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HNR: Bargain and Speculative Hybrid
Posted by: Johannes Climacus (IP Logged)
Date: March 1, 2013 05:09PM

After sustaining a 40% blow to its stock price last Wednesday, Harvest Natural Resources (HNR) now walks the line that separates speculative stocks from bargain issues. On the one hand, Harvest is currently sitting on approximately $725 million in oil reserves in Venezuela, as well as the company’s noteworthy prospects in Gabon and Indonesia — not bad for a company with a market cap of less than $220 million. On the other hand, HNR’s Venezuelan assets are (unfortunately) in Venezuela, and as such are subject to the anti-corporate whims of the Venezuelan government. HNR is an attractive buy for the value investor whose portfolio can withstand a higher degree of risk, for multiple reasons.

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.[1] 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%[2]).[3] HNR’s stake also includes 27 billion cubic feet of proven natural gas reserves.[4]

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 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.

[1] HNR’s Conference Call June 27 2012

[2] []

[3] HNR’s 2011 Annual Report

[4] HNR’s 2011 Annual Report

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Re HNR Bargain and Speculative Hybrid
Posted by: Henniker82 (IP Logged)
Date: March 1, 2013 06:49PM

Great article, and I agree with most of your thesis on this former Mohnish Pabrai pick. It has been a roller coaster since Pabrai first bought (and later sold). The bottom line here is that Pertamina was willing to offer over $700m for HNR's Petrodelta stake ($525m net to Harvest after taxes). The market is now valuing the entire company at $215m. There was no major impairment to the asset -- the government simply declined to approve the deal.

It is as if a home for sale fell out of contract shortly before closing. There is uncertainty because we can't inspect the inside of the house, we can only look at it from the street. Everyone is worried..."is there something wrong inside the house?" Did the inspection turn up something bad? The local government in the neighborhood plays fast and loose with eminent domain, so maybe we need to discount it a bit. But is the house really worth 40% of what it was valued at last week?

I think what we are seeing is a shift in investor base. The folks who sold were looking for the short-term catalyst. The catalyst is now gone and it will take longer for the thesis to play out. But the value is still there and there are other potential buyers out there.

My main disagreement is with your point about the nationalization scenario. True, we might get back some of our capital via the courts or the Venezuelan government years later. But there is a time-value to money. Even if they reimbursed us 100% of the value after slugging it out in the courts for 3 years, that requires a significant discount to fair value. How much would you be willing to pay for the promise of $1 delivered 3 years from now? Certainly not $1.

BUT, that is a minor disagreement, and I still agree with your conclusion that HNR is significantly undervalued at this price. Speculative play worth a small position.

Thanks for the article!

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Re HNR Bargain and Speculative Hybrid
Posted by: Johannes Climacus (IP Logged)
Date: March 1, 2013 08:03PM


Point taken about the time-value consideration--I hadn't fully considered that. Granted, I wouldn't pay $1 for $1 in 3 years. But I *would* pay 30 cents for 1 dollar in 3 years--wouldn't you?

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Re: HNR: Bargain and Speculative Hybrid
Posted by: [email protected] (IP Logged)
Date: March 3, 2013 10:02PM

Great article, thx for sharing your insights.

One huge risk that I see, but not covered in your article, is the exchange rate risk. As you know, Venezuela recently depreciated their currency by 44%. Currently, each US dollar fetches 6.29 Bolivars (compared to 4.30 earlier; source: HNR 10-Q from 09/2012). Of course, the black market valuations are 4 times higher, as reported by some news sources, but for now, let's assume the official exchange rate.

Reading into HNR's latest 10-Q filing from September, they state several times that Petrodelta is their biggest source of income (you cover that as well), and all their payments from their Venezuelan subsidiary is in Bolivars. With about 50% currency depreciation, and assuming their original price of asset sale at $725M (@4.30BVRs) stands with another suitor, and assuming they would still be eligible for $525M (again, @4.30BVRs), suddenly, this has a material impact on their $ fetch value of the assets. My calculations show:

asset sale price: $725M (assumes they get a similar size offer)
HNR's stake value:$525M
HNR's stake value, in BVRs: 2,257.5BVRs (@4.3BVRs)
in today's exchange rate, HNR's stake in $ value: $358.33 (@6.3BVRs)

The economics change significantly. While still an upside, but do note that if Venezuela is thrown into chaos post-Chavez, and assuming similar ratios of 30% reward (to what Exxon was owed in your article link above), HNR is getting about ~110M from this venture. Add $20M in cash, and no debt, and the stock looks overpriced.

Of course, I make tons of assumptions, and this valuation is a floor in the extreme case and ignoring the value of other assets, but my point is, that exchange rate risk is a HUGE HUGE factor here.

What are your thoughts in this regard?

Thx again for your well-written article.

Best, Nitin

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Re HNR Bargain and Speculative Hybrid
Posted by: Johannes Climacus (IP Logged)
Date: March 5, 2013 07:31AM

Hi Nitin,

Thanks for this! Very interesting--I'm going to look into it further in the next 36 hours.

I have two initial thoughts: First, I would be very surprised if the transaction were to occur in an unstable currency like BVRs. Granted, their day-to-day production ops are done in BVRs--but that does not mean that a 3rd nation state will have to pay a US stakeholder in a currency not belonging to either country. I think that if this were the case, the Indonesians would have been much more eager to continue waiting for BVR inflation to act as an increasing discount, and then approved the deal last minute, after getting the property for approx half the original price.

I'm going to try to confirm my suspicions, and will keep you posted. Thanks again for bringing it to my attention.


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Re HNR Bargain and Speculative Hybrid
Posted by: Henniker82 (IP Logged)
Date: March 5, 2013 06:07PM

HNR spikes after-hours on reports of Chavez's death. Then gives back some of the gains after remembering that the vice president is not a capitalist. Hilarious quote from the WSJ:

"Hours before announcing that Hugo Chávez died, Venezuela's government resorted to one of the late president's favorite ploys to try to unite his supporters: Talk of an alleged conspiracy by the U.S. to destabilize the country. Vice President Nicolás Maduro kicked out two U.S. military attaches for allegedly plotting against Venezuela and even suggested that Washington may have been behind Mr. Chávez's cancer. 'Behind all of [the plots] are the enemies of the fatherland,' Mr. Maduro said on state television, flanked by the entire cabinet, state governors and Venezuela's military commanders."

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