Need for change
The purpose of this solicitation by and on behalf of Cation is to solicit proxies from shareholders to seek the election of all four of the Cation Nominees to the Board at the Meeting.
Crescent Point’s share price has fallen drastically. The stock, once a market darling, now lags its peer group in virtually all relevant metrics and the incumbent members of the Board are either unable or unwilling to address the very serious issues confronting the Company.
Cation believes Crescent Point’s dismal underperformance cannot be blamed on external factors, as the Company is prone to do, but rather on flawed strategy, poor execution and ultimately failed governance by the Board. Subsequent to Crescent Point’s surprise $650 million equity offering in September 2016 at $19.30 a share, the Company’s shares have lost 52% of their value, while relevant indices and other metrics have shown growth or substantially smaller losses. The issue is clearly specific to Crescent Point and it appears that the Board has been unable to identify, let alone cure, what the exact problems are.
Simply stated, BILLIONS in shareholder value has been destroyed
Cation believes the opportunity at Crescent Point is unique, both in the amount of value that can be unlocked and how readily it can be achieved. In an effort to unlock that value for shareholders, Cation has nominated the Cation Nominees for election to the Board at the Meeting.
Cation has attempted to share its views and analyses with the special committee established by the Board to deal with its proposals, with whom it would prefer to work collaboratively. Despite its good faith efforts to address its concerns outside of the public sphere, Cation continues to receive no meaningful sign of collaborative engagement or that the Company intends to address its numerous strategic and governance challenges, let alone an external signal that the Company’s negative trajectory has changed. Put simply, Crescent Point believes that its current strategy is working! When the Company finally begrudgingly met with Cation, all that they were prepared to offer is that they would consider ONE of the Cation Nominees for a Board seat.
That will not do. Despite a rotation of six new directors since 2014 (with a seventh nominated this year) the Board has proven completely ineffective at addressing any of the numerous issues facing Crescent Point. The addition of one or two new directors will not suffice. Crescent Point’s high board turnover coupled with its rigid adherence to a failed strategy confirms what the street has known all along – that Crescent Point is for all purposes controlled by a select group of individuals. It is noteworthy that it is essentially this same group – united by business interests outside of their service to Crescent Point – that comprises the special committee of “independent” directors that has rebuffed our attempts to effect necessary change at Crescent Point. Crescent Point needs new leadership at the Board level involving those with the expertise, vision and courage to stand in the face of the entrenchment and cronyism that prevail today. A confident, independent voice is needed.
The Cation Nominees, whose compelling biographies are provided in this Circular, are uniquely suited to this task and in preparation for this campaign have invested substantial amounts of their own money to ensure alignment with the all but forgotten shareholders of Crescent Point. As of the date of the Circular, the Cation Nominees hold more than double the amount of shares held by all of the incumbent non-employee directors.
The purpose of this solicitation by and on behalf of Cation is to solicit proxies from the shareholders to seek the election of the Cation Nominees. The Cation Nominees have the governance, capital markets and public company experience needed to implement our strategy in order to realize opportunities to create long-term value for shareholders.
Under the right leadership, the Company should produce substantial returns for its shareholders given the strength of its asset base.
THE CASE FOR A CHANGE IN STRATEGY
Crescent Point, once a market darling and the beneficiary of a premium valuation, has lost its luster in the capital markets and suffers from a high cost of capital. Even as the energy sector as a whole has seen some decrease in investor interest, Crescent Point stands out for the precipitous decline in its share price relative to its peers and the broader market.
Crescent Point is the largest oil and gas producer in Saskatchewan and among the top ten producers in Canada. While larger companies have improved efficiencies in the recent commodity sell off, Crescent Point has lagged its peers in all efforts. This has directly affected the Company’s share price and long-term investors have become disillusioned.
Crescent Point’s strategy over the years has been to grow through acquisitions and exploit through the drill bit. The Company has publicly disclosed an annual capital program of at least $1.8 billion for the next several years. But, higher drilling costs mean it is less attractive to drill and in an environment where it is less expensive to acquire reserves in the ground than it is to drill for them, Crescent Point’s uncompetitive cost of capital prevents it from accretively exploiting this market dynamic. Until such conditions change, Crescent Point will continue to generate inferior returns to its competition.
