Petrobank Energy (PBEGF) – An Terrible Risk/Reward ScenarioPop41499 views 2010-10-22 16:23 Tags: PMG
I am going to give my detailed analysis of Petrobank (TSE – PBG) right off the start because I don't care for research opinions from some firm who makes lots of money by doing investment banking deals with oil companies. I like to keep my investment ideas simple, but significant losses may occur by in investing in Petrobank.
Please note that all figures are taken from the respective companies annual reports, annual information form, and quarterly reports. The debt and share data is the most recent and the reserves reports are from 2009 year end review.
The Subsidiaries Are Trading at a Steep Premium to Intrinsic Value
1) Lets start with Petrobakken (TSE - PBN). First, the PBN's reserves have a net present value, discounted at 10%, before tax value (NPV10-BT) of $2.46 billion for proved reserves (1P) and a NPV10-BT value of $3.65 billion for proved plus probable reserves (2P). I tend to be conservative and use proven reserves but for this analysis it won't matter much so we'll use the more optimistic value of $3.7 billion, which includes reserves that are not yet on production. The company has a convoluted debt structure of bank debt, net working capital deficiency and convertible debentures. The convertible debentures are convertible into common shares at prescribed prices so for the sake of analysis I will add them to the fully diluted shares and only consider the debt to be the sum of the bank debt and working capital deficiency. For PBN the total debt is $698 million. The fully diluted shares outstanding if you include all options and convertible debentures is 207.7 million shares. Petrobank owns 58% of PBN.
The Net Asset Value (NAV) of the reserves, discounted at 10%, debt adjusted per share is as follows:
NAV10-BT 1P = ($2460 million – 698 million) / 207.7 million shares = $8.48/share
NAV10-BT 2P = ($3650 million – 698 million) / 207.7 million shares = $14.21/share
The PBN shares closed today at $22.84, a sizeable premium to the reserves. This is a 61% premium to the 2P reserve value.
I know some will point out that they have some other assets, such as land which is not included in this analysis, but those assets are usually insignificant and don’t provide any cash from operations.
2) Secondly, Petrominerales (TSE – PMG). The NPV10-BT is $1.46 billion for 1P reserves and NPV10-BT is $2.08 billion for 2P reserves. Again they have a convoluted debt structure similar to PBN (I will comment on the stock options below). PMG has no debt and net working capital of $67 million. PMG however has significant convertible debentures and they will be converted into equity (as per the company's formula) again for the sake of analysis. Fully diluted shares outstanding total 125.9 million. Petrobank owns 66% of PMG.
Similarily, the Net Asset Value per share computes to be:
NAV10-BT 1P = ($1460 million + $67 million) / 125.9 million = $12.12/share
NAV10-BT 2P = ($2080 million + $67 million) / 125.9 million = $17.05/share
The PMG shares closed today at $25.45 again a sizeable premium to the reserve value. This is a 49% premium to the 2P reserve value.
3) Heavy oil assets. Here, they don’t have any proven producing reserves in the report, but simply NPV10-BT of $367 million for 2P reserves. I believe some of these are coming online as of this year. These assets are held at the parent company level and PBG has no debt. The fully diluted shares outstanding is 110.2 million.
The Net Asset Value can be computed to be:
NAV10 2P = ($367 million + 0) / 110.2 million = $3.33/share (These are wholly owned by PBG)
4) THAI technology. This is interesting because Baytex and Shell Canada just sold their respective shares in the project to Petrobank. Since they are partners they know exactly how well the THAI process is performing. Why did they just sell? I would guess the results aren’t coming on as expected and both partners wanted out. It was interesting that Baytex didn’t even discuss in there last report. Ascribing a value is very difficult so I will give it a value of zero.
Total Company Value
So if we take the sum of the parts for the probable basis (2P), the total equals $3.49 billion or 31.76/share of PBG. PBG currently closed today at $40.46/share. On a proven basis (1P) and including heavy oil assets, the total is $2.39 billion or $21.73/share.
Clearly you can disagree with the engineering value of the reserves but that is as close to reality you can get. It takes into consideration the production profile, royalties, operating cost, abandonment costs, etc and discounts it back to today at 10%. It’s the best shot at the cash flow the wells will produce.
Now the value of the company will vary depending on the discount rate you choose and oil price. I would guess the company is being valued at a discount rate of 7.5% and $80 oil and $5-6 AECO gas price and the current proven and probable reserves (2P).
As a value investor, you want to buy with a margin of safety. This investment clearly doesn’t offer and room for error on the reserves or the price of the commodities. Clearly a lot of arm waving is required to believe that these shares provide a margin of safety. Analyst reports are not worth the value of the paper they are printed on. Commit them to the fire.
I will add that this analysis is for a specific point in time (Dec 31, 2009). I have not analyzed the company’s return on invested capital for the last several years. That will tell us how well management has done drilling new wells and if they are earning positive returns on capital. PBG’s return on equity was 20% in 2008 and 4% in 2009. Returns on total capital are obviously less than that given the leverage these companies use. If someone would like to calculate please go ahead but I don't see any value in light of what else I dug up in the financial reports on stock options.
Stock Options – Where can I get some?
The main reason I wouldn’t touch any of these companies with a ten-foot pole is the deferred common shares and the incentive shares. Both of these are basically a stock options and I quote:
In the second quarter of 2010, shareholders approved an incentive plan for directors, officers, service providers and employees. The plan allows the holder to receive one common share upon the vesting and payment of $0.05 per share exercise price. The terms of the incentive shares granted are determined by the Company’s Board of Directors but typically, incentive shares vest after four years from the date of grant and expire between five and 10 years after the date of grant.
Now if that isn’t lucrative, please let me what is. Essentially they are options priced at $0.05/share and expire 10 years after the grant date.
Can someone explain how these options align the interest of the shareholders to management and employees? Why $0.05 per share and not $0.01 per share? Why leave the nickel on the table? What shareholder would agree to these terms? Oh thats right, Petrobank is the majority shareholder in both PBN & PMG, go figure.
Reread the last paragraph, be careful what you read on message boards and where you get your ideas. I leave you with a quote from Warren Buffett.
“The market, like the Lord, helps those who help themselves. The market unlike the Lord, does not help those who know not what they do.”
Disclosure (1) – No position in any security mentioned.
Disclosure (2) - I dedicate this analysis to David Einhorn.
My blog is http://Canadianvalueinvesting.blogspot.com