Here’s an AIM-listed enigma to ponder on Monday.
Life is looking rather good if you’re a London-listed oil mid-cap at the moment. Kind of less so if you’re out to buy one. Why?
As Oriel Securities’ Richard Rose noted on Monday, the summer wave of M&A that has hit London’s oilers (Cairn and Vedanta, the KNOC-Dana ‘love story’) has come at a premium for the acquirers:
On our numbers for the KNOC approach we believe they have either assumed a 6% discount rate and paid full value for the firm and potential developments (including Western Isles and Aran) against the futures strip or assumed an 8% discount rate and are paying for the current risked value of the exploration programme. We saw similar metrics on the Vedanta deal with Cairn where it only makes sense if we fully derisk the contingent resource base and EOR upside as well as paying for c300mmb of additional exploration upside. Both deals highlight though that some industry players are willing to use more aggressive assumptions than in our current valuation models…
Well, some players are just willing to be more aggressive outright — KNOC went hostile on its offer for Dana relatively quickly, for instance.
We’d note (along with Rose) that this is in part because second-tier buyers are behind these deals, from countries with a strategic interest in grabbing reserves — whether at home (Vedanta) or in a region hemmed in by other competitors for efficient oil supply (KNOC).
So there’s a political premium here; the price of being able to grasp the geopolitical nettle before bigger players in China or elsewhere, perhaps.
Although that might not be the whole story.
The over-pricing issue has sent Evolution Securities’ analysts into a fit of existential angst, for example:
Thought for the day: Have we got it all wrong?
But they reckon it really comes down to stronger valuations of assets from explorers, rather than from the market. As they note:
The recent asset transactions and potential bids (BP, Dana, Cairn) have one thing in common. The deals are at prices ahead (in some cases well ahead) of most analysts’ expectations for 2P reserves in production. Is this companies “overpaying” or is it more fundamental? – i.e, we the analytical community have missed that fact that the oil companies are more bullish on asset valuations – either through using a higher oil prices assumption or through using a lower discount rate. Either way, the empirical evidence suggests that it is cheaper buying barrels on the stock market than it is exploring.
Which sounds to us a bit like this M&A wave might be a bit more unstable than it appears, especially if bidders get choosier as competition increases. According to Evolution:
Some of us are old enough to have seen this before – and in those cases there was a wave of M&A activity before analysts played catch up with asset values. If the companies are more bullish than the stock market on valuations for 2P reserves in production the obvious candidates for a rerating are those companies with “real” reserves such as Premier Oil, Salamander and Enquest…
All of which dovetails with Rose’s own views of where next for this odd little M&A episode in the market (note that starred companies have or have had corporate finance relationships with Oriel):
If we apply the same metrics from the Dana and Cairn deals to the other potential candidates in the UK mid cap E&P sector we see an average 50% step up in our valuations (see the table attached), with for instance, Premier* worth potentially c2500p/sh and EnQuest 175p/sh…
Premier Oil* has often been ruled out as a take-over candidate because of it diverse portfolio, but this is erroneous in our view given the attractive valuation and growth profile with rumours last week that Sinochem maybe interested (not a ridiculous idea). We saw it as a more compelling target for KNOC than Dana and could be on the shopping list in the medium term once Dana is acquired and the acquisition bedded down…
Salamander* has built a solid production portfolio in SE Asia and if exploration results for the remainder of the 2010 programme prove disappointing then we see the company’s concentrated portfolio as attractive as a bolt on new core area for an established E&P company, as well as to encumbents in the region…
We wouldn’t be surprised if this is all converted into grist for a certain muppet mill, either…
Related links:
KNOC bid for Dana is a rare act of aggression – FT
Of Vedanta and Vikings – FT Alphaville
Of Vedanta and Vikings, Part II – FT Alphaville
Vedanta - Lex