It is evident to Cation that the current Board has not been leading the industry but rather following, adapting to change slowly, if at all. The Company has made some missteps in recent years. Investors have accepted these, giving the Company time to resolve outstanding issues. However, as weak performance has persisted, it is evident that the market has lost patience and confidence in leadership.
Cation’s plan is to restore investor confidence and bring Crescent Point to the forefront by cutting costs, improving efficiencies and enhancing returns through a relentless focus on better risk-adjusted capital allocation.
Shareholders have lost ~71% of the value of their shares since May 1, 2015 (being the month the Legacy Oil + Gas Inc. acquisition was announced). Crescent Point’s share price has fallen drastically, a direct result of investors' dissipating interest in owning the Company's shares.
Share Price Performance
Underperformance is Not Solely Market Related
While the energy sector as a whole has seen decreasing investor interest, Crescent Point has seen far greater declines in its share price than its peers and the broader market, and has severely underperformed all relevant benchmarks. Since January 1, 2015, an investment in Crescent Point has generated a total return of –55%, significantly below the sector (-19%, TSX Energy Index) and the overall market (+3%, TSX Composite). During the same period, an index of the Company’s primarily produced commodity, crude oil, has risen +18%.
If you invested $100 at the beginning of 2015, your investment is now worth…
Significant Valuation Discount, Relative to Peers
One key driver of shareholder value destruction has been Crescent Point’s significantly discounted valuation, both relative to its peers and relative to the valuation premium it enjoyed not long ago.
Relative to its peers, Crescent Point has one of the lowest 2018E EV/EBITDA multiples despite its assets having the highest exposure to light oil and it yields top quartile operating netbacks. In order to compete with its peers, it must generate greater returns on capital.
Valuation Premium Lost
The magnitude of the downgrade in valuation metrics is substantial. Four years ago Crescent Point commanded a premium valuation to its peer group mean, compared to its substantial discount today. Crescent Point has one of the lowest 2018E EV/EBITDA multiples of all relevant oil producers in Canada. Clearly the premium valuation multiple has been lost.
Underperformance Compounded by Erratic Dividend Strategy
Another key driver of shareholder value destruction has been Crescent Point’s poor management of its dividend.
It took 14 months from the great oil collapse of 2014 for the Board to act and defend the Company’s balance sheet and sustainability. On August 12, 2015, the Company announced a 57% cut to its monthly dividend to $0.10/month. This came after prolonged messaging to the market on the strategy of “protecting the dividend” at the cost of running the total payout ratio higher and funding the dividend with debt. It took the Board a further seven months to realize a more significant dividend reduction was required. On March 9, 2016, it reduced the dividend by a further 70% to $0.03/month. Had the more significant dividend cut happened in August 2015, Crescent Point’s Net Debt would be ~$250 million (~6%) less today. For comparative purposes, companies within Crescent Point’s peer group started cutting their dividend in 2014 and eliminating the dividend all together in 2015.
The dividend has been reduced by 87%: The dividend has been cut twice over the past four years, even though the CEO “expected this cycle to be no different” and Crescent Point has “been through downturns before and have not only protected our dividend and balance sheet during those times but have come out of them even stronger than before”. A timely reduction of the dividend that preserved shareholder value would have been appropriate and prudent. However, the Company instead elected to delay dividend reductions relative to its peers, adopting a “too little, too late” approach that both deprived the Company of necessary cash on hand and eroded shareholder value.
Crescent Point’s shareholders cannot continue to endure further value destruction under the current Board
Despite having a number of years to improve the business, the Company continues to be plagued with deteriorating performance. Unacceptably high costs combined with ballooning leverage and executive compensation costs demonstrates that the current Board is unable, unwilling or unmotivated to pursue opportunities to recover this enormous shareholder value gap.
Crescent Point has underperformed its oil-weighted peers despite realizing top quartile commodity pricing. Contributing to this is the Company’s high, all-in, general and administrative costs, increased operating costs, inefficient capital allocation and inflated debt burden.
Crescent Point’s average selling price is one of the highest among producers and as a result has one of the highest operating netbacks substantiating the high quality nature of its asset base. The benefit of receiving this top quartile pricing is lost as a result of other costs being higher.
