Surge Energy shares soared when Paul Colborne took over as CEO. For once, the market got it right
by Anthony A. Davis
The stock market can be a harsh taskmaster, a place where logic, well, sometimes defies logic. At the beginning of this year, it began to lay a beating on Calgary-based Surge Energy, a junior oil producer that seemed to be doing most things right. In its three and a half years of existence it had grown oil production from zero to 11,000 barrels of oil equivalent per day (boe/d). It had one of its best quarters ever, be it in terms of production per share, earnings per share or the success of its drilling program, in the first quarter of 2013. Investors should have welcomed the news, and the company’s progress. Instead, they did the opposite. From a high of $8.85 in September 2012, the company’s shares traded as low as $2.70 this past March.
Illustration Dave Webber
Then, last May, Surge’s board of directors announced radical surgery in an effort to save the patient. It replaced president and CEO Dan O’ Neil (who had been ailing with a heart problem that some say was exacerbated by the stress brought on by the poor performance of his company’s shares) with Paul Colborne, who had been Surge’s chairman of the board. Colborne quickly went to work. Following a playbook he developed – and perfected – as one of the founders of Crescent Point Energy, he converted Surge from a high growth junior into a sustainable, modest-growth, dividend paying company.
Well, what a difference a new face can make – especially if it happens to be Colborne’s. In the fickle world of Canadian oil and gas, the 54-year-old has garnered an unusual degree of respect among both analysts and investors for building up juniors – those companies that average between 500 and 10,000 boe/d – into the kind of tantalizing morsels that get gobbled up by bigger companies. More importantly, he has a track record of delivering fat payouts to his company’s shareholders in the process. In the month following the Colborne announcement on May 8, Surge shares shot up 50 per cent to $5.70. Analysts perked up. Investment banks were back in Surge’s corner, ready to underwrite new offerings when other junior oil and gas companies were being sidelined. Surge was back in business – all thanks, it seems, to Paul Colborne. But why?
According to Don Rawston, the managing director of institutional research with AltaCorp Capital who follows Surge closely, Surge’s success is a reflection of the market’s faith in Colborne. “He has a track record of success,” Rawson says. “And that is usually a good indication of future success in our industry.” More important, perhaps, is the fact that Colborne’s track record is longer than most. In his 22 years in the business, he’s founded, led, grown and flipped a whole host of juniors, virtually all of which have either been snapped up at a premium or grown into viable entities in their own right. He is to the energy sector what a skilled quarterback is to a good football team – someone who can read the defense, make adjustments on the fly and go deep when the situation calls for it. And no wonder: in his university years, he quarterbacked the University of Calgary Dinos football team for three straight years beginning in 1978. He likes the huddle so much, in fact, that he sat on 11 boards before his CEO appointment at Surge, though he has pared that down since.
Peter Bannister, an old elementary school chum, occasional business partner and fellow board member at Surge, says Colborne took a lot of his skills from the huddle to the C-suite. “He’s a team player, and a leader, and a motivator. And he brings that to the table in the corporate world. And he’s smart enough to listen to his teammates too. A lot of guys, they get in that position, and don’t listen to them. He’ll push them, challenge them. But at the end of the day, if they have a view, and they are strong enough to express it, he’ll listen to them, for sure.”
Colborne was a lawyer for nine years – one armed with an economics degree, too – before he ventured into the oil and gas world as a businessman. He handled securities and oil and gas law for three years at Parlee McLaws LLP after university, then spent almost five years at Husky Energy. He spent his last year as a lawyer at Wascana Energy, but eventually the idea of starting his own junior producer germinated in Colborne’s mind. In 1993, Colborne co-founded Startech Energy with geologist Kel Johnston and geological engineer Murray Mason. The learning curve was steep for Colborne. He’s not a technical guy, but surrounds himself with the best he can find, and he likes to share the spoils with his people.
Startech Energy may have been the company that made Paul Colborne’s name in the patch, but it’s StarPoint Energy, the company that he founded in 2003, that made him (and other investors) millions. After creating the company with an initial private placement of just $6 million, Colborne merged StarPoint with Acclaim Energy in 2005 in a deal worth an estimated $5 billion. The assets of those two companies were then used to create two new ones, Canetic Resources Trust and TriStar Oil and Gas. They, too, were nabbed in short order by bigger players.
“I remember the first day at Startech,” says Colborne, reminiscing via cell phone from a Montreal hotel. He’s in the middle of a two week stretch of hectic travel in July in Quebec and Eastern Canada, pitching Surge’s new story to the retail investment community. Colborne, who won’t be taking a salary as CEO but will get potentially lucrative stock option incentives, had already spent a good chunk of May making presentations in Toronto and New York City to institutional investors, where he would come away with a $247.5 million bought equity deal that gave Surge the capital to acquire some “elite” oil assets in southern Saskatchewan from Cenovus Energy for $240 million. That’s a far cry from where he was at when Startech was getting off the ground. “I think we were at 300 boe a day. All three of us had left good careers at big companies. And we all looked at each other and said, ‘What have we done?’ The first year no one picked us up for (analyst) coverage. And everyone was asking me, how can a lawyer be running an oil and gas company? And the truth is I had two really good technical guys with me.”
