‘Net benefit’ has U.S. investors scratching their heads

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As the federal government prepares to rule on two major foreign takeover bids in the oil patch, investors are nervously handicapping the outcome and Alberta is making a last-minute appeal to consider the consequences of rejection.

Ottawa could issue its verdict as early as next week on plans to acquire Alberta's Nexen Inc. and Progress Energy Resources Corp. But shares of the two companies remain far below their bid prices, indicating investors are allowing a significant chance that the Canadian government could turn down one or both acquisition proposals.

China's CNOOC Ltd. is offering $27.50 (U.S.), or about $27.32 (Canadian), per share to acquire Nexen, in a bid to gain a major foothold in Canada's oil sands industry. Shares of Nexen rallied Friday, but at $24.39 on the Toronto Stock Exchange remain nearly 11-per-cent below the bid price. Malaysia's Petronas is offering $22 a share to acquire Progress, but shares of the Calgary energy company closed at $20.18 on Friday, more than 8-per-cent below the bid.

Both suitors are controlled by their respective governments, which has triggered a debate in Canada about takeovers by state-owned companies and left critics worried the country is ceding too much control over its resources.

Investors aren't the only ones concerned about the risk of rejection. Proponents of the takeovers argue Canada needs outside investors in order to develop its resources.

Alberta Energy Minister Ken Hughes questioned what will happen if Ottawa turns down the deals.

"I would just say at this stage that if Canada is not comfortable with investment coming from state-owned oil, energy companies, we need to think about where we're going to get the capital to develop the resources we have in this country," he said. "The implication of rejection of these kinds of investments will be worth hundreds of billions of dollars of investment, because this will set the tone for many other investments as well."

He added: "To those who are saying that this should not happen, I say then where do you think we're going to find hundreds of billions of dollars of investment to develop the economy in this country over the next five years?"

The gap between shares of the target companies and their bid prices is larger than typically seen in most takeover situations, reflecting concern about the approval process.

"It is the largest spread the hedge funds have ever seen with any deal like this," said Bob Schulz, a professor at Haskayne School of Business at the University of Calgary. "The majority of the shares, in my opinion, are held by hedge funds predominantly in New York. And the people in New York are scrambling around trying to figure out how Canada works."

Prof. Schulz said he regularly receives calls from New York about the two transactions, with traders wanting to know how they should interpret Prime Minister Stephen Harper's signals. They want to know if the government can block the deal, how does net benefit work, has this happened before. Traders were closely watching Mr. Harper's trip to Asia, this week's federal byelections, and comments ministers make.

"The market always looks at risk. If you are sitting in New York, it looks like there is a lot of risk." Folks in Calgary, Prof. Schulz said, are more confident.

Canada must deem that the acquisitions bring a net benefit to the country for the government to issue its approval. Some analysts expect the deals could be approved with added investment or job guarantees, and possibly guidelines concerning future state-owned acquisitions. While Dec. 10 is currently the deadline to issue a ruling on the Nexen acquisition, that could be delayed along with the Progress decision.

Immigration Minister Jason Kenney, a cabinet member who was expressed reservations about the Nexen deal, on Friday said some of Canada's concerns about reciprocity with China have been addressed by the Foreign Investment Protection and Promotion Agreement.

"One of the key reasons why we finalized the Foreign Investment Protection and Promotion Agreement (FIPPA) after 18 years of negotiations is to provide for a degree of reciprocal protection for investment on both sides," said Mr. Kenney, whose nervousness about the Nexen deal stems, in part, from his concern over human rights. "So as far as I'm concerned, the FIPPA gives us a great deal of reciprocity," he said. "Now, Canadians will have some enforceable legal remedies to protect their investments in China. So that speaks to reciprocity."

In the meantime, many traders are confused – to them, the deals clearly benefit Canada. Now they are scrambling to understand every factor in Canada that may influence the outcome of the deals.

One New York trader, who declined to be named, wondered if the government is waiting for the NHL lockout to end before issuing a ruling, or whether Justin Bieber's fashion choices are a distraction.

"I saw the outfit he wore when he saw Harper. That's embarrassing," the trader said of Mr. Bieber's striped overalls, which he wore with one shoulder strap undone, while receiving a Diamond Jubilee Medal. "But it scares me with Harper spending the time tweeting about: 'Oh, I told him to wear that,' or something. Shouldn't he be working on the rules?"