Reasons to Reject Total’s Bid
ANALYSIS AND REASONS FOR THE SAVANNA BOARD’S CONCLUSION AND RECOMMENDATION TO REJECT THE TOTAL OFFER
The following are the principal reasons for the UNANIMOUS recommendation of your Savanna Board to Shareholders to REJECT the Total Offer and NOT TENDER your Common Shares to the Total Offer.
- The Total Offer does not provide a control premium for Shareholders.
The Total Offer is at a discount to the current Common Share trading price.
- On December 21, 2016, the closing prices of the common shares of Savanna and Total on the TSX were $1.97 and $14.43, respectively. Based on the Total Offer of 0.13 of a Total Share for each Common Share, this implies that the Total Offer is at a discount of approximately 5% to the current trading price of the Common Shares.
- Total’s stated intent during discussions with Savanna prior to making the Total Offer was to provide no premium to Shareholders.
- Based on the exchange ratio disclosed in Total’s announcement on November 23, 2016 of its intention to make an offer for the Common Shares, no premium was offered for the Common Shares. Although the Total Offer, as indicated in the Total Circular, included a small premium to the closing price of the Common Shares on the trading day prior to the date of the Total Offer, investors have demonstrated by their actions that the Total Offer is inadequate by continuing to purchase Common Shares at prices above the implied $1.88 per Common Share price offered in the Total Offer based on the $14.43 price of the Total Shares on December 21, 2016.
- On November 23, 2016, GMP FirstEnergy, financial advisor to Total, published a research report discussing the impact of the Financings on Savanna. The report provided a 12-month price target for the Common Shares of $2.75 (an increase from GMP FirstEnergy’s previous price target of $2.25 per Common Share). Based on the GMP FirstEnergy price target, the Total Offer is at a discount of approximately 32%.
The discount offered compares poorly with the average premium for acquisitions of Canadian publicly listed companies.
- Over the past five years, the average premium offered in acquisitions of Canadian publicly listed companies with transaction values greater than $200 million was approximately 40% at the time of such offer. This is in stark contrast to the Total Offer, which currently provides a discount of approximately 5%.
- The Total Offer is at a discount to the trading price of the Common Shares and does not reflect the significant share price movement Savanna’s peers have experienced since announcements of production cuts by OPEC members and certain non-OPEC producers.
- The trading price of the Common Shares has been hindered relative to Savanna’s public market peers as a result of the Total Offer. Actions taken by Total on December 9, 2016 resulted in a trading halt on both Total and Savanna from before the market opened until mid-morning when Total formally announced the Total Offer. While halted, Savanna’s public market peers experienced significant share price appreciation as a result of material movement in oil prices that morning. Savanna’s share price has been range bound relative to the public market peers as a result of actions taken by Total.
- Since the announcement of the production cuts by OPEC and certain non‑OPEC producers, Savanna’s share price performance has lagged its most comparably sized public contract drilling and production and completion services peers due to hindrance from the Total Offer, even though Savanna’s share price has significantly outperformed that of Total.
2. The Total Offer is highly opportunistic and timed to deprive Shareholders of both significant positive recent market changes and value-increasing actions achieved to date which had not yet been reflected in the share price.
- The Savanna Board believes that the timing of the Total Offer is highly opportunistic. The Total Offer is being made at a time when the trading price of the Common Shares has not yet reflected the effect of the Financings on Savanna.
- The Total Offer was made in the face of material agreements having been reached by OPEC members and certain non-OPEC producers to curb production which is resulting in the revaluation of contract drillers such as Savanna and significant increases in share prices of public oilfield services companies. This is anticipated to commence the reversal of a trend of depressed commodity prices over the prior two years, which had caused oil and natural gas companies to significantly reduce their capital expenditures to historically low levels, especially expenditures for contract drilling.
- Two recent pipeline approvals by the Canadian government and the recent nominations of U.S. cabinet‑level government officials who are proponents of the energy industry have materially increased confidence that contract drilling activity will increase in North America.
- Due to recent improvements in economic conditions benefiting oil and natural gas producers, Savanna expects an increase in activity by its North American customers in 2017 and 2018 compared to 2016.
