August 31, 2020
Bonterra Energy Corp.
901, 1015 – 4th Street SW
Calgary, Alberta T2R IJ4
Attention: George Fink – Chairman, President & Chief Executive Officer
Cc: Bonterra Energy Corp. Board of Directors
As you are aware, Obsidian Energy Ltd. (“Obsidian Energy“) and Bonterra Energy Corp. (“Bonterra“) have been engaged in periodic discussions pertaining to a potential friendly business combination transaction since at least January of 2019. Based on the extensive due diligence and analysis conducted by our financial advisor Tudor, Pickering, Holt & Co. (“TPH“) and our senior management team, we strongly believe that a combination between our two companies would result in significant cost synergies that would drive very substantial accretion across all financial metrics while creating a “Cardium Champion” with significant scale given the contiguous nature of our Pembina operations. The pro forma entity would have production in excess of 35,000 boe/d, achieve a highly competitive WTI break-even price whilst maintaining production levels and benefit from a low corporate production decline rate when compared to light oil-weighted operators across the North American landscape. With a robust and efficient operating platform, we foresee that the pro forma entity would look to benefit from a stable balance sheet structure that could quickly pursue further value-creating consolidation within the Cardium play.
Obsidian Energy’s Board of Directors has been prepared to immediately engage in substantive transaction discussions and work expeditiously and collaboratively with Bonterra towards the announcement of a mutually-beneficial combination transaction since June. At that time I informed you that our Board of Directors was prepared to table a formal expression of interest to Bonterra’s Board of Directors, but we agreed that the more appropriate next step was for our respective management teams to commence discussions under a confidentiality agreement. During our subsequent conversations, both you and your advisors at Peters & Co. verbally agreed that the strategic and financial merits of a transaction between our two companies “made a lot of sense”. We also discussed the fact that both the equity and debt capital markets have been sending a clear signal for over two years that they are no longer supportive of small to mid-cap sized upstream energy producers. As a result, they would embrace the pursuit of strategic and financially accretive M&A to create a more competitive go-forward entity.
However, despite these positive initial discussions and Obsidian Energy’s consistent efforts to further the engagement between our two companies, we have failed to make any meaningful progress. In part, this is due to Bonterra’s desire to have Obsidian Energy sign a “standstill” that would be unduly restrictive given current market conditions. In lieu of this, Obsidian Energy offered to amend the confidentiality and standstill agreement Bonterra executed in September 2019 to ensure that the parties are on a level playing-field. You have been unwilling to proceed on this basis.
As a result, I write to you on behalf of Obsidian Energy’s Board of Directors to make a formal non-binding business combination proposal. Assuming a $US50/bbl WTI and $1.95/MMBtu AECO 2021 forward commodity price outlook, and based on the extensive analysis that we have conducted, we believe that a business combination between Obsidian Energy and Bonterra would result in:
(I) Approximately $50 million in year one and $100 million over the first three years in G&A and operating expense reductions, capital cost savings and incremental cashflow from recycling capital from the pro forma operations to Obsidian Energy’s higher-return Willesden Green drilling inventory, resulting in significantly greater free cash flow available to accelerate debt repayment resulting in improved financial performance;
(II) A significantly lower 2021 break-even WTI price of ~ $US37 WTI to maintain exit to exit production levels while achieving free-cash flow neutrality, with further break-even price improvement in 2022 and beyond due to lower interest expense from debt repayment;
(III) Significant improvement in credit metrics due to improved cashflow and lower debt resulting in a lower risk profile and forecasted 2022 year-end Debt / EBITDA of 2.0x;
(IV) Increased size and scale that we believe would allow the combined entity to access alternative debt financing to refinance existing first lien debt resulting in a more stable and diversified capital structure that would not be reliant on and exposed to semi-annual bank redeterminations;
(V) Robust accretion across all equity metrics resulting in significant per share value appreciation;
(VI) Increased efficiency in managing asset retirement obligations, the majority of which reside in our respective Pembina holdings;
(VII) Bonterra shareholders realizing significant equity participation in a pro forma entity optimally positioned to drive further accretive consolidation in the Cardium;
(VIII) The eventual reinstatement of a dividend to shareholders after sufficient debt pay down; and
(IX) An outcome far superior with regards to all financial measures compared to what either company could achieve on a stand-alone basis.
