Grey Wolf Gets Greedy

There's driller drama brewing in the Great White North, and now it's time for shareholders to play their part. If you've missed the twists and turns thus far, here's a recap.

Back in April, Grey Wolf (AMEX: GW  ) announced a "merger of equals" with Basic Energy Services (NYSE: BAS  ) , though the proposed retention of the name "Grey Wolf" for the combined entity tells you who's in the driver's seat there. Shares of Grey Wolf dropped on the news.

Earlier this month, Canadian driller and well-servicer Precision Drilling Trust (NYSE: PDS  ) crashed the party with a $9-per-share takeover bid for Grey Wolf. The latter firm rejected the offer, as well as a follow-up bid that was just a smidge higher. Precision then took a less tentative step with its third and ostensibly final offer of $10/share.

But cagey Grey Wolf remains an elusive quarry. The company rejected bid no. 3 today, providing an extensive justification for doing so. Having dubbed the initial pairing of Grey Wolf and Basic "puzzling," you know where I stand. It's more important that all you Grey Wolf shareholders consider the latest arguments, since your votes at the upcoming special meeting will help decide this driller dance-off.

Grey Wolf conveniently broke out its opposition to the bid in easy-to-digest segments, and I'll structure my rebuttals in the same format.

Undervaluing of (and insufficient premium for) Grey Wolf

  • The $10 offer undervalues Grey Wolf? Plenty of disappointed investors seem to disagree, given that Grey Wolf is today trading below even the initial bid of $9.
  • The company notes that Precision's offer values the company at "only" a 12-times multiple of 2009 earnings. That may sound low to shareowners of less cyclical businesses, but oil and gas is notoriously volatile. For this reason, even industry stalwart ExxonMobil (NYSE: XOM  ) trades at less than nine times the average 2009 analyst earnings estimate.
  • Grey Wolf notes that Precision's usage of the trading price the day before its initial bid isn't an "unaffected" price, because Grey Wolf shares were "temporarily depressed" by the Basic merger plan. As Grey Wolf doggedly (lupinely?) pursues its preferred merger, that depression is looking less and less temporary.

Uncertainty in long-term value of Precision's trust units
This point plays off the Canadian government's decision to torpedo the tax benefits of the income trust structure employed by Precision, Penn West Energy (NYSE: PWE  ) , and many other high-yielding players. The effects of that event, which presented a fat pitch for cool-headed Fools, have long been priced into the shares of these so-called CanRoys. The matter is a complete red herring.

Outlook for Canadian drilling and well-service markets

  • Sure, the drilling business was looking dismal for a while, but even with a more restrictive tax regime, it's amazing what 70% higher natural gas prices can do for a sector. The Baker Hughes (NYSE: BHI  ) Canadian rig count for May was up 26% over last year. That's off a low base, but things are turning positive very quickly.
  • On a related note, if things are so grim on the service side, why did Calfrac more than double its capital budget?
  • Grey Wolf rattles off a list of seven resource plays in the United States, as if we have a monopoly on oil- and natural gas-bearing shales. The Bakken is indeed rich in North Dakota, but the formation extends up into Saskatchewan and Manitoba as well. And while EnCana's (NYSE: ECA  ) excited about the Haynesville, the firm's sitting on serious gas up in its British Columbia-based Horn River and Montney plays.
  • The Grey Wolf team also fails to point out Precision's ongoing southerly rig migration.

Risk of substantial pressure on trust unit price
Perhaps the best point the company makes is that Precision and Grey Wolf shareholders have different expectations regarding payouts. Precision pays out a high amount of cash flow to unitholders on a monthly basis, while Grey Wolf retains cash flow for reinvestment. Grey Wolf shareholders might thus be inclined to sell units of the combined entity to avoid receiving those pesky distributions.

But if Grey Wolf shareholders are so fixated on capital gains, why take on extra debt to pay out a one-time cash dividend in consummating the Basic merger? Maybe Grey Wolf investors are receptive to receiving cash after all.

Possible future under investment
Save for the ongoing cash payout commitment, pretty much everything in this section could be said for the combined Grey Wolf and Basic. If things turn down in the industry, growth capital with take a back seat to debt service and/or paydowns. I don't think a combined Precision and Grey Wolf would be any nimbler financially.

I think I've said enough on the subject for now. If you're a Grey Wolf shareholder, I'd love to hear which way you're planning to vote, and why.

Precision Drilling is a Global Gains recommendation. Tango with any of our subscriber newsletters free for 30 days.

Fool contributor Toby Shute doesn't have a position in any company mentioned. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 27, 2008, at 6:25 PM, johneb22 wrote:

    The article never talked about the fact that BAS brings "regular cash flow" to a driller.I think the combined company is alot better than either alone.If you want $10.00,take the $1.80..NOW...and end up with 3/4 less shares at $32.00? Invest the $1.80 in a dividand paying Canadian driller and watch what happens to your new 3 Billion dollar company.

  • Report this Comment On June 28, 2008, at 2:46 PM, tttgraham wrote:

    After buying this stock in 2006 for under 7, I sat and sat and sat on it just knowing that with the rising costs of energy, would send the profits through the roof. Frustrated with the performance of GW, I bought PBT a full year later, hoping that it would be a better performer. Well.... in short it has... more than doubled, sporting a dividend yield north of 9%, and with energy prices continuing to soar and profits along with them... well you get the picture. Still have both, but would love an exit strategy from GW around $10 if I get to make that decision. Already have the dividend paying stock that I would buying more of as well... Maybe GW invests its dividends in its Quarterly Report that it sends out to shareholders, because it looks fantastic when compared to PBT's. As for me and my portfolio, give me the cash and let me invest it a management team that peforms month in and month out for the benefit of the shareholder.

  • Report this Comment On August 25, 2008, at 3:36 PM, XMFSmashy wrote:

    The line was submitted as:

    "I see a combined Precision and Grey Wolf as no less nimble financially."

    A subsequent edit reversed the intent of the statement.

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