Crescent Point has among the highest all-in general and administrative costs (“G&A”)/boe of its peers: When accounting for all G&A costs which include capitalized and share-based compensation, Crescent Point’s G&A/boe is among the highest in its peer group. Share-based compensation costs are a significant contributor to these costs which is counter-intuitive given the Company’s significantly underperforming share price. Besides a failure to implement necessary cost-cutting initiatives, there are multiple contributors to the high G&A costs including: increasing employee count from 1,007 to 1,085 (an increase of 8%) since 2014 while the industry in general has faced mass layoffs, premium office space, a U.S. office in Denver (which has resulted in duplicative costs while the new core area it oversees is only ~14% of overall production) and a bistro/cafeteria at its head office.
2017 General and Administrative Expense Comparison
Crescent Point highlights its commitment to keeping basic G&A at $1.50/boe, yet the peer group average is $1.35/boe. Crescent Point’s all-in G&A is 37% higher than the peer group median even after investors have stressed the need for cost cutting initiatives. A full evaluation of strategic cost cutting initiatives needs to be undertaken to decrease overall G&A. If the Company can reduce all-in G&A/boe from $3.29/boe to the peer median of$2.38/boeb it would generate significant annual cost savings.
Operating costs remain at the high-end of the peer group suggesting an opportunity to generate savings from economies of scale: Crescent Point has operating costs (defined as operating and transportation costs) per boe that are ~12% higher than its peers. Understanding peer group best practices for improved efficiencies and targeting to be the low-cost producer in Saskatchewan could result in significant cost savings.
2017 Operating and Transportation Expense
Crescent Point’s operating and transportation costs are higher compared to its peers. An evaluation of operating and transportation cost cutting initiatives should be undertaken to see if efficiencies can be realized. If Crescent Point can reduce operating costs to the peer median it would generate significant annual cost savings.
Capital expenditures do not yield maximum results: In 2017, Crescent Point spent $162 million or 12.6% more than budgeted (as of July 27, 2017) on drilling and completions and yielded the same exit production and approximately 1,500 boe/d of average production for the year. On October 26, 2017, the Company increased the drilling and completion budget by $90 million for the last two months of the year and overspent that by $72 million and still did not increase exit production guidance. Was this increase and overspend made to meet 2017 exit production guidance?
2017 Capital Expenditures
If the difference in capital spent of $162 million was paid to shareholders instead, it would have resulted in a special dividend of ~$0.30 per share. Conversely, Crescent Point could have used the savings to repurchase 3.1% of the shares outstanding (assuming a $9.50 purchase price for 17.1 million shares).
2017 Capital Efficiency (or lack thereof at Crescent Point)
The graphs below highlight Crescent Point versus an oil weighted peer group. Crescent Point is less favourable than its peers and has been unable to yield the efficiencies one would expect from one of the largest drillers.
The Cation Nominees would focus on achieving cost efficiency across all areas of the Company.
Debt has Increased
Crescent Point has a Net Debt to cash flow ratio of 2.0 times: Net Nebt has doubled since the end of 2013, from ~$2 billion to greater than $4 billion.
When accounting for debt, the Company’s per share growth is negative as compared to the Company’s advertised per share growth measures which ignore the impact of debt and reflects increases that are due to untimely acquisitions. The Board's focus on growth has come at the cost of operating efficiencies of the business and material share price erosion.
Directors and Management are NOT Financially Aligned with Share Price Performance
Crescent Point’s share price has declined from $37.62 on January 2, 2013 to $9.17 on April 6, 2018. Despite a 76% erosion in entity value over this period, management has received greater than $90 million of compensation.
Notwithstanding poor corporate performance over recent years, executive compensation has spiked, with an increase of 17% in total compensation for 2017 year over year, even as shareholders have suffered a ~48% plunge in the value of their shares. To add insult to injury, shareholders have repeatedly demonstrated their dissatisfaction with matters related to executive compensation without seeing any results, including in the 2016 proxy cycle where Crescent Point received a “no” vote on its say on pay resolution with a dismal 31% of votes cast in support of the Company's approach to executive compensation.
Reflecting the complete disconnect between executive compensation and shareholder returns, directors and officers collectively own just 0.6% of the outstanding shares of the Company. Cation does not believe that this low level of ownership provides any incentive to work in the best interests of shareholders. Until recently, Crescent Point’s CEO was the only officer with mandatory minimum ownership requirements. This year, minimum share ownership requirements were added for the CFO and COO. The other officers are NOT required to meet minimum share ownership requirements. The non-employee directors hold a median number of shares totaling 15,000 per director.
