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Petrobank Energy (PBEGF) – An Exceptional Risk/Reward Scenario

October 20, 2010 | About:
Canadian Value

CanadianValue

210 followers
I’m a man of few stocks. I’m not sure why, but I’ve always been that way. I guess I figure that if you have what you think is an exceptional idea then you better make sure that when it works out it makes a difference to your financial well being.

I’m far from mistake free (ask me about ATPG which is a work in progress), but this philosophy has worked out pretty well for me. The most important part of applying an investing approach like this is making sure that the worst case scenario is one that you can live with.

In other words as Pabrai says “Heads I win, tails I don’t lose much”.

And being a man of few stocks I’m very pleased to introduce you to what I think is an exceptional opportunity in a Canadian oil company called Petrobank Energy (PBEGF).

In my opinion we can modify the Pabrai saying to “Head I win huge, tails I win pretty big”.

I’m going to give you a high level recap of Petrobank and will in future articles dig further into the details.

The investment thesis is actually pretty simple. There are four parts to Petrobank:

1) 110,000,000 shares (58%) of Petrobakken. Current share price of PBN is $23 which is a market value of $2.5bil

2) 66,000,000 shares (65%) of Petrominerales. Current market cap of PMG is $1.65bil

3) A heavy oil business unit that sits within the parent company that has 670 million BOE

4) Ownership of a potentially game changing oil sands extraction technology that could be worth billions

Now as I have boldly claimed above I’m focused on rule #1 first and foremost which is trying to make sure I don’t lose any money. Petrobank itself has 106,000,000 shares outstanding with a current price of about $40 per share. That is a market cap of $4.2bil. The company has minimal net debt. The shares owned in just 1) and 2) above are worth in the market today $2.5bil + $1.6bil = $4.1bil.

Petrobank Market Cap = $4.2bil

Market Cap of the Two Public Subs = $4.1bil

So the market is implying that 670 million BOE and the THAI technology are worth $100mil. I know, it is ridiculous.

But how is the downside protected ?

In several ways I think.

The Subsidiaries Are Trading at a Pretty Steep Discount to Intrinsic Value

$4.1bil is the combined market cap of the two publicly traded subs. It is not the intrinsic value of them. I think that is considerably higher.

At $23 per share Petrobakken is a company that has a dividend yield over 4% per year, is growing production at 10% every year (it has enough drilling in the Bakken and Cardium to continue this growth rate for a decade), has the highest netbacks in Canada (the most profitable oil production) AND is buying back shares. Imagine that. 10% growth year on year, a 4% dividend and a share buyback. I’ll get into the deep valuation work on PBN in my next article, but most analyst valuations that I have seen suggest at least $30 per share.

And Petrobakken may well be the ugly sister. Petrominerales on its own might be an exceptional value. Production growth of over 100% over the past 4 years, a 2% dividend, again industry leading netbacks and full funding for an exploration program that is targeting 2.1 million acres in Columbia and another 5.2 million acres in Peru. This exploration portfolio is on some very high potential acreage and continued production growth is virtually certain. Again I will get into more detailed valuation work later on PMG, but most analyst price targets are around $35 per share.

Using actual estimates of intrinsic value rather than market caps, I estimate the value of PBG’s interest in the two subs to be:

Petrobakken 110mil shares x $30 = $3.3bil

Petrominerales 66mil shares x $35 = $2.3bil

Total value is $5.6bil / 106mil PBG shares = $52 per share

So just the value of the subsidiaries is $52 per share vs the current share price of $40.

The Heavy Oil Assets (With No Help From THAI) Are Likely Worth More That Either Subsidiary

I think above I made a reasonable case that a share of PBG would be attractive today just for ownership of the two subsidiaries which together are worth over $50 per share.

The third piece of the pie however, is likely worth more than either of the first two.

The third piece of the pie is the Heavy Oil Business Unit. This division has title to a best estimate of 670 million BOE of reserves with a PV10 value of over $3.3 billion.

$3.3billion / 106 million PBG shares = $31 per PBG share

This NPV value is based on the production potential assuming SAGD technology not the THAI technology that Petrobank is working on.

To update. I now have a $52 per share estimate for the two public subs plus a $31 per share estimate for the Heavy Oil Business Unit. That is $83 per share of value vs $40 per share. And we are just getting to the best part.

THAI Technology – Petrobank’s 800 Pound Gorilla

$80 plus per share in value so far, and now the fourth leg of the stool the Petrobank technology division. And I have to admit that I have no idea what value to put on this, so I value it at zero.

And why not ? I’ve got a pretty reliable $80 per share in value from the first 3 parts vs the current $40 share price. Even if I’ve overvalued the first 3 parts by an incredible 100% I’m still not going to lose money because I’m buying them for 50% of what I think they are worth.

And I think the opportunity to buy the first 3 parts at 50% of their value is a pretty great opportunity. But the fact that you also get the THAI technology thrown on top of this makes Petrobank the best risk/reward scenario I have ever seen. Without THAI being worth anything I have a pretty great investment opportunity. I get a free ride on whatever THAI is worth and take virtually no risk of permanent loss of capital.