We would note that we have shared our assumptions with our banking syndicate, our noteholders and their respective financial advisors.
Based on the information we have had available to us, Obsidian Energy’s Board would be prepared to offer an exchange ratio of 2.0 common shares of Obsidian Energy per common share of Bonterra, representing total ownership by Bonterra shareholders in the pro forma entity of approximately 48%. While this is currently below a trading price-based exchange ratio, our detailed contribution analysis supports that this is a competitive and highly compelling exchange ratio. Bonterra currently trades at a premium to Obsidian Energy and other relevant public oil producing companies, despite recent performance that has been weaker than Obsidian Energy as measured by cash flow, operating costs, and well results. We recognize the attractive, low-decline attributes of Bonterra’s portfolio, but we do not believe that the Bonterra valuation premium will be sustained in the stand-alone entity. More importantly, we believe that the combined company will have dramatically superior financial performance due to the significant synergies available, and we believe that it is very unlikely that any other company would be able to achieve the scale of synergies that are available between our two firms. We are seeking to deliver a path to enhanced underlying cash flow and asset value to meaningfully increase the equity value for both Obsidian Energy and Bonterra shareholders. Obsidian Energy will consider an increased exchange ratio in the event Bonterra is able to demonstrate additional value.
At the proposed exchange ratio, we, in conjunction with our financial advisors, see the potential for significant accretion to the benefit of both Obsidian Energy and Bonterra shareholders. Modelling $US50 WTI/bbl and $1.95/MMBtu AECO commodity prices in 2021 and assuming the pro forma entity trades at 4.5x Enterprise Value / 2021 EBITDA, a trading multiple consistent with peers, Bonterra’s common shares would appreciate by greater than 300% to approximately $6.40 per share, representing approximately $3.20 per common share of Obsidian Energy. Under the same commodity price assumptions, extrapolating a 4.5x multiple to projected 2022 EBITDA would result in Bonterra’s common shares appreciating by almost 600% to approximately $10.50 per share and approximately $5.25 per common share of Obsidian Energy due to modest production growth resulting in higher EBITDA, along with equity value improvement due to significant debt pay down from free cash flow generation.
Given the significant equity appreciation that would result from a combination between our companies, we feel strongly that engaging with Obsidian Energy is a far better outcome for Bonterra shareholders than the pursuit of incremental second-lien debt financing from the Business Development Bank of Canada. It is clear that adding more debt to an already over-levered balance sheet is a vastly inferior outcome for Bonterra equity holders compared to the synergies and corresponding share price appreciation that a merger would enable.
It is our steadfast belief that a negotiated transaction is in the best interests of our respective shareholders. As a result, our management team as well as our advisors are prepared to immediately engage in prompt discussions to share our cost synergy and business plan assumptions and to negotiate mutually acceptable definitive agreements and finalize a transaction to combine our companies on an expedited basis. A combination transaction has the unanimous support of Obsidian Energy’s Board of Directors, and we envision a short period of exclusivity for each party to conduct any additional due diligence and for the parties to negotiate customary and appropriate definitive transaction documentation. Signing would be subject to final approvals by our respective Boards of Directors and closing would be subject to approval by our respective shareholders, as well as other customary conditions, including regulatory and stock exchange approvals. If the Bonterra Board of Directors feels a market check or similar process is necessary before effecting the proposed combination transaction, Obsidian Energy is prepared to consider non-preclusive deal protections and to permit a “go-shop” period on customary terms. Similarly, we recognize the social considerations inherent in any combination transaction and we are committed to fairly addressing these in order to allow the combined company to flourish. We have worked extensively with our legal, financial and tax advisors to confirm not only the feasibility of the proposed transaction, but also our plan to ensure a smooth and expeditious path to closing.
We look forward to your response to this letter as soon as possible and in any event on or before Friday, September 4, 2020. Absent expeditious engagement by Bonterra over the coming days, Obsidian Energy is prepared to pursue all options to consummate this transaction.
(signed) “Stephen E. Loukas“
Stephen E. Loukas
Interim President and Chief Executive Officer
Obsidian Energy Ltd.