HNR: Bargain and Speculative Hybrid
First, I’ll provide background information on HNR so that the company’s recent developments can be put into proper context. Next, I will describe the catalyst of HNR’s recent 40% drop, namely Indonesia’s withdrawal from the sale of HNR’s Venezuelan assets. Last, I will explain why I see HNR as a slightly speculative, but ultimately attractive buy.
Harvest Natural Resources is principally focused on the exploration, acquisition and development of fossil fuel basins. While HNR does have a limited oil-production capacity that is sufficient for certain types of accessible basins, oil extraction is not the company’s forte. The firm simply lacks the external financing and operative means to fully exploit large or technically difficult hydrocarbon basins. HNR is far better suited to locate, develop, and sell its major discoveries to larger production-based firms. A recent example of this is HNR’s sale of its Utah assets in 2011.
In 2007, Harvest fully converted its 32% stake in Petrodelta, a mixed company oil company of the Venezuelan government. As Harvest’s sole valuable asset until 2007, Petrodelta was acquired to be the operative foundation for HNR’s future growth. Management depended on its income to be the primary (if not sole) source of funding for future international exploration. The results of HNR’s 32% stake in Petrodelta have been highly positive, yielding 38.6 million barrels of proven oil, and an additional 50 million barrels of probable oil (where “probable” indicates a likelihood between 50% to 90%). HNR’s stake also includes 27 billion cubic feet of proven natural gas reserves.
The quality of Harvest’s assets in Gabon are at this point unclear. While multiple oil reservoirs have indeed been discovered, the accessibility and quality of the oil are yet to be determined. Similar uncertainty surrounds HNR’s assets in Indonesia.
Eager to free themselves from the obligation of playing nice with Chavez and co., Harvest Natural Resources gladly announced in June of 2012 that it planned to sell its 32% stake of Petrodelta to Pertamina, the Indonesian state-owned oil company. The sale, which totaled $725 million, would net HNR approximately $525 million, with the difference of about $200 million being owed in taxes. News of the Petrodelta sale was music to the ears of HNR shareholders for two key reasons.
To begin with, dealing with Chavez’s Venezuelan government is risky business if you're an American corporation. Since the Chavez-era’s inception in 1999, Venezuela has exhibited increasingly antagonistic behavior toward American firms, showing little hesitation to engage in outright takeovers and drawn-out legal battles. Recent examples include the government’s forays with ExxonMobil, ConocoPhillips, and other various European firms. Just to put things in perspective, a recent World Bank report suggests that if you’re looking to expand your business internationally, you’re better off looking at war-torn Afghanistan or chaos-ridden Haiti rather than Venezuela. Harvest has itself not been immune to Venezuelan pugnacity, having not received an owed dividend payment from their Petrodelta counterparts in two years.
Second, shareholders are eager to convert their Venezuelan assets to cold, hard cash simply because Harvest is not in a position to fully capitalize on Petrodelta’s oil reserves. HNR’s shallow cash pools and lack of proven asset depth effectively block it from the external financing required for such production operations.
Alas, after seven months of various rumors and reports (some of which called the planned sale “dead,” and others of which called it “highly likely”) news came that the Indonesian government had denied approval of the sale — anathema to the ears of HNR shareholders. As a result, the stock price dropped 40% immediately. Goodbye heap of cash, hello (soon-to-be) post-Chavez pandemonium.
So after all this grim news, why would any sensible investor consider putting his money in with HNR? Indeed, there are good reasons not to. Perhaps the biggest reason to avoid HNR is that the company simply has zero leverage in dealing with the Venezuelan government, and is thus left vulnerable to all of Venezuela’s anti-business policies. If Venezuela were to enact some policy that temporarily shuts down oil production at Petrodelta (thereby constricting HNR’s main source of cash flow), or perhaps nationalize Harvest’s 32% stake altogether, the company’s only recourse would be found in making an appeal to the International Chamber of Commerce. And, as we’ve seen from its recent ruling in the ExxonMobil case, the ICC is not afraid to rule against American firms. Simply put, HNR’s future with post-Chavez Venezuela is rife with black swan potential.
Be that as it may, the company is still far undervalued today. In fact, it is rather difficult to imagine a set of future developments that would justify HNR’s current valuation. In order for the current $220 million valuation to be considered fair, something like the following scenario would have to play out:
1) Venezuela nationalizes HNR’s stake in Petrodelta, resulting in an ICC lawsuit. The ICC awards HNR with an unheard of one-seventh of the actual value $725 million.
2) Both of Harvest’s two oil discoveries in Gabon (which total over 23 million barrels of proved oil) turn out to be worth less than $50 million.
3) Harvest’s prospects in Indonesia also have to prove to be worth less than $50 million.
The likelihood of any two of these events — let alone all three — playing out is highly unlikely. But even if this woeful trifecta were to actually occur, the total value of the company would still not be far under its current market valuation. This fact gives HNR a nice buffer to its floor.
Second, the absence of bids for HNR’s Petrodelta stake should not be interpreted as a lack of interest in the property, but rather trepidation about the political climate there. With Venezuela emerging as the most oil-rich country on the planet, there are likely a host of state-owned companies that could be eager to bolster their relations with the burgeoning fossil fuel capitol. As a Bloomberg.com commentator reported in 2012, China’s state-owned China National Offshore Oil Corp (CNOZ) and China Petroleum & Chemical Corporation are both likely candidates for such a purchase. A likely explanation for the lack of bids (as well as Indonesia’s withdrawal) is that potential buyers are simply waiting to see what the future holds for Venezuela’s political climate. The future is simply too murky right now to feel secure about initiating a three-quarter billion-dollar investment. With top Venezuelan officials now reporting that Chavez is fighting for his life, however, the situation could unfold within months.
Some may argue that the $725 million appraisal for the Petrodelta assets warrant a discount, one that is significant enough to offset the risks inherent in doing business in Venezuela. I would readily grant the possibility of a discount, but it is hard to imagine a haircut greater than 20%. And again, even with that generous discount, HNR fair value would then be at least double compared its current market valuation.
Last, a word to those potential investors who are concerned that Venezuela will arbitrarily deny any bids for HNR’s stake in Petrodelta: Check out the correlations between HNR-related news and HNR’s stock price from the last two years. At the mere word of another bid or share purchase, investors will rush to HNR immediately with the worry that they will miss its run to $14 (the expected value of HNR’s stock after the sale of Petrodelta).
The point is, the Venezuelan government can deny all the bids they want, but the stock price will still jump to at least $8.50 before anything is finalized or terminated. Concerned investors need not stick around for that long to see how the deal materializes, though.
To conclude, while a certain degree of risk does surround Harvest Natural Resources, the company is simply sitting on too many valuable assets for a herd-ignoring investor to stay away. Its not a risk-free bargain, but it’s a bargain nonetheless.
 HNR’s Conference Call June 27 2012
 HNR’s 2011 Annual Report
 HNR’s 2011 Annual Report