Summary
- Det Norske is well positioned to generate robust cash flows from a game-changing acquisition of Marathon Oil Norge AS.
- The complementary production profile of the company’s biggest assets ensures that funding is secured until first Johan Sverdrup oil in 2019.
- The valuation gap suggests a potential 200% upside with a 12-18 month time horizon.
(Editors' Note: Det Norske trades on the Oslo stock exchange under the ticker symbol DETNOR.OL, with ~18.5M NOK average daily volume).
Investment Summary
In my initiation, I had discussed the funding concerns for the massive Johan Sverdrup development and potential asset sale to fund the development. The scenario completely changes with this acquisition. This re-initiation discusses the acquisition and why it is a game changer for the company. Given the current valuation, Det Norske is well set for a 100% upside.
The Acquisition
On June 2, 2014, Det Norske announced the acquisition of Marathon Oil Norge AS for a cash consideration of $2.1 billion. The cash consideration is based on a gross asset value of USD 2.7 billion and is adjusted for debt, net working capital and interest on the net purchase price.
While the acquisition is expected to close in the fourth quarter 2014, the effective date of the transaction is January 1, 2014. The positive impact of the acquisition was evident on the stock price with Det Norske surging by 9% on the day of acquisition announcement.
The Financing
For financing the acquisition, Det Norske has a fully committed and underwritten acquisition loan facility provided by BNP Paribas, DNB, Nordea and SEB. The company has also mandated and is in advanced discussions with the same four banks to finalise a seven-year Reserve Based Lending facility of $2.75 billion. This long-term facility will replace the acquisition loan and refinance Det Norske's current facilities.
Det Norske also intends to strengthen its equity base by issuing $500 million in new equity issue through a rights issue. The company's largest shareholder Aker Capital AS (OTC:AKAAF) has pre-committed to subscribe for its 49.99% pro rata share of the rights issue. Further, the remaining 50.01% is fully underwritten by a consortium of banks. In other words, the complete financing plan is largely secured.
Assets After Acquisition
Marathon Oil Norge AS, at the time of acquisition, had 136mmboe of proven and probable reserves. In addition, the company had 24mmboe of contingent resources and 80mmboe of potential upside in discoveries. Marathon Oil Norge had a 2013 net average production of 80,000boepd with revenue of $3.2 billion. In terms of acquisition price, Det Norske has paid $19.85 per barrel of oil equivalent considering a gross asset value of USD 2.7 billion.
For the combined entity, the proved and probable reserves as of December 2013 were 202mmboe with 60% of the combined reserves in production. Further, for the combined entity, the contingent resources are 101mmboe and the 2P and 2C reserves exclude the Johan Sverdrup development.
Among the acquired and producing assets, Alvheim field has 2P reserves of 93mmboe with more than 80% liquids. The production in the field is expected to last until 2031. The 2014 working interest production from the Alvheim field is expected to be 60,000boepd. The Volund field has 2P reserves of 14mmboe and production in the field is forecasted to last until 2025. The Vilje field has 2P reserves of 14mmboe with production until 2030. The Boyla field, which has reserves of 15mmboe, is expected to commence production in the first quarter of 2015. The gross plateau production from the field is expected to be 20,000boepd and the production is forecasted to last until 2030.
Among the existing assets (excluding Johan Sverdrup), Ivar Aasen has 2P reserves of 55mmboe, Gina Korg has 2P reserves of 7mmboe with other assets having 2P reserves of 3mmboe. The company's Ivar Aasen project is on schedule and the first oil from the project is expected in the fourth quarter of 2016. The company's share of production from Ivar Aasen is expected to be 16,000boepd with a plateau of 23,000boepd by 2019.
The Game Changer
I mentioned at the onset that the acquisition is a game changer for Det Norske. In summary, the acquisition and the financing discussed above ensure that Det Norske is fully funded for its Sverdrup development. In other words, the company will not need any additional external funding through 2019, when the first oil is expected from Johan Sverdrup.