So what is THAI ? To be honest I can’t do it justice, so I’ve provided a link below to a company video discussing it. Long story short it is a technology that could make production of billions and billions of additional barrels of oil possible, oil that is currently worthless. You guess is as good as mine when it comes to valuing this, but if it works the number certainly starts with a capital B.

Here is the link to the video:

http://www.petrobank.com/heavy-oil/thai-video/

Conclusion

I hope I’ve shown you that it is going to be very hard to lose money investing in Petrobank at $40 per share. To lose money I will have had to have made a huge error on my valuation of the two subsidiaries, and both the heavy oil reserves and the THAI technology will have to be completely worthless. To get that kind of downside protection and get a free ticket on THAI strikes me as a very rare opportunity. I plan to cover the company closely for gurufocus.com in the coming months and am happy to discuss further either in the comment section or you can send me an e-mail at swizzledxxx@yahoo.ca

This week Petrobank announced that they are going forward with an expansion at their THAI pilot program at Kerrobert which implies they think it is ready for commercial production.

I’ll leave you with a quote from a recent analyst report from Canaccord which pretty much sums things up:

“Current PBG, PBN, and PMG share prices imply there is no heavy oil/oil sands value in PBG’s stock implying that even if THAI doesn’t work, PBG’s oil sands resource base is worthless, which we believe is absurd. We reiterate our BUY rating.”



About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 4.0/5 (38 votes)

Comments

Hester1
Hester1 - 3 years ago


What about taxes? If Petrobank was ever to realize the value of the subs they would pay taxes, wouldn't that destroy much value?

Also, do you short the two public subs? Seems to me that investing here is like depending on the valuation of those two companies holding up.

Lowes (L) also trades at a discount to public subs, and owns many other things. It never trades at much of a premium to public subs, likely because of two reasons. Taxes they would have to pay if they divested, and the fact that the value will not be realized because they won't divest.
Hester1
Hester1 - 3 years ago


EDIT:

I should make myself clearer regarding the valuation of the public subs. You probably wouldn't short them because you believe they are undervalued, but isn't this strategy more risky because you have to be right on three different companies valuations, instead of just one?
CanadianValue
CanadianValue - 3 years ago


"What about taxes? If Petrobank was ever to realize the value of the subs they would pay taxes, wouldn't that destroy much value?"

If they sold the subs yes. I believe the plan is to spin them out to shareholders at some point in the not too distant future.

VinnyATPGtotheMoon
VinnyATPGtotheMoon - 3 years ago


How's the $100+ Valuation on ATPG working out?

Wake me when we're Rich.
Kevin Graham
Kevin Graham - 3 years ago
I wouldn't rely on the analyst opinions. The investment bankers are in bed with most oil companies in Calgary.

Why not value the companies on your own? I am also surprised that you don't even mention the price of oil in your analysis of the company. Obviously this is the hugest factor in valuing any oil and gas company. They are a price taker, like any commodity business. This makes the returns on capital very hard to value.

Good Luck,

Kevin
CanadianValue
CanadianValue - 3 years ago


"I am also surprised that you don't even mention the price of oil in your analysis of the company. Obviously this is the hugest factor in valuing any oil and gas company."

That is absolutely true. You have to have an opinion on oil prices to invest in an oil company.

Here is some background on my thinking on the subject:

http://www.gurufocus.com/news.php?id=108452

http://www.gurufocus.com/news.php?id=106592

http://www.gurufocus.com/news.php?id=105594
Kevin Graham
Kevin Graham - 3 years ago


I have completedd my full detailed analysis of the companies mentioned. It can be found here:

http://www.gurufocus.com/ic/space.php?uid=87291&do=blog&id=83


My analysis of the facts should temper your excitement for this company. Feel free to point out where I am wrong in my analysis.

CanadianValue
CanadianValue - 3 years ago


"My analysis of the facts should temper your excitement for this company. Feel free to point out where I am wrong in my analysis."

You are a confident fellow. I'll have a read and get back to you.
CanadianValue
CanadianValue - 3 years ago


"My analysis of the facts should temper your excitement for this company. Feel free to point out where I am wrong in my analysis."

You are a confident fellow. I'll have a read and get back to you.
CanadianValue
CanadianValue - 3 years ago


"My analysis of the facts should temper your excitement for this company. Feel free to point out where I am wrong in my analysis."

Kevin,

Did you really think that just spending 10 minutes per company and dividing PV10 numbers by shares outstanding is what makes for extraordinary value investing work ?

I've gone through your analysis. And I have to admit, I think you have missed a lot of what is important.

http://valueinvestorcanada.blogspot.com/2010/10/severe-critic-of-my-petrobank-analysis.html
FIFOkid
FIFOkid - 3 years ago
I used to be long in Petrobank and held the stock from 2003 but fully scaled out in late 2007 when I read a report about the skyrocketing cap ex in the oilsands sector.

My issue with Petrobank is its bitumen assets and the stinky low single digit IRRs for new projects  and the huge capex requirements for these projects. I am one of those who believe that these assets are pretty close to worthless.

Unfortunately THAI hasn't been cost effective enough to put these assets into commercial production.

I hate to say but the only people in the oilsands business that make money completed the project a decade ago.

One day this may change but I don't see any signs of it.


Kevin Graham
Kevin Graham - 6 months ago

Looks like you lost quite a bit on PBG/PBN. Good Call.

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