TEACHERS AIMS AT PETROCAN

A battle is at hand over the future of Petro-Canada, as the Ontario Teachers' Pension Plan escalates a shareholder campaign for restructuring at the iconic oil company that could lead to a showdown for control of the board.

Ontario's largest pension fund is preparing to submit documents to the U.S. Securities and Exchange Commission revealing that it has become an activist investor in Petrocan, according to sources.

The filing will likely happen in the next two weeks and is expected to show that Teachers owns between 7 and 10 per cent of the company, a stake that would be worth between $900-million and $1.29-billion.

A similar move by Teachers on BCE Inc. nearly two years ago - the filing of what's known as a schedule 13D - forced that company into play. A consortium led by Teachers' private equity division later agreed to take over BCE for $35-billion, though the deal fell apart in December.

In the case of Petrocan, a takeover would be impossible under federal law. The Petro-Canada Public Participation Act prohibits any group from owning more than 20 per cent of the voting shares.

But the Teachers fund is positioning itself to launch a proxy battle, with support from other institutional investors, that would be aimed at setting a new strategy for the Calgary-based company and replacing the directors if necessary.

"There are only two avenues here - moral suasion and a proxy battle," said one source familiar with the fund's plans who spoke on condition that he not be identified.

A spokeswoman for Teachers declined to comment.

Petro-Canada spokeswoman Andrea Ranson said the company isn't aware of a 13D filing, but that it is open to dialogue with its shareholders, including Teachers.

"Discussions we've had with them have been cordial and constructive, and they've certainly not indicated any intent to make such a filing," she said in an e-mail yesterday. "We share their objective of creating long-term value for shareholders."

The aggressive tactics from Teachers come after a prolonged period of what the fund perceives as underperformance at the former state-owned oil producer, and following requests for change from a number of institutional investors.

Despite sharply higher prices for oil and gas, Petrocan's shares have lost 3 per cent over the past five years, including dividends. That compares with a 56.3-per-cent total return for the S&P/TSX energy index and a 110-per-cent total return for Imperial Oil Ltd.

A key complaint from shareholders is that Petrocan has too much capital tied up in too many large projects with inadequate results, like its joint venture with Libya's national oil company to exploit more than 20 oil fields there.

Petrocan is developing six major projects, including the delayed $21-billion Fort Hills oil sands property in Alberta (of which it owns 60 per cent), gas fields in Syria, and a Montreal refinery. But BMO Nesbitt Burns analyst Randy Ollenberger said after last week's "disappointing" fourth-quarter earnings that the company's key growth projects had stalled.

"This company has not focused its operations, or paid proper attention to rates of return on assets such as its Libyan properties, which is a chronic problem," said one major shareholder who has unsuccessfully pitched Petrocan on restructuring ideas.

One proposal, circulated last year by Toronto hedge fund West Face Capital, would have seen Petrocan divest its valuable 12-per-cent ownership in Syncrude Canada Ltd. and use the money to repurchase its own shares.

While Petrocan has listened to pitches from unhappy shareholders, its executives, led by chief executive officer Ron Brenneman, have doggedly stayed the course. Company officials say it is unwise to spend cash on buybacks or sell assets in a downturn. They also say it is unfair to criticize the share performance after oil prices have been in freefall.

"It's highly unlikely Petro-Canada will buy back shares in 2009. We need to preserve our liquidity given the condition of the financial markets," Petrocan's Ms. Ranson said in an e-mail last week. "Having more than $1.4-billion of cash on our balance sheet, and financial flexibility to access a further $4.7-billion, positions us well to weather this downturn and emerge well on the other side."

As for Syncrude, Ms. Ranson said: "We continue to view our interest in Syncrude as a long-life asset that generates solid cash flow. As well, from a technical perspective, we can apply mining knowledge from Syncrude to the Fort Hills project."

But Teachers hopes that the frustration over the lagging stock price will help it gain investor support for any activist crusade. Many Bay Street analysts agree that the company has been a poor performer. BMO's Mr. Ollenberger wrote in a report last week: "We do not see a short-term catalyst that could drive stronger share price performance."

"[Petro-Canada]will trade at a discount until a clearer picture of the company's future growth strategy emerges and management demonstrates stronger capital discipline."

*****

THE GOOD

Petro-Canada's balance sheet is nearly spotless - which is ideal at a time when money is hard to get and the company faces a big bill for developing Fort Hills its signature oil sands project.

THE BAD

Fort Hills is billions of dollars over its original cost estimates. Some analysts say other big Petrocan assets, like those in Libya, don't even earn a double-digit return on capital.

THE UGLY

Despite a historic bull market in energy that ended last summer, Petro-Canada shareholders have made no money in the past five years.