- Given Savanna’s significant exposure to drilling and well service activities compared to Total, services that are very sensitive to increases in the price of oil, increased pipeline capacity and the removal of regulatory blockages, Savanna has more leverage than Total to the recent developments. Savanna has a fleet of 101 contract drilling rigs and 87 workover rigs in Canada, the U.S. and Australia, compared to Total’s fleet of 18 contract drilling rigs operating only in Canada and no workover rigs anywhere.
- The expiry of the Total Offer is before the deadline for the release of the 2016 year end financial statements and before the end of the first quarter of 2017. Shareholders may not have the benefit of knowing those results before a decision in respect of the Total Offer is required. As disclosed by Total on August 10, 2016, Total has a $21.3 million order (representing approximately 34% of Total’s fabrication sales backlog as at September 30, 2016) for compression equipment which Total has publicly stated is expected to be completed by the end of the first quarter of 2017. Shareholders will not have the benefit of knowledge of the economic impact, or lack thereof, of the completion of this contract on Total prior to making a decision with respect to the Total Offer. Further, Total has publicly advised that an $8.1 million order included in Total’s backlog at September 30, 2016 is in dispute with a customer that has cancelled its order. Such amounts may not be realized, but Savanna believes such amounts have already been included in research analysts’ forecasts.
- At December 21, 2016, Savanna trades at a significant discount to the peer group and the Total Offer implies an even lower share price.
3. The Total Offer substantially undervalues the contribution that Savanna’s assets would bring to a combined entity and provides inadequate value to Shareholders.
- The Total Offer would result in Shareholders only owning approximately 33% of the combined entity even though Savanna would have contributed the majority of cash flow and EBITDAS to the combined entity from 2013 to September 30, 2016 and the majority of tangible book value, property, plant and equipment (PP&E) and total assets as at September 30, 2016.
- Based on the unaudited consolidated financial statements as at and for the nine months ended September 30, 2016 of each of Savanna and Total, Savanna would have contributed approximately 71% of the cash flow for the nine months ended September 30, 2016 and approximately 65% and 61% of the PP&E and total assets, respectively, as at September 30, 2016. Shareholders would own only a minority position in the combined company, even though Savanna would contribute the vast majority of the cash flow and assets.
4. Transaction multiples are too low compared to similar transactions.
- The Total Offer implies a price to tangible book value ratio of approximately 0.5 times based on Savanna’s tangible book value as at September 30, 2016. The range of price to tangible book value ratios for the more than 30 Canadian corporate oilfield services transactions (with transaction values greater than $50 million) that have taken place since 2010 is approximately 0.7 times to 8.2 times.
- Transactions since 2011 involving Canadian publicly listed companies where more than 10 drilling rigs were acquired have been completed at an average implied price per drilling rig of approximately $11.5 million. Based on these precedent transactions, Savanna’s drilling rig fleet alone, which consists of 101 drilling rigs, would have an implied value that is well in excess of the Total Offer, before assigning any value to the other components of Savanna’s business.
Transactions since 2011 involving Canadian publicly listed companies where more than 10 service rigs were acquired have been completed at an average implied price per service rig of approximately $2.0 million. Based on these precedent transactions, Savanna’s North American service rig fleet alone, which consists of 75 service rigs, would have an implied value of $150 million. Savanna also has 12 service rigs in Australia, which cost more than four times greater than service rigs in North America and attract day rates commensurate with their higher capability and cost.
5. Superior offers from third parties or other more attractive alternatives for Shareholders may emerge.
- Since Total’s announcement of its intention to make an offer for Savanna, Savanna has received strong expressions of interest from third parties in evaluating the opportunity to make a competing offer for Savanna. Under the supervision of the Special Committee, Savanna’s management, with the assistance of its financial and legal advisors, intends to conduct a formal process to explore the full range of strategic alternatives, which may include a merger or partnership with strategic or financial partners, a sale reflecting full and fair value for Shareholders or an acquisition by Savanna, with a view to maximizing value for all Shareholders. While it is impossible to predict whether any compelling proposals will emerge. from these efforts and discussions, the Savanna Board believes that Savanna and its business are potentially very attractive to other parties in addition to Total.
