Tourmaline to spin off royalty division — a move that could inspire other natural gas companies

CALGARY – As share prices in Canadian natural gas producers trade at depressed valuations, Tourmaline Oil Corp. is spinning out its royalty business that analysts say will capture more value for the parent company.

Tourmaline shares soared 15 per cent, reaching $12.34 by close Friday as the market digested its late Thursday announcement of the formation of Topaz Energy Corp., a company which will capture royalty interest on Tourmaline’s oil and gas lands, an interest in two of Tourmaline’s natural gas processing facilities and a portion of the revenue Tourmaline collects from other companies through joint ventures.

Tourmaline will receive $775 million for the assets and retain 78 per cent of its new subsidiary, which is expected to pull in $89 million in revenues this year. Tourmaline president and CEO Mike Rose as well as chief financial officer Brian Robinson and three independent directors will sit on the board of the new company.

“You never know what the market is going to do,” Rose said, adding that he was pleased with the reaction to the news but looking over the longer term.

“All Canadian (exploration and production companies) are in the same boat – we’re all undervalued,” he said, adding that Topaz was a way for Tourmaline to boost its value.

The spinout of Topaz continues a trend set in recent years by Encana Corp. and Canadian Natural Resources Ltd. and Diamondback Energy Inc. in the U.S., that either spun out or sold off their royalty lands in recent years. In the case of Diamondback, the company spun out parts of its infrastructure in the Permian basin in Texas in 2014 into an entity called Viper Energy Partners LP.

The Topaz spinoff, however, is unique in Canada in combining the royalty and the infrastructure business in a spinoff, Rose said.

In each case, the companies spinning out royalty and infrastructure businesses have been rewarded in a challenging market for oil and gas.

While Tourmaline values the deal at $775 million, analysts say the deal would have been worth more in the public market — as much as $1.25 billion — as energy royalty and infrastructure companies trade at much higher multiples than oil and gas exploration and production companies.

GMP FirstEnergy analyst Robert Fitzmartyn said that Canadian oil and gas companies are currently trading at three to four times their debt-adjusted cash flow.

By contrast, he said, companies that might compare to the spin-out Topaz are PrairieSky Royalty Ltd. and Keyera Corp. that are trading at multiples of 16- to 18-times their adjusted cash flow – which demonstrates the large upside to Tourmaline.

Small- to mid-sized natural gas producers often emulate Tourmaline’s business model as it is one of the largest gas producer in the country by volume, and the move to spin-off Topaz could lead to some other companies following suit.

“I think most boards will prefer to see a little bit longer term. Where is this in six months? How will Topaz look when it goes public?” Fitzmartyn said. “I think though that you’ve got to acknowledge it and weigh the merits of (the spinoff). You’re not doing your fiduciary duty if you don’t.”

Canadian natural gas producers have been challenged by extremely low commodity prices for months and many are trading at or near their historic lows.

For much of the summer and fall, natural gas at the AECO hub in Alberta fetched under US$1 per thousand cubic feet – and the commodity fell to a price as low as 7 cents per mcf in September.

AECO has rebounded in recent days to average US$1.61 per mcf on Thursday, according to data from AltaCorp Capital.

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