Oilpatch dealmaker on hunt for new takeover target with $1.4-billion fund

A billionaire dealmaker in the oilpatch known for unapologetic takeover bids is on the hunt for another company to acquire, with the launch of a forthcoming private equity fund.

Adam Waterous’ Calgary-based Waterous Energy Fund, which manages three separate pools of capital, plans to raise approximately $1.4 billion for a fourth fund, matching the size of its third.

“We’re out of money!” Waterous said in an interview, when asked why he’s launching another fund.

That’s because his firm’s third fund was fully exhausted of capital after its Greenfire Resources Ltd. paid $1.3 billion to acquire a neighbouring oilsands producer this summer.

That acquisition came a year after Strathcona Resources Ltd., the Calgary-based oil producer he owns, withdrew its scrappy, drawn-out bid for MEG Energy Corp. — clearing the way for Cenovus Energy Inc. to buy the company instead.

The latest fund’s goal, like the three that came before it, will be to deploy all its capital into building a single Canadian oil and gas company through mergers and acquisitions.

When Waterous raised his first fund in 2017, investors had largely written off Canadian oil and gas. He compared the sector’s standing at the time to the video rental business.

“People asked me, ‘What are you doing? It’s over,’” he said in an interview.

Waterous’ fourth time around stands out in a sector where Canadian private equity, according to him, has largely dried up.

He estimates his firm has accounted for most of the private capital deployed by Canadian oil and gas private equity funds over the past nine years.

“Money follows great returns,” he said. “That’s our Jedi mind trick. Great returns.”

The fourth fund will be hard capped at $1.4 billion, regardless of demand, Waterous said. “And our existing limited partners have already committed to supplying 80 per cent of the capital.”

To understand the returns his funds have generated involves understanding his firm’s investment strategy.

Waterous argues private equity players focused on North American energy tend to operate with a flawed model. He said it opened the door to a different approach, the one his team uses, which is rooted in a Depression-era strategy known as value investing.

For the past 30-plus years, he said, most North American private equity funds focused on the oil and gas business used a growth-equity strategy.

“And most of the time this venture-capital style model failed,” Waterous said.

In this approach, a single fund would lower its risk by investing in, say, 10 different technical teams. Each team would compete for funding based on how clearly they showed their oil drilling project would be profitable.

Waterous broke the mould by taking a value investor’s approach to Canadian oil and gas. This appealed to a particular kind of backer, whom Waterous calls free-thinking investors.

Many of them are ultra-high-net-worth individuals rather than institutions following the herd.

Benjamin Graham, the late Columbia University professor and Wall Street financier who famously mentored a young Warren Buffett, first laid out the value investing philosophy in his Depression-era textbook Security Analysis.

To Graham, the intelligent investor buys only when the price sits well below an asset, or company’s intrinsic value. That gap is the margin of safety, which protects against errors in judgment and bad luck.

To Waterous, value investing in a Canadian energy context boils down to two things when identifying margin of safety in a takeover target.

The first is the price per barrel needed to cover all the necessary costs to hold production steady. The second is the size and durability of its reserves.

To Waterous, “everything else is a distraction.”

He likes to use real estate investing as an analogy. “Find a good neighbourhood, find a good street, find a house, then buy the block,” Waterous said. “We missed the diversification memo in business school.”

His Waterous Energy Fund first put its consolidation strategy to work at Strathcona Resources, a heavy oil producer it began building in 2017.

Strathcona took its current form in August 2020, when two portfolio companies, Strath Resources and Cona Resources, combined.

From there, the company expanded by acquiring neighbouring assets in the same heavy oil regions.

In 2022, Strathcona bought a thermal oilsands project from Cenovus Energy for $800 million.

Later that year, the company acquired Serafina Energy in Saskatchewan’s Lloydminster heavy oil region for $2.3 billion, its largest purchase at the time.

Strathcona went public on the Toronto Stock Exchange the following year and now has a market value of nearly $6 billion. The company produces about 120,000 barrels of oil equivalent a day, making it Canada’s fifth-largest oil producer.

Focusing on heavy oil was a deliberate choice. To Waterous, the business case for Canada’s natural gas holds less appeal given the commodity’s persistently low price.

Strathcona sold its natural gas position last May to the region’s three biggest gas producers.

“You have to be a giant in natural gas,” Waterous said. “We voted [on that commodity] with our feet.”

That said, Waterous’ new fund will still have a broad Canadian energy mandate. “It will target regions away from where Strathcona and Greenfire operate,” he said.

It will also deliberately stay out of the United States.

In January 2020, he wrote an op-ed for an institutional investing magazine arguing American oil output was near its peak. It was a contrarian view.

U.S. production had nearly tripled from about five million barrels a day in 2011 to 13 million in 2019, and many forecasters expected it to reach 20 million. Instead, it has hovered around 13 million barrels a day since.

Canada’s reserves, on the other hand, are likely to matter more to North American supply as U.S. fields age and shale becomes costlier to drill.

Energy data firm Enverus estimates Canada could keep producing low-cost oil at current rates for nearly 53 years without new discoveries or technological gains, compared with 17 years in the United States.

Nine years after Waterous launched the first fund, the number of available takeover targets has fallen.

“We’re in the bottom of the ninth inning of consolidation in the Canadian oil sector,” he said. “It was a great idea in 2017 to do what we did. But you can’t start from scratch now.”