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I’ve been meaning to cover the return of San Leon for a while and today I’ve finally got around to it. Late in August San Leon return from suspension with the announcement of a deal in Nigeria and connected equity placing to the tune of £170m, at 45p a share. The shares today are trading just below the placing price at 44.62p, this gives an Enterprise value of around £195m, so is there plenty of value to be had here?
What is the background of San Leon?
Prior to the deal being done, San Leon had a range of fairly uninteresting exploration and appraisal stage assets, in Europe, Morocco and Western Sahara. The later of these assets had meant San Leon was no stranger to controversy, with a Major Norweigan Pension Fund blacklisting the company for ‘serious violations of fundamental ethical norms through its onshore hydrocarbon exploration in Western Sahara’. The Norwegians are not the only group either than San Leon have offended, Oisin Fanning the San Leon Energy CEO has been deeply unpopular with shareholders throughout his tenure. Oisin had been rewarded significantly through his £900,000 salary, despite San Leon not achieving much up until now. Protests from shareholders led Oisin to take his salary in shares, at least that way rewarding him for success. (For me his salary is still extortionate compared to the limited operations of the company.)
So what is this latest deal announced by San Leon?
On 22nd January the shares were suspended on AIM due to the takeover of Mart Resources Inc, together with Midwestern Oil resulting in an indirect acquisition for San Leon of a 9.72% stake in producing asset OML18 onshore Nigeria. Mart the acquired company was a Calagary based TSX listed company and San Leon’s co acquirer Midwestern Oil is a Indigenous Nigerian company, part owned by the Delta state government. The other two partners are NNPC, the Nigerian National Oil Company and Sahara, another Nigerian private energy company.
It is unclear to me the status of the operator EROTON post deal as Mart was a major shareholder in this entity, but I suspect San Leon, Mid Western and Bilton will continue to procure the services of EROTON as operator at least in the near term. I do note though that San Leon has a right to provide oil field services under the agreement so it a bit unclear how this will work post deal. It should also be noted that San Leon is also the only non indigenous partner. The complete Joint Venture structure is show in Fig 1 below:
OML 18’s estimated gross 2P reserves are approximately 576 MMbbl of oil and approximately 4.2 Tcf of gas and its gross 2C contingent resources are approximately 203 MMbbls of oil and approximately 1.6 Tcf of gas. A pretty significant asset then for sure, production wise as of June 2016 OML 18 was producing at approximately 50,000 bopd of oil and approximately 50 MMscfpd of gas. Oil production is expected to peak at 120,000 boe per day by 2020, this requires though CAPEX of around US$1.8bn, this being fully funded by production. The final key metric; Opex per Boe is estimated to be between US$10-13 per Boe. It is clearly an exciting asset.
More good news came on 26th August whenSan Leon announced it had conditionally raised approximately GBP170.3 million (US$221.4 million) through an equity raise to fund the above acquisition, subject to shareholder approval which is likely to be granted on Tuesday 20th September.
San Leon post completion will also appoint Mutiu Sunmonu, highly experienced former Nigeria Country Manager of Shell as Non Exec chairman, this seems like a sensible appointment. Also appointed as Non-Executive Chairman is Ewen Ainsworth, former Finance Director of Gulf Keystone Petroleum and current Finance Director of Nostra Terra, two companies which have failed to deliver for shareholders so I’m less excited about this appointment. Overall though it is pleasing to get some non executives on board to place a check on the executive board. The executives will be the same as today, Oisin Fanning, Joel Price and Alan Campbell.
This is undoubtedly an ambitious deal and I can’t recall a fund raise as big on AIM this year…
But can the Nigeria deal turn around the companies fortunes?
Based on the house broker report here the unrisked NPV of the project is $514m (£395m), i.e. double the current market capitalisation. In fact if things go well the project will have paid back by 2018 (see fig 1) and if things work out the asset should throw off cashflow from there. This seems like excellent value, especially when you also consider San Leon have also promised to return 50% of the Free Cashflow (FCF) to shareholders, the 2017 dividend yield is a whopping 19% at todays share price! The 2017 Price/FCF ratio is also around 3x, so on every level this is a value play and that is before further upsides are considered such as developing the contingent resources and taking part in other exploration prospects in the region.
So what’s the catch? What are the risks?
A company with a Forward Price/FCF of 3x and a dividend yield of 19% usually means one thing – investors don’t believe a word management say. You see these crazy dividend yields a lot with some of the Chinese AIM stocks where fraud and other suspicious activity means most investors treat the whole sector as bargepole. However, San Leon despite some questionable practises is definitely not to be associated with that lot.
Nigeria definitely poses a risk, many investors know the Afren corruption story and many are also aptly aware of an increase in violence in the Delta region, this can often lead to sabotage giving a production downtime risk. That said the partnership structure may make it is easier for the JV to co-exist with the local communities, indeed there have been no recent interruptions to production at the field.
The field has produced well since Eroton took operatorship in 2015, but to maintain and increase production a significant programme is required, as noted above. That said no significant debottlenecking is required to raise production, the work looks limited to workovers, new drilling wells and associated infrastructure. In theory this looks straight forward, however I am unclear of Erotons role going forward given the change of JV structure and it should be noted that neither San Leon nor Midwestern have a significant track record as successful producers/developers.
BUY – Target 65p, capitalising at £280m with still plenty of room left in the NPV valuation.
San Leon knows it has pissed off shareholders previously and thus it is encouraging to see improved corporate governance with the appointment non executive appointments, Oisin taking his salary in shares and finally a mechanism to return cash to shareholders.
There are some risks for San Leon on this asset but there is nothing that causes me too much concern and having a heavyweight in Mutio Sunmono should be able to assist on many of the ‘on the ground’ issues. The dividend yield of 19% and Price/FCF of 3x means that management have plenty of room to screw up significantly and there still be significant value here.
A potential way of investing is to take a small exposure now and add more once the deal is concluded and the production in the first few months is reported.