Surge Energy to buy PE-backed Mount Bastion for $320 mln

Surge Energy Inc (TSX: SGY) has agreed to acquire the issued and outstanding common shares of Mount Bastion Oil and Gas Corp, a Calgary-based oil and gas explorer and producer, for $320 million in cash and stock.

The deal, expected to close in October, is supported by Mount Bastion directors and officers as well as its largest shareholder, collectively representing about 70 percent of the company’s shares.

The acquisition by Surge, a Calgary-based oil-focused company, will provide exits to Canadian energy private equity firms JOG Capital and Lex Capital Management.

JOG invested in Mount Bastion in 2016. Managing Partner Ryan Crawford sits on the board.

Mount Bastion’s Alberta assets include about 5,500 barrels of oil equivalent per day of light crude oil production.

(This post has been updated to note Lex Capital Management’s investment in Mount Bastion.)

PRESS RELEASE

Surge Energy Inc. Announces Accretive $320 Million Core Area Light Oil Acquisition

CALGARY, Sept. 5, 2018 /CNW/ – Surge Energy Inc. (“Surge” or the “Company”) (TSX: SGY) and Mount Bastion Oil and Gas Corp. (“Mount Bastion” or “MBOG”) have announced that they have entered into an arrangement agreement (the “Arrangement Agreement”), pursuant to which Surge has agreed to acquire all of the issued and outstanding common shares of MBOG (“MBOG Shares”) by way of a statutory arrangement (the “Transaction”).

The Transaction is 11 percent accretive to Surge’s forecast 2019 adjusted funds flow per share1, and adds over 600 million barrels of net internally estimated light original oil in place (“OOIP”2), concentrated reserves, production, land, and operations. The addition of the MBOG assets (the “MBOG Assets”) increases Surge’s operating netback per boe by 12 percent, and is forecast to add over $85 million of net operating income1 in 2019.

Surge anticipates increasing its dividend by 25 percent, from $0.10 per share annually ($0.00833 per month) to $0.125 per share annually ($0.0104 per month), while improving Surge’s all-in payout ratio from 89 percent to 87 percent. Any dividend increase will be subject to the approval of Surge’s Board of Directors with consideration given to the business environment upon closing of the Transaction.

The MBOG Assets include 5,500 boepd (98 percent liquids) of operated, light oil production from the structural reef complexes within the geological Beaverhill Lake Group – with a corporate decline of 23 percent. The Transaction results in a 22,500 boepd (85 percent oil-weighted), light and medium gravity, intermediate, growth and dividend paying company. The MBOG Assets are located near Surge’s core, waterflooded, light oil pools at Nipisi and Nipisi South in Western Alberta.

TRANSACTION HIGHLIGHTS

The Transaction has the following key benefits to Surge shareholders:

11 percent accretive to Surge’s forecast 2019 adjusted funds flow per share;
Increases oil and liquids weighting from 81 percent to 85 percent;
Increases Surge’s light oil weighting to 55 percent;
Increases Surge’s operating netback by 12 percent to over $31 per boe3;
Lowers Surge’s corporate decline to below 24 percent;
Surge’s all-in payout ratio1 improves to 87 percent from 89 percent, after accounting for the anticipated 25 percent increase to the annual dividend;
Adds over 600 million barrels of net combined internally estimated OOIP under management; and
Increases Surge’s December 31, 2017 independently engineered net asset value (Sproule) from $6.06 per share to an estimated $6.52 per share4.
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1 Adjusted funds flow, adjusted funds flow per share, net operating income, and all-in payout ratio are non-IFRS measures. See the Non-IFRS Measures section in this press release.

2 Original Oil in Place (OOIP) is the equivalent to Discovered Petroleum Initially In Place (DPIIP) for the purposes of this press release. “Internally estimated” means an estimate that is derived by Surge’s internal APEGA certified Engineers and Geologists (who are also Qualified Reserve Evaluators) and prepared in accordance with National Instrument 51-101.