- Soft Support Shareholders who have entered into the Soft Support Agreements can terminate the agreements in accordance with their terms in order to accept a more favourable transaction.
6. The Total Offer does not attribute any value to the potential future success of Savanna’s ongoing actions to increase Shareholder value.
Savanna’s balance sheet and implemented cost savings measures can endure a sustained low activity level environment while retaining significant upside optionality to an industry recovery that now appears underway.
- With its significantly improved cost structure and balance sheet, Savanna is positioned to maintain strong performance in an extended industry downturn and to thrive in a market recovery.
- Savanna reduced the amount drawn under its credit facility from $161.2 million as at December 31, 2014 to $78.2 million as at September 30, 2016, a reduction of $83.0 million, through cash flow and sales of real estate and other redundant assets.
- Following completion of the Financings, Savanna has repaid the majority of its $150 million credit facility and repurchased and cancelled $62.5 million of the $169.6 million of outstanding Senior Notes. The second draw on the Second Lien Facility is expected to be used to repurchase the remaining Senior Notes at par, on or before June 1, 2017. Savanna has restructured its balance sheet and has significant liquidity to run its business, redeem or repurchase its Senior Notes prior to expiry and take advantage of an industry recovery. Since the Financings were announced one day before Total announced its intention to make an offer for Savanna and were completed four days after the Total Offer was made, the positive impact of the Financings was not fully reflected in the trading price of the Common Shares at the time of the Total Offer.
- The Second Lien Facility carries an attractive fixed interest rate of 7.15% for a term of five years. This new facility provides Savanna with the financial flexibility to execute on its business plan and significantly reduces liquidity risk. In addition, Savanna has the option and financial capacity to redeem the Second Lien Facility at par following the third anniversary of the issue date. Savanna’s right to require the exercise of the Warrants at a price of $2.50 may also be triggered, subject to certain conditions.
- Savanna recently secured a $17 million mortgage with the Business Development Bank of Canada on its operating facility in Leduc. The mortgage has a 25 year term maturing on December 31, 2041 and bears interest at 4.95%.
- Savanna’s general and administrative expense (see “Non-IFRS Measures“) in the nine months ended September 30, 2016 declined by $16.4 million, or 47%, relative to the nine months ended September 30, 2015 and $23.3 million, or 56%, relative to the nine months ended September 30, 2014. In the nine months ended September 30, 2016, Savanna’s general and administrative expense represented 8.5% of revenue compared to Total’s general and administrative expense which represented approximately 11.7% of revenue over the same time period.
- Savanna has a stable base of EBITDAS (see “Non-IFRS Measures“) in the current market environment as a result of its quality and diverse complement of assets and services and diverse geographic operations.
Since the appointment of a strong and experienced management team in Q2 2015, Savanna has achieved top decile share price performance while successfully executing its strategy of significant cost and debt reduction.
7. Peters & Co. has delivered a written opinion to the Savanna Board that the consideration offered pursuant to the Total Offer is inadequate, from a financial point of view, to Shareholders.
- The Savanna Board has received a written opinion of Peters & Co. dated December 21, 2016 to the effect that, as of that date and subject to the assumptions, limitations and qualifications contained therein, the consideration offered pursuant to the Total Offer is inadequate, from a financial point of view, to Shareholders.The full text of the foregoing opinion, setting out the assumptions made, matters considered and limitations and qualifications of the review undertaken in connection with the opinion by Peters & Co. is attached as Appendix “A” to the Directors’ Circular.The summary of the opinion in the Directors’ Circular is qualified in its entirety by reference to the full text of the opinion. The opinion is not a recommendation as to whether or not Shareholders should accept or reject the Total Offer. The opinion is one of a number of factors taken into consideration by the Savanna Board in making its unanimous determinations that the Total Offer does not represent adequate compensation to Shareholders and is not in the best interests of Savanna or its Shareholders and to recommend that Shareholders reject the Total Offer. Please refer to “Opinion of Peters & Co. Limited” for further details regarding the opinion.
