Last Friday, in the October issue of Canadian Edge, I reported that Daylight Energy Ltd’s (TSX: DAY, OTC: DAYYF) falling share price had raised questions about its ability to roll over its primary credit line. I also wrote that the company appeared to have settled its production problems from early in the year. But that given the drop in natural gas prices, I was rating the stock a “hold” until there was more clarity on the loan.

Happily, all that became a moot point on Sunday, Oct. 9. That’s when state-backed giant China Petroleum & Chemical Corp, better known as Sinopec (NYSE: SNP), announced it would buy Daylight for CAD10.08 per share in cash. That’s a 43.6 percent premium to the stock’s 60-day average weighted trading price.

It’s also more than twice the depths to which Daylight’s share price had plunged in recent days due to the slide in natural gas. And it should be enough to assure a tidy profit for Canadian Edge readers. The total return from our initial entry price on Feb. 6, 2009–including distributions and changes in the US dollar/Canadian dollar exchange rate–is roughly 68 percent.

In my view, this is a classic case of motivated seller meeting a far-sighted buyer. That Daylight has been trading at a fraction of the net asset value of its reserves is no secret. But the drop in natural gas prices to barely USD3.50 per million British thermal units in recent weeks is a major threat to operating cash flow. Meanwhile, the drop in Daylight shares due to falling gas prices has severely limited its ability to raise new equity capital.

The company has been reorienting its production mix toward oil and natural gas liquids. But weather conditions beyond its control slowed that move in the first half of 2011, even as liquids prices have backed off. The result will almost certainly be added pressure on second-half 2011 cash flows, and the company still needs to roll over or pay down the CAD437 million outstanding on its CAD625 million credit line.

Meanwhile, Sinopec has been steadily adding to its reserves in Canada, paying CAD4.65 billion last year for a stake in the Syncrude partnership. The offer for Daylight gives it access to 300,000-plus acres of land and a reserve portfolio that grew 46 percent in 2010, which is on track for comparable growth this year. The Alberta and British Columbia properties include valuable stakes in the Deep Basin (gas) and Pembina Cardium (light oil).

Daylight’s huge inventory of low-risk development locations is the major reason I’ve stuck with it in the face of weak gas prices. The other is superior management that has built this portfolio amid extremely volatile conditions in the energy markets.

This purchase will need to clear regulators in both Alberta and Ottawa, where foreign takeovers of Canadian assets have become considerably less popular recently. On the other hand, Daylight’s pre-deal market capitalization is less than CAD1 billion, which will make it harder to block outright.

My advice is to continue to hold Daylight Energy shares and to vote “yes” on the Sinopec deal. Shares appear to be trading at about a 30-cents-per-share discount to the CAD10.08 takeout price, and there will be at least one more payment of the CAD0.05 per share monthly dividend. Finally, as markets stabilize, I look for the Canadian dollar to rebound against the US dollar, which will increase the USD value of this deal.

Note that I may advise US investors to sell their Daylight shares before the actual close. That’s to avoid any confusion with less adept brokers and clearing corporations. There should be absolutely no withholding on cash received by US investors, who will be taxed on capital gains at the appropriate rate.

The Sinopec/Daylight deal also has very positive implications for other high-dividend Canadian energy producers. Even if there are no forthcoming takeover offers, Sinopec’s dollars confirm skittish investors are dramatically undervaluing these stocks.

That includes other debt-challenged, natural gas-focused companies like Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV) and Perpetual Energy Inc (TSX: PMT, OTC: PMGYF). But it also includes much higher-percentage fare such as ARC Resources Ltd (TSX: ARX, OTC: AETUF) and Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) that carry far less operating and debt risk.