The complementary production and cash flow profile for Det Norske and Marathon Oil Norge AS assets makes this acquisition an excellent and well timed deal. My point will be clear with the charts below.
The first chart gives Det Norske's standalone production profile.
It is clear that the next few years would have been associated with relatively low production. The first production bump-up comes when Ivar Aasen starts first oil by the first quarter of 2016. The second production bump-up comes when Johan Sverdrup starts production in 2019.
The issue with the standalone entity was the lack of internal funding available for investment in the massive Johan Sverdrup project. For the same reason, I had discussed in my initiation that the company is exploring some asset sale option.
The second chart below gives the production profile for Marathon Norge.
It is clear that Marathon Norge is at the peak production profile at this point of time. The company's production in 2013 averaged 80,000boepd. For 2014, the production is expected marginally lower at 60,000boepd.
The most critical point here is that the complementary production profile ensures that Det Norske, as a combined entity, produces robust cash flow from 2014. The chart below gives the production profile of the combined entity.
The company's management expects that the cash flow from Marathon Oil Norge production, cash flow from Ivar Aasen and the recent financing will be sufficient to fund all the investment needed for Johan Sverdrup until 2019.
Another positive related to the acquisition is the prior to Marathon Norge; Det Norske was not in a tax paying position. Consequently, all the investments had to be funded on a pre-tax basis and the company was building up significant tax losses.
These tax losses could not be offset against revenue before Johan Sverdrup came on stream in 2019. After the transaction, the company can offset the tax against fields in production from day one. In other words, the use of tax benefits shifts to 2014 from an earlier expected date of 2019. While this is one of the side advantages, it was important to mention as it underscores the excellent timing of the acquisition.
Revenue Projections For 2014 and 2015
For the first quarter of 2014, Det Norske reported revenue of $27 million and a negative EBITDA of $2 million. This section discusses the revenue outlook for the remainder of 2014 and the revenue for 2015. The objective is to determine the kind of EBITDA and potential operating cash flow for Det Norske after the acquisition.
For the first quarter of 2014, Marathon Oil Norge AS reported an average production of 69,000boepd. The production in 1Q14 was negatively impacted by severe winter weather which resulted in eight days of curtailed production.
Therefore, for the remainder of 2014, my assumption is a marginally higher production of 72,000boepd. Det Norske (standalone) reported an average production of 2,895boepd in 1Q14. I have assumed production to remain at the same level for the remainder of 2014. In other words, the expected production for the remainder of 2014 is likely to be 74,895boepd. The projections for 2014 are considering this production level and a sales price of $106 per barrel (current crude oil price).
Marathon Oil Norge AS reported an EBITDA margin of 87% for the year ended December 2013. I have assumed the same EBITDA margin for 2014E. Also, Marathon Oil (MRO) reported an EBITDA cash conversion ratio of 74% for 1Q14 and I have assumed the same conversion ratio for operating cash flow calculation.
Therefore, with the acquisition, Det Norske is likely to generate an operating cash flow of nearly $1.4 billion for 2014. Strong operating cash flows will help fund the massive investment plan for Johan Sverdrup.
For 2015, the production upside will come from the Boyla field, which is expected to commence production in the first quarter. Considering a gross production of 20,000boepd from the field, the company's share of production comes to 13,000boepd for a 65% stake.
For my assumptions, I have considered production from other fields to remain stable at 72,000boepd and a production of 13,000boepd from the second quarter of 2015 from the Boyla field. Also, the EBITDA margin and EBITDA cash conversion ratio have been assumed to be the same as 2014. The sales have also been considered to be executed at a current oil price of $106 per barrel. With these assumptions, the revenue, EBITDA and cash flow outlook is as below.
The revenue, EBITDA and operating cash flow is likely to be $3.2 billion, $2.7 billion and $2.0 billion respectively for 2015E. Even for 2016 and 2017, the production bump-up will come from the rich Ivar Aasen field. The point I want to stress is that Det Norske will transform from a no cash generating position to a point where the company increases its revenue annually and also generates robust operating cash flows.