8. If successful, the Total Offer may have an adverse effect on the liquidity of the Common Shares.
- Pursuant to the Total Offer, Shareholders would receive Total Shares which have limited liquidity. Based on Total’s average daily trading volume on the TSX over the 90 day period ended December 21, 2016, it would take Shareholders approximately 486 trading days (approximately 1.9 years on a calendar basis) to trade out of the aggregate Total Shares received as consideration pursuant to the Total Offer.
- There may be downward pressure on the share price of the Total Shares if the Total Offer is successfully completed. Given the significant level of cross ownership between Total and Savanna shareholders, certain Shareholders may look to decrease their ownership positions in an effort to reduce absolute dollar value exposure and company concentration risk.
9. The Total Offer is conditional and does not represent a firm offer.
- The conditional nature of the Total Offer effectively provides Total with the right not to proceed with the Total Offer.
- The Total Offer contains numerous subjective conditions, several of which include numerous sub-conditions, which must be satisfied or waived before Total is obligated to take up and pay for any securities deposited under the Total Offer. Certain of the conditions and sub-conditions provide a broad discretion in favour of Total, a number of which are not subject to any materiality thresholds or other objective criteria, and include language such as “the Offeror shall have determined in its sole judgment” and similar phrases, in several cases without any requirement for reasonableness in these determinations.
- The Total Offer is subject to the approval of the shareholders of Total. There is no certainty that such shareholder approval will be received and that Total will be able to complete the Total Offer.
- Certain agreements to which Savanna or its subsidiaries are party may require the consent of the counterparty to such agreements in the event of a change of control of Savanna. Total may not meet certain conditions relevant to the provision of such consent, or such consent may not be provided on terms satisfactory to Total.
10. The value of the consideration under the Total Offer is uncertain and entirely dependent on the value of the Total Shares in the future.
- The value of the consideration to be received by Shareholders under the Total Offer is uncertain and will depend on the value of the Total Shares at the time the Common Shares are taken up under the Total Offer. Under the terms of the Total Offer, the exchange ratio will not be adjusted to reflect any change, including a decline, in the market value of the Total Shares. If the market price of the Total Shares declines, the value of the consideration received by Shareholders will decline as well.
11. Total, an amalgamation of many disparate small businesses, has not emerged as a material player in any particular business line, has never completed an acquisition of Savanna’s size, and is underdeveloped in the highly consequential oilfield operations sector.
- Management of Savanna believes Savanna’s oilfield operations are significantly larger, more technically advanced and more geographically diverse than Total’s.
- Total’s drilling rig fleet, located entirely in Canada, consists of only 18 rigs located in Alberta and British Columbia. Total has no drilling rigs in the U.S. or Australia and its management team has limited operational experience in the United States and internationally.
- Savanna’s highly diverse Canadian drilling fleet consists of 68 drilling rigs in Canada including: 25 telescoping double drilling rigs, seven ultra-heavy AC electric telescoping double drilling rigs, 12 TDS-3000™ drilling rigs, eight TDS-2200 drilling rigs, 15 CT-1500 hybrid drilling rigs and one single drilling rig.
- Savanna’s U.S. drilling operations consists of 28 drilling rigs including: three 1500 horsepower AC triple drilling rigs, two mechanical triple drilling rigs, 15 telescoping double drilling rigs, five ultraheavy AC electric telescoping double drilling rigs and three TDS-3000™ drilling rigs.
- Savanna presently operates five new, highly mobile hybrid CT-1500 drilling rigs in Australia, ideally suited for coal seam gas drilling in Queensland.
- Savanna operates a fleet of 75 high quality workover rigs across Canada and the U.S. In addition, Savanna operates nine new high-specification workover rigs and three new high‑specification flush-by units in Australia which are significantly different than North American service rigs. Savanna’s workover rigs and flush-by units in Australia have a cost more than four times greater than those in North America and attract day rates commensurate with their higher capability and cost. Total has no workover rigs in Canada, the U.S., Australia or anywhere else.