3 Based on pricing averaging as follows: US$65.00WTI/bbl; CAD$86.67WTI/bbl; EDM CAD$77.33/bbl; WCS CAD $60.00/bbl; AECO $1.95/mcf

Paul Colborne, President and CEO of Surge stated: “We believe that this Transaction is an exciting opportunity for both Surge and MBOG shareholders. Shareholders in the combined Company will participate in the newest, intermediate crude oil, growth and dividend paying company in Canada, while benefitting from Surge’s exciting growth opportunities, our top tier all-in payout ratio, and Surge’s excellent balance sheet; together with Mount Bastion’s light oil netbacks, and its long life asset base”.

The Transaction will be funded through a combination of cash, common shares of Surge, and the assumption of positive working capital from MBOG, structured to minimize dilution to Surge shareholders while improving Surge’s balance sheet. The cash portion of the Transaction will be funded from the projected, revised credit facility and does not require any external financing.

The Company estimates that Q4 2019 net debt to annualized adjusted funds flow ratio will be 1.62 times. Surge estimates bank debt for the combined entity of $390 million at closing on a projected bank line of $525 million. The Company estimates that it will have approximately $135 million of undrawn credit avaibility at closing. All of the directors and officers of MBOG and its largest shareholder, collectively representing approximately 70 percent of the outstanding MBOG Shares, have entered into support and lock-up agreements to vote in favor of the Transaction and have agreed to certain escrow agreements with respect to any Surge Shares received from the Transaction for a period of nine months following the completion of the Transaction, subject to certain exceptions.

PROFORMA HIGHLIGHTS

Operational platform to continue to execute on sustainable growth plus income model:

Over 2.4 billion barrels of net combined, internally estimated, conventional OOIP – with a 6.9 percent recovery factor to date;
Combined proven plus probable year end 2017 reserves of over 120 million boe (90 percent oil);
22,500 boepd light and medium gravity oil producer (85 percent oil and liquids weighted);
Combined forecasted 2019 adjusted funds flow of $230 million;
Corporate base decline of less than 24 percent;
Development drilling upside: >800 locations5 (internally estimated); provides drilling inventory of more than 10 years; and
>14 year reserve life index (proved plus probable).
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4 Based on the independently evaluated total proved plus probable value presented in the Surge December 31, 2017 reserve report, and the Mount Bastion December 31, 2017 reserve report titled “Evaluation of the P&NG Reserves of Mount Bastion Oil & Gas Corp. (as of December 31, 2017) for Surge Energy Inc. using Surge Energy Inc.’s Development Plan”, dated August 31, 2018.

5 See Drilling Locations section of this press release.

Financial platform to deliver low to mid double digit, all-in annual per share returns:

Proforma operating netbacks of over $31 per boe at US $65 WTI per bbl;
Forecasted full cycle corporate capital efficiencies of less than $25,000 per flowing boepd;
Anticipated annual return components to include five to six percent growth in production per share, five percent dividend yield, and four to five percent free adjusted funds flow yield6 – for an estimated total annual shareholder return of approximately 15 percent;
Liquidity – in excess of $135 million in undrawn capacity forecast on the expected combined bank line of $525 million;
Post-closing, Surge estimates that the Company will have approximately $31 million of free adjusted funds flow in 2019 (i.e. over and above exploration and development capital expenditures and the anticipated, upwardly revised dividend) at US $65 WTI crude oil prices.

TRANSACTION METRICS

(See charts and notes here.)

TRANSACTION DETAILS

The aggregate purchase price payable by Surge under the Transaction will be $320 million, to be paid, at the election of each holder of MBOG Shares, (i) in cash; (ii) common shares of Surge (“Surge Share”); or (iii) a combination of cash and Surge Shares as elected by such holder, subject in each case to proration, such that the aggregate consideration to be paid to holders of MBOG Shares will be $145 million in cash and 75,431,034 Surge Shares.

In addition, Surge anticipates that it will assume approximately $3 million of MBOG positive working capital8 (after transaction costs) upon completion of the Transaction.

All of the directors and officers of MBOG as well as MBOG’s largest shareholder, collectively holding approximately 70 percent of the outstanding MBOG Shares, have entered into support and lock-up agreements pursuant to which they have agreed to vote their MBOG Shares in favor of the Transaction and have agreed to certain escrow agreements with respect to any Surge Shares received from the Transaction for a period of nine months following the completion of the Transaction, subject to certain exceptions.