Yet it would seem the Company now intends to go a step beyond disconnecting incentives from shareholders’ interests by actually rewarding management for destroying shareholder value. With the Company’s shares hovering, over the course of the last year, near a 15-year low, we shareholders would expect a Board and management team whose interests are aligned with shareholders to be buying shares. Instead, at the upcoming Meeting, the Company is seeking to further enrich its executive leadership by adopting a new equity compensation plan and ratifying grants of nearly 3 million options made without shareholder approval but with apparent urgency, when the shares were was reaching lows earlier this year. With a correspondingly depressed exercise price, these options are essentially risk-free money – for management, at shareholders’ expense – that rewards insiders for having decimated the share price.
As if that weren’t enough, the Company is also asking shareholders to approve an increase in the number of shares eligible for issuance under the Company’s existing RSBP. It is outrageous to so richly reward a leadership team that has presided over the evisceration of shareholder value that has befallen Crescent Point.
Crescent Point also believes a member of the Board has a conflict of interest due to related-party transactions, further calling the Board’s alignment of incentives into question. Crescent Point uses Secure Energy Services Inc. (“Secure”) whose CEO is also currently a Board member of Crescent Point. The Company uses Secure for oilfield services and the related-party transactions in 2017 have resulted in payments to Secure totaling $12.9 million. Within its peer group, Crescent Point is the only producer that has any related-party transactions of this magnitude with a Board member for such services. Given the unprecedented nature of these transactions within the peer group, it is difficult to understand how the Board justifies this relationship, especially since this Board member, until recently when he joined the Corporate Governance and Nominating Committee, only sits (and is the Chair) on the Environmental, Health & Safety Committee which in itself is a potential conflict, as the services provided by Secure may fall within of the scope of such a committee.
Management Has Lost Credibility on Capital Spending and Dividends
On significant matters of capital spending and dividend policy, Company management has lost credibility with investors by repeatedly contradicting guidance and breaking promises.
In a press release on January 6, 2015, Crescent Point’s CEO stated, “Oil prices have always been cyclical. We’ve been through downturns before and have not only protected our dividend and balance sheet during those times but have come out of them even stronger than before …We expect this cycle to be no different. We will be conservative and prudent with our capital spending and will remain flexible to react to changing oil prices.” Directly contradicting this guidance only four months later, Crescent Point acquired two highly leveraged businesses in May and July of 2015 for an aggregate of $1.8 billion. Further, the Company announced its first dividend cut on August 12, 2015.
In a press release on March 9, 2016, Crescent Point’s CEO stated, “With our revised dividend and capital, we are living within cash flow and protecting our balance sheet in 2016 at price levels below the current forward strip … As commodity prices improve, we will have greater flexibility to improve our balance sheet, increase our per share growth, internally fund future acquisition opportunities or raise our dividend.” Yet, with WTI prices having more than doubled since the lows of 2016, the Company has failed to deliver the suggested improvements.
Instead, on September 8, 2016, Crescent Point announced a surprise bought deal financing of $650 million with stated use of proceeds to reduce indebtedness and to fund future capital expenditures. The equity financing effectively paid down debt from previous acquisitions but further diluted existing shareholders. As a result, it sent the share price down to levels from which it has not recovered.
Crescent Point has Strong Assets and Opportunities to Unlock Shareholder Value
Crescent Point has a strong asset base consisting of desirable light and medium crude oil and significant opportunities to recover the enormous loss of shareholder value that has resulted from the Company’s failing strategy and governance.
According to Crescent Point’s calculations at March 1, 2018, the Company’s share price is currently trading at only 37.5% of its calculated net asset value of $24.44. Put another way, $8.7 billion of value is not being reflected in the entity value of the Company.
Crescent Point Publicly Stated Net Asset Valuation as of December 31, 2017
A CHANGE IN STRATEGY REQUIRES A CHANGE IN THE BOARD
Under the leadership of the current Board, Crescent Point has continued to disappoint the market. Equity research analysts have been urging change for over a year now, but nothing material has been done to address and implement change. The Company has failed to meet the call to action by the institutional community and as a result has suffered poor performance.