- Savanna has invested over $880 million in new equipment since 2009. In addition to four new-build rigs added in the 4000 metre plus depth range in 2014, Savanna’s drilling rig fleet in North America has been upgraded and enhanced since 2009 in terms of hookload, pump and draw works capacity, and the number of rigs with top drives
- Savanna’s drilling and well servicing operations accounted for 94% of total revenue for the nine months ended September 30, 2016 while Total’s Chinook Drilling segment accounted for only 5% of total revenue over the same period.
- Total’s contract drilling customer base is insufficiently diverse. For the year ended December 31, 2015, Total’s top three customers for its Chinook Drilling division accounted for 32%, 22% and 14% of segment revenue, respectively. Total’s top 10 customers accounted for the full 100% of segment revenue.
- Savanna’s contract drilling customer base is very diverse. For the year ended December 31, 2015, Savanna’s top three customers for its drilling division accounted for 18%, 14% and 7% of segment revenue, respectively. Savanna’s top 10 customers accounted for only 66% of segment revenue.
- Total is focused in Canada and has limited operational experience in the United States and internationally. North American oilfield services companies that enter the Australian market have historically experienced challenges both operationally and financially in the first two years due to the differences in the regulatory and operational environment in Australia. Total has yet to demonstrate its ability to successfully do business in Australia.
- Total’s compression rental fleet has been significantly reduced in the last two years and completion of a significant contract is uncertain.
- As at September 30, 2016, the compression horsepower available in Total’s compression rental fleet was 39,200 horsepower, which represents an estimated decline of approximately 30% since early 2014. Total’s customers have, and may, exercise purchase options on leased compression equipment in its Compression and Process Services division thereby reducing Total’s fleet further. Additional capital expenditures would be required for Total to meet surplus demand in a market recovery.
- Concurrently with the announcement of its second quarter results on August 10, 2016, Total announced that its Compression and Process Services segment received a $21.3 million order from a large Australian natural gas producer. Total has publicly said it expects the compression equipment to be completed pursuant to this order by the end of the first quarter of 2017. As noted in Total’s management’s discussion and analysis for the nine months ended September 30, 2016, the timeline for conversion of sales backlog into revenue varies from order to order and often changes due to factors outside of Total’s control. Total has not publicly provided an update on the status of this contract and Total has yet to demonstrate its ability to successfully complete such contract on an international basis
- Management of Savanna believes Total does not have any material intellectual property. Savanna has valuable patented coiled tubing drilling technology which has recently drawn renewed interest for deployment internationally.
- The Total Offer fails to reflect the value of Savanna’s assets and future prospects, including the value of Savanna’s existing asset infrastructure and personnel.
- Total has a poor track record of completing larger scale acquisitions in the public domain.
- Two days following its announced intention to make an offer for Strad Energy Services Ltd., Total reversed its decision.
- While Total has completed several small acquisitions, it has never completed a material acquisition of this size or an acquisition with operations outside of North America and has not demonstrated its ability to successfully integrate a significant acquisition with such operations.
12. Total has failed to provide adequate disclosure that would reasonably be expected to affect the decision of a Shareholder to accept or reject the Total Offer.
- See “Errors, Misleading Statements and Breach of Laws by Total” for a description of the inadequate disclosure provided in the Total Circular.
CONCLUSION AND RECOMMENDATION
For the principal reasons outlined above, the Savanna Board, on the recommendation of the Special Committee, has unanimously determined that the Total Offer significantly undervalues the Common Shares and is an attempt by the Offeror to acquire Savanna without offering adequate compensation to Shareholders.The foregoing summary of the information and factors considered by the Savanna Board in reaching its conclusion and recommendation is not intended to be exhaustive. The members of the Special Committee and the Savanna Board evaluated the various factors summarized above in light of their own knowledge of the business, financial condition and prospects of Savanna, and based upon the advice of the Special Committee’s and Savanna Board’s financial and legal advisors. In view of the numerous factors considered in connection with the evaluation of the Total Offer, the Special Committee and Savanna Board did not find it practicable to, and did not, quantify or otherwise attempt to assign relative weight to specific factors in reaching its conclusion and recommendation. In addition, individual members of the Special Committee and Savanna Board may have given different weight to different factors. The conclusion and unanimous recommendation of the Special Committee and Savanna Board was made after considering all of the information and factors involved.