His legal background did come in handy in some ways, though. It made him particularly cautious about acquisitions, for one thing. When he started Startech Energy back in 1997, he remembers first learning how wildly inaccurate engineering reports on potential reserves could be. “Someone would say there were 10 million barrels left, and it turns out there were two. Or the other way, someone says there’s two million barrels in remaining reserves, and it turns out there’s 10. So they can be out by a factor of five.” When he was retained to be a lawyer, he says, “if I was out by even just 100 per cent, you would have fired me, right?” So Colborne insists his technical people intensely screen potential property acquisition. The law degree had another benefit, Colborne says. “I thought if I fall flat on my face, I can always go back and practice law.”
He didn’t. Colborne ran and rapidly grew the company until 2001, when it was bought by ARC Energy Trust for $500 million. That was just the beginning, too. He would go on to lead a series of other highly successful junior oil and gas producers, including Crescent Point Energy, a company that’s widely considered one of the patch’s brightest stars and biggest success stories and one that’s worth more than $14 billion. In 2003, meanwhile, he created StarPoint Energy, which grew from zero to 36,000 boe/d in two years before it was merged with Acclaim Energy Trust in 2005. That deal was worth $4.5 billion, and the investors who got in the ground floor and stayed until the end saw their initial investment more than triple, from $7 to $25. It’s safe to say Colborne doesn’t need to worry about falling back on that law degree anymore.
It’s clear that Colborne has given Surge Energy new life. But why did it need it? After all, it was putting up decent numbers and it had Colborne at the head of its board of directors. Yes, it had to deal with the widening spreads between WTI and Brent Crude that reduced both its profit margins and its ability to access the capital markets, but it was hardly alone in that respect. Surge’s struggles were more a reflection of the operational stumbles it had, departures on the management team and poor communication that “undermined the market’s confidence in the story,” according to AltaCorp’s Rawson. Eric Nuttall, a Toronto-based portfolio manager with Sprott Asset Management, who also follows Surge, is even blunter in his assessment of the situation the company was in. “Management effectively gave up,” he says. “They came across as defeated. And they needed new blood to rehabilitate the story.”
Colborne doesn’t see it quite so starkly, and says it was frustrating to see the market ignore Surge’s fundamentals and effectively force its board to push out O’Neil. “I actually think the Surge management had done a great job. They built a really good high growth junior.” But that wasn’t what the market wanted, it seems, and what was done was done. Now it’s up to Colborne to move the company forward, and he thinks a few key strategic moves will do just that – and help the company close the gap between where its shares are trading and its per-share net asset value of $8.21. Chief among them is the switch to a dividend-oriented model like the one Crescent Point has used to increase both its production and its payouts to shareholders. Surge plans to grow by a modest three to five per cent per year in size, and pay a 40 cent per share annual dividend to investors, one that amounts to about a 7.8 per cent yield.
Colborne says when juniors reach a certain “inflection point,” at about 10,000 boe/d, the growth model under which companies are rewarded primarily for increasing their production either by discovering or acquiring more reservoirs becomes difficult to sustain. Maintaining production as older reserves are drained can eat up tremendous amounts of cash flow, money that’s needed to fund the additional growth the market demands. Colborne’s past has taught him that the dividend model is a more sustainable (and less risky) way to deliver returns to shareholders. “It’s a great model,” he says. “I get to return capital to my partners – my shareholders – every month.”
The analysts covering Surge are divided on the dividend model, though Nuttall sees it as “highly necessary.” It can help bring back investors who abandoned the Canadian oil patch in recent years, and, in a low interest environment, older, risk-averse investors are looking for new sources of yield. But Rawson isn’t so sure. “I think the bottom line is that it is not necessarily an easy model to deliver successfully. Many companies don’t have the asset base that allows them to make that transition successfully,” he says, citing Renegade Petroleum’s switch to a dividend model in early 2012. Embarrassingly, after announcing an annual dividend of 23 cents per share last December, Renegade had to pare it down to just 10 cents in July in order to increase “financial flexibility.” It let its CFO go in the same month, and its shares, which traded at a high of $3.11 this past year, were sitting at a buck and a quarter as of mid-July. “Dividends,” Rawson says, “are not a panacea.”
Nevertheless, Colborne says converting to a dividend model helped Surge raise the capital needed to buy the elite reservoirs Colborne’s always on the lookout for. In this case, it was the 54 contiguous sections of land Surge bought from Cenovus in Saskatchewan’s lower Shaunavon basin. The properties contain an estimated 250 million barrels of recoverable crude, and currently generate production of 3,600 boe/d. Many other companies coveted the properties, but only Surge, on the strength of Colborne’s name, could get underwriters, led by Macquarie Capital Markets, to finance the purchase.
And while Colborne was dismayed at how investors treated Surge last spring, it seems he has a forgiving attitude. “You know what I find,” he says. “The market is incredibly brilliant. I am not a president who gets too caught up in the stock price. Because I really do believe if we deliver a great strategy, put out great quarters, and deliver growth, the market will always pay up. We have to go out and earn that respect – and we are not afraid to do that.”