Johan Sverdrup Revisited
In my initiation on Det Norske, the capital expenditure funding for Johan Sverdrup was not certain and the asset value was therefore not completely discounted in the stock. I would again like to discuss Johan Sverdrup at a time when the funding is certain until first oil in 2019. I believe that the stock will discount the asset value, especially when the plan for development and operations, scheduled to be delivered in early 2015. This will be another significant stock upside trigger for Det Norske.
Johan Sverdrup was the biggest oil discovery in the world in 2011 and the biggest in Norway in decades. Det Norske holds stake in 2 licenses in Johan Sverdrup with the company holding a 20% stake in PL265, which is estimated to have gross contingent resources in the range of 900mmboe to 1,500mmboe.
Considering an average resource of 1,200mmboe, Det Norske's share in the license would come to 240mmboe. Det Norske also has a 20% stake in the PL502 license. The reserves in this stake are not significant as PL265 and PL501 are the main licenses. In order to have a conservative estimate, I would peg the total reserves from both the licenses at 250mmboe. The positive factor to mention here is that Statoil has recently announced that oil recovery of 70% is achievable in Johan Sverdrup. Higher oil recovery is likely to boost the asset valuation.
As mentioned in my initiation coverage, Lundin Petroleum (OTCPK:LNDNF), which also has stake in Johan Sverdrup, believes that the current transaction value for Johan Sverdrup should be in the range of $10/boe. This would peg the value of Det Norske's share of reserves at $2.5 billion in contrast to the company's current market capitalization of $1.7 billion and implies a stock upside of 56% from current levels.
Valuations
I consider Lundin Petroleum to be the best peer for Det Norske. The reason being that Lundin Petroleum also holds stake is the giant Johan Sverdrup field. The key difference between the two companies was the fact that Lundin expects significant cash flows from current developments to finance its investment in Johan Sverdrup. On the other hand, Det Norske was struggling to find a way to fund the Johan Sverdrup development.
With the acquisition, Lundin Petroleum and Det Norske are at par when it comes to financing Johan Sverdrup and Det Norske's forward valuation should catch up with Lundin Petroleum's valuation.
I had initiated Lundin Petroleum in one of my earlier articles and taking the 2015E EBITDA (revised for current oil prices), the stock is currently trading at an EV/EBITDA valuation of 4.8. On the other hand, Det Norske is trading at an EV/EBITDA (2015E) valuation of 1.6.
This implies a valuation gap of 200% and I strongly believe that Det Norske has this upside potential after the game-changing acquisition. I must mention here that I have incorporated the $2.7 billion acquisition debt and the planned $500 million equity offering by Det Norske in the calculation of EV. This largely incorporates the factors related to the acquisition.
Risk Factors
With high 2P reserves after the acquisition and a stable production profile, the risk related to immediate developments in the company is minimal. Of the current 2P reserves, 60% are in production and this ensures strong operating cash flow for the company over the next few years. The offsetting factor to strong cash flows can be a decline in oil prices.
For the forecast, I have assumed crude oil price of $106. Any decline in prices can negatively impact cash flows and also potentially delay the development of Johan Sverdrup. I however believe that a decline in oil prices is unlikely considering the supply constraints that might arise from prevailing tensions in the Middle-East. From that perspective, the company is operating in a safe-zone when it comes to geo-political risks.
Conclusion
The $2.7 billion acquisition of Marathon Oil Norge AS completely changes the scenario for Det Norske in terms of funding and growth. The acquisition complements the company's production profile and provides robust cash inflow until 2019. Just over the next two years, a potential cash inflow of $3.4 billion is likely.
Det Norske stock was depressed prior to this news as there were big funding concerns. On the day of acquisition announcement, the stock jumped by over 9%. This is just the beginning of a long-term rally for the company and I believe that the valuation gap will be filled over the next 12-18 months. During this time period, the company will be generating strong cash flows and the plan for development and operations for Johan Sverdrup will also be in place. Det Norske is a "Very Strong Buy" at current levels.
Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks
Excellent investing advice.
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