The Times: Tempus

November 17, 2007
Nick Hasell: Tempus

It is no coincidence that Wood Group should wade into Canada’s oil sands in the same month that crude touched nearly $100 a barrel.

The synthetic crude extracted from the bitumen-soaked sands beneath Alberta’s peat bogs ranks among the world’s dirtiest oil. It is also among the costliest to produce, and requires crude prices to sustain a level above $50 a barrel to make such activity viable.

But that is not a calculation that need concern the Aberdeen-based oilfield services group for now. In paying an initial $140 million (£68 million) for the Canadian company IMV it is gaining a significant strategic foothold in what promises to be a fast-growing market.

IMV is the country’s third-biggest oil sands engineer, and the only independent. Its business is providing the likes of Shell and Encana of Canada with the technology and skills for “in situ” extraction, whereby steam is pumped underground to heat the oil sands, lower the viscosity of the bitumen and allow it to flow to a production well, leaving the sand behind.

That competence is attractive given that the development of Alberta’s oil sand reserves – put at more than 170 billion barrels – is steadily shifting from surface mining to lower-lying deposits: about 80 per cent of Canada’s reserves are considered too deep to mine conventionally. On current forecasts, production of crude from this method is expected to treble by 2020, from 1.1 million barrels a day at present to 3.5 million barrels.

So in buying IMV at a multiple of eight-times operating profits, Wood appears to have struck a favourable deal. The purchase should enhance next year’s earnings by at least 4 per cent, and provide a greater boost after that, should IMV’s revenues grow in line with forecasts.

There are other attractions, not least the potential synergies with Wood’s pipeline engineering businesses in the US. Canada’s crude undergoes first-stage refining locally before being shipped south of the border for consumption, so Wood might be expected to benefit from having skills both at the source of the oil and in the mid-stream activities that follow. IMV also has experience in offshore engineering in Newfoundland, and Arctic exploration, which, while not the rationale behind the transaction, may prove useful should those territories become more fully developed.

In its earlier purchases of JP Kenny and Mustang, Wood has proved itself an able integrator of American assets, and with IMV’s management being retained, the risk of postdeal upsets is low. At 407¾p, or 17 times next year’s earnings, Wood is worth buying on weakness.

BHP Billiton/Rio Tinto

Yesterday’s speculation that Rio Tinto may turn the tables on BHP Billiton by bidding for its predator is unlikely to be the last attempt to second-guess the next twist in this $140 billion takeover battle before Rio lays out its formal defence strategy later this month.

Leaving such suggestions aside, movements in both miners’ shares should continue to be driven by the stock market’s estimation of the extent to which BHP will have to sweeten its current offer – pitched as a three-for-one share exchange – to win acceptance. Its assertion that it should be able to generate $3.7 billion of savings by the seventh year after completion – more than 6 per cent of the two companies’ combined cost bases – should give London’s biggest listed miner reasonable room for manoeuvre.

But holders of Rio, whose shares have gained 28 per cent over the past fortnight, might give equal thought to whether the deal will happen at all. Advisers to BHP play down the notion that China is an issue in this transaction. The People’s Republic is the biggest customer of both companies but what can China do? There will be a few small asset sales to accommodate worries about concentration in iron ore, where the merged companies would achieve 36 per cent of the market. Beyond that, China will just have to stomach the deal. It has no jurisdiction over Anglo-Australian companies and its steel industry is too fragmented to mount a commercial challenge. It could buy a large shareholding in one or other miner, most likely Rio, but offensive strategies have not, so far, paid off for Chinese companies – as CNOOC, the oil company found when it bid for America’s Unocal.

It is not just China’s steel industry that is the likely loser. European steelmakers are already protesting about BHP’s plans. That lengthens the odds that the European Commission or the US Department of Justice will simply give the nod to this tie-up – despite BHP’s insistence that it has examined all regulatory issues “in detail”.

All of which suggests that political considerations of commodity trade flows and price inflation in strategic resources should be given just as much weight by shareholders on both sides as the chances of a counterbid for Rio, or even by Rio for BHP. Sit tight for now.

Aero Inventory

In sealing a $1.2 billion (£590 million) deal with ACTS, the Canadian aircraft maintenance specialist, Aero Inventory has notched up the second-biggest contract in its history and filled the most glaring gap in its operations. The tendency of US carriers to flip in and out of Chapter 11 has meant the AIM-listed company, which manages the spare parts requirements of airlines, has hitherto concentrated on expanding elsewhere, namely Asia, where it serves Qantas and Cathay Pacific, and Europe, through its relationship with SR Technics, a spin-off of Swissair.

It is encouraging that in taking on a ten-year outsourcing deal with ACTS, which was once part of Air Canada, Aero has again proved that it can add scale without raising fresh equity – the $95 million of inventory it is buying from ACTS will be funded from existing bank facilities. An arrangement for ACTS to exercise options over 2 million shares at 588p should the contract double in size also reassures on the scope for significant earnings growth with minimal dilution. At 722½p, or 12 times next year’s earnings, Aero should have farther to go. Hold.

http://business.timesonline.co.uk/tol/business/markets/article2886679.ece

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