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(B)(N) PRY Pinecrest Energy Incorporated

November 22, 2012

Deal Book. Pinecrest Energy is about to acquire STO Spartan Oil Corporation in a friendly exchange of shares pro rata their current market values. That means that each common share of Spartan will be exchanged for 2.738 common shares of Pinecrest which will be new shares issued from treasury and the shares of the combined company. The “deal”, of course, is fair by definition because the parties have agreed to it but one could also say that the exchange of copper pans for Manhattan was “fair” because the natives agreed to it and, from the wider perspective of societal innovation and enterprise, all great fortunes are won or lost on the basis of a trade or exchange of assets or things that look to be the same but have different risk characteristics.

In this case, the assets of Pinecrest appear to be substantially riskier than those of Spartan and, therefore, we can calculate an expected downside risk of 60% in the share price of the combined company, from a nominal $1.87 at the start of trading for the combined company to $0.75 for the combined company. (Please see the Postscript for the details of this calculation.) Of course, it is not an unusual situation that the share price should exceed the price of risk. However, the difference is an “economic free good” that will tend to evaporate unless earned. Please see our Post, The Price of Risk, August 2012, for more information on how that works.

Exhibit 1: (B)(N) PRY Pinecrest Energy Incorporated – Risk Chart

Pinecrest is engaged in the acquisition and exploration for and development and production of oil and natural gas in Western Canada.  Pinecrest has a significant position in the emerging, light oil Slave Point carbonate resource play focussed in the greater Red Earth area of north-central Alberta.  The common shares of Pinecrest are listed on the TSXV under the symbol “PRY”.

(Please Click on the Chart to make it larger if required.)

Exhibit 2: (B)(N) STO Spartan Oil Corporation – Risk Chart

Spartan Oil Corporation is engaged in the business of acquiring crude oil and natural gas properties and exploring for, developing and producing oil and natural gas in western Canada.  Spartan is uniquely positioned with a significant position in two of the leading oil resource plays in western Canada, being the Cardium light oil play in central Alberta and the Bakken light oil resource play in southeast Saskatchewan.  The common shares of Spartan are listed on the TSX under the symbol “STO”.

(Please Click on the Chart to make it larger if required.)


The exchange of shares by the current market values of $5.12 per Spartan share and $1.87 per Pinecrest share (yielding a factor of 2.738=$5.12/$1.87) would seem to transfer the assets and liabilities of Spartan – the whole company and its contracts and commitments – at its current market value and to give the shareholders of Spartan “fair value” in that they could sell their shares for cash and get back exactly what they have today. However, a dollar of Pinecrest is not the same as a dollar of Spartan because the Pinecrest dollar is freighted with more risk than the Spartan dollar (please see Exhibit 1 and 2 above) and we can calculate whether the diluted shares of Pinecrest with the Spartan assets that make up the new company can be expected to remain the same or trade at more or less than $1.87 per share.

From the Charts we can see that Pinecrest is currently trading at $2 well below its Risk Price (SF) (Solid Black Line, a step-function) of $4.50 whereas Spartan is trading at $5 and, for all reasonable purposes, is at its Risk Price (SF) of $5. In other words, on a risk equivalence basis one Spartan share should garner only 1.11=$5/$4.50 shares of Pinecrest which is a shocking conclusion and re-writes the deal book. How is the Spartan shareholder to be paid the apparent deficiency on closing of  $3.06 = $5.12 – 1.11×$1.87 per share? Since the payment is not in cash, it will be “paid” by an expected decline in the share price of the combined company from $1.87 projected in the deal to $1.87×(1 – $3.06/$5.12) = $0.75 absent an extraordinary performance in the opportunities of the new company.

The RiskWerk Company does not own any of the common stock of either of these two companies and has no financial or fiduciary interest in these transactions.

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Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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