1.6 times (x) to 2.3x (outside the “A” range). However, Husky has noted that approximately $200 million in synergies could be realized annually from the acquisition of the MEG assets. Also, the combined entity is expected to generate material free cash flow (cash flow after capital spending and dividends) that can be deployed to reducing net debt and financial leverage. The Company anticipates a net debt-to-cash flow ratio of the combined entity (based on current strip pricing in 2019 for West Texas Intermediate oil of USD 70.50/bbl and a heavy light oil differential in Western Canada of USD 26.26/bbl) to be approximately 1.0x in 2019.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 2018), DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (April 2018) and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2017), which can be found on dbrs.com under Methodologies.

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