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8 Working capital is calculated as current assets minus current liabilities, including transaction costs.

STRATEGIC RATIONALE FOR TRANSACTION

Surge management has positioned the Company over the last three years of the crude oil price downturn to be able to identify and acquire complementary, large OOIP crude oil assets – as oil prices recover.

The Transaction is consistent with Surge’s defined business model of acquiring operated, light and medium gravity crude oil reservoirs, with large OOIP and low recovery factors. MBOG’s Assets include 5,500 boepd of which 98 percent is light crude oil production, located in Surge’s NW Alberta core area, with an estimated 23 percent base decline. The business combination will result in a new intermediate company with over 22,500 boepd (85 percent oil and liquids), and annual base decline rate of less than 24 percent.

Production from the MBOG Assets is primarily from the structural reef complexes of the Beaverhill Lake Group – specifically the Slave Point formation. These structural reef build-ups (as opposed to the lower reservoir quality found in the regional Slave Point carbonate platform) have pay thicknesses of up to 22 meters, and porosity and permeability of up to 15 percent and 100 milliDarcy’s respectively. The MBOG Assets have an internally estimated net OOIP of over 600 million barrels, with a low 6.6 percent recovery factor to date.

The MBOG Assets are focused in NW Alberta, located near Surge’s core, waterflooded, light oil pools at Nipisi and Nipisi South. The MBOG Assets are over 90 percent operated, with over 80 percent working interests, and possess a reserve life index of 12.5 years (proved plus probable). In addition, a portion of the MBOG Assets are under waterflood.

Approximately 3,500 boepd of the MBOG Assets daily light oil production (i.e. greater than 55 percent) is generated from the 91 percent working interest, operated Sawn asset. The Sawn asset is a structural reef complex containing 208 million barrels of (net) internally estimated OOIP; it has a 6.6 percent recovery factor to date; and it is under waterflood.

Sawn currently has a 25 percent decline, a 15 percent royalty, and a netback of $45 per barrel at prices of US $65 WTI per barrel. Surge management recognizes significant additional upside at Sawn through full implementation of the waterflood across the entire field, together with infill and step-out development drilling.

Post-closing, Surge will have an internally estimated net OOIP of over 2.4 billion barrels of operated light and medium gravity crude oil under the Company’s ownership and management. The current recovery factor on the combined internally estimated 2.4 billion barrels of net OOIP is approximately 6.9 percent, with over 800 internally estimated development drilling locations in inventory (>10 year drilling inventory). The MBOG Assets have extensive infrastructure in place to facilitate further development drilling and waterflood.

OUTLOOK; PROFORMA SURGE

Growth Strategy

Upon the completion of the Transaction, Surge’s projected 2018 production exit rate is now expected to increase to more than 22,500 boepd (85 percent crude oil and liquids). Post-closing, Surge’s corporate decline is expected to drop below 24 percent. The Company will have an estimated $31 million of free adjusted funds flow in 2019, over and above its annual exploration and development capital expenditure program and the upwardly revised dividend.

Surge management anticipate capital efficiencies to average less than $25,000 per flowing boepd across the proforma asset base.

In 2019 Surge will continue to focus growth capital towards high quality, large OOIP, light and medium gravity crude oil reservoirs. Management’s primary goals for Surge include achieving five to six percent organic annual per share growth in reserves, production, and adjusted funds flow, maintaining and growing a sustainable dividend, continued debt reduction from the Company’s free adjusted funds flow, together with the pursuit of high quality, accretive acquisitions.

Surge will also continue to maintain balance sheet flexibility with an effective risk management program that looks to protect the Company’s capital program and dividend, and to pursue the Company’s waterflood program. Management will continue to evaluate hedging up to 50 percent of Surge’s net after royalty crude oil production for periods of up to 18 months.

An integral part of Surge’s ongoing business strategy is to increase oil reserves and recovery factors throughout the Company’s extensive crude oil portfolio through the continued implementation of waterflood projects, lowering corporate decline rates and maximizing shareholder value. The Company will also pursue continued, year over year increases in recovery factors from its portfolio of conventional light and medium crude oil assets through continued development activities, including in-fill and step out development drilling.

Dividend

Surge’s dividend policy will continue to target a dividend payout ratio of 20 to 30 percent, and an all-in payout ratio in the range of 80 to 90 percent. Additional free adjusted funds flow beyond Surge’s targeted five to six percent annual production growth will be allocated to an expanded capital program, debt repayment, dividend increases, or share buybacks.

Surge anticipates increasing its dividend by 25 percent, from $0.10 per share annually ($0.00833 per month) to $0.125 per share annually ($0.0104 per month), while improving Surge’s all-in payout ratio from 89 percent to 87 percent. Any dividend increase will be subject to the approval of Surge’s Board of Directors with consideration given to the business environment upon closing of the Transaction. This increase represents a dividend payout ratio of 17 percent of estimated 2019 adjusted funds flow at US $65 WTI crude oil pricing9.

The Transaction improves Surge’s all-in payout ratio from approximately 89 percent to 87 percent. Post-closing, Surge estimates that the Company will have approximately $31 million of free adjusted funds flow (above exploration and development capital expenditures and Surge’s upwardly revised dividend) at a crude oil price of US $65 WTI per bbl in 2019.

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9 Dividend payout ratio of 17 percent is calculated as follows: $39 million in estimated 2019 annual dividend expense divided by $230 million of forecast 2019 adjusted funds flow.

Upward Revision to 2018 Exit Rate & Preliminary 2019 Guidance

The following is the Company’s increased guidance for Surge’s 2018 production exit rate target, as well as, preliminary guidance for 2019 (after giving effect to the Transaction):

(See chart and notes here.)

LEGAL TERMS OF THE TRANSACTION

The Transaction is expected to close in October 2018. Completion of the Transaction is subject to the approval of at least 66 2/3 percent of the MBOG shareholders and the issuance of Surge Shares to MBOG shareholders pursuant to the Transaction will be subject to the approval of at least a simple majority of the Surge shareholders. The meeting of Surge shareholders is currently expected to be held in mid-October 2018 and, in connection therewith, it is currently expected that a management information circular and proxy statement will be sent to Surge shareholders in mid-September 2018. Completion of the Transaction is also subject to, among other things, the receipt of court approval and other customary closing conditions.

All of the directors and officers of MBOG as well as MBOG’s largest shareholder, collectively holding approximately 70 percent of the outstanding MBOG Shares, have entered into support and lock-up agreements pursuant to which they have agreed to vote their MBOG Shares in favor of the Transaction and have agreed to certain escrow agreements with respect to any Surge Shares received from the Transaction for a period of nine months following the completion of the Transaction, subject to certain exceptions.

Each of MBOG and Surge has agreed to pay a termination fee of $10.5 million to the other party in certain circumstances, including in the case of MBOG, if MBOG recommends, approves or enters into an agreement with respect to a superior proposal. MBOG has agreed not to solicit or initiate any discussions regarding any other acquisition proposals or sale of material assets. MBOG has also granted Surge a five business day right to match any superior proposal.

ADVISORS

Macquarie Capital Markets Canada Ltd. is acting as exclusive financial advisor to Surge with respect to the Transaction. McCarthy Tétrault LLP is acting as legal advisor to Surge with respect to the Transaction. GMP FirstEnergy and BMO Capital Markets have also been appointed strategic advisors to Surge.

CONFERENCE CALL DETAILS

A conference call hosted by Paul Colborne, President and CEO of Surge, will be held for the investment community to discuss the Transaction. Details of the conference call are as follows:

Date:

Thursday, September 6, 2018

Time:

6:45 am MT (8:45 am ET)

Dial-In:

1-888-241-0326 (toll free)

International Dial-In

647-427-3411

Conference ID:

7978867

For further information: Paul Colborne, President & CEO, Surge Energy Inc., Phone: (403) 930-1507, Fax: (403) 930-1011, Email: pcolborne@surgeenergy.ca; Jared Ducs, Vice President, Finance, Surge Energy Inc., Phone: (403) 930-1046, Fax: (403) 930-1011, Email: jducs@surgeenergy.ca