mpo merger with arn, page-5

Unfortunately, MPO can't afford to buy their asset package which will go for north of 100M. That's my estimate.

I know Lone Pine only superficially so don't know whether a merger there would make sense. 300M in straight debt supported by 2k boed is really too scary for a merger.

Basically there is a lot of money flowing into (undervalued) Canadian energy right now. That's why a merger with a debt laden, undervalued player with a large resource like ARN made sense.

When I made the proposal, MPO traded about where it is while ARN was about 1/2 the price. Here was what I envisioned. I still think this merger is our best exit. I don't really want to see the current management or BOD of MPO continue in any fashion. Steve is a good guy but exploration is not his forte. He is more M&A.

So keep in mind two things when reading my analysis: ARN is now in a much strong position with their pending asset sale and increased share price, while MPO is in a weaker position thanks to the lawsuit, reduced cash and reduced expectations for the wolfcamp play.

So the numbers in the proposition need to be tweaked. Here were my original thoughts when both companies were in the doldrums:

"I want to look at the benefits of the merger to shareholders of both companies. It involves dilution but I think it's worth it because I suspect the share price will double from current levels (at least).

ARN:

98M shares. Trading about 0.60. Total debt of 317M roughly with 150M bank debt and convertibles (86M 2016 and 85M 2018). The convertibles are not a problem if the share price can be boosted enough by 2016. I think this is possible.

G&A expenses are still too high and need to be cut in half. Operating costs are still too high and need to be reduced further. This will improve with the Ethel pipeline in June.

Production is approx 4k a day and stabilized with waterflood showing positive signs. Operating netbacks of $50 are good and the corporate netback of $35 is good with room for further improvement. Cash flow is hedged for 3 years at the 50% level.

This is all a significant improvement over past metrics. So we are talking roughly 40-50M a year in cash flow at current levels. Capex should be pegged to cash flow.

The most important asset is their land position and potential 30% recoveries of a huge amount of oil. 700M boe OOIP.

About 36M boe of 2P so far. Even valuing these at $15 a boe gives 540M in reserve value or 223 EV, which is roughly $2.27 a share. If one uses $20 a boe (which is more reasonable) then 720M in reserve value, 403M in EV or $4.11 a share. There are also substantial tax credits.

We are trading at a tiny fraction of EV regardless of how you cut it and this is all because of debt.

The market is currently assigning 376M in EV to ARN at current prices (~0.60).

MPO:

246M shares. Trading at 0.26 AUD. Roughly 65M in cash (USD). So EV is approximately 64M - 67M (cash) ~ 0M Canadian dollars. Current production is about 900 boed (I don't know about declines).

They have 26k net acres of Wolf Camp land which should be worth considerably more than the 24M they paid for the land (despite mediocre drilling results to date). The land might be worth 3 times or more this value by the metrics of recent land sales. This is adjacent to AREX land.

However MPO can't develop this play without burning their cash. So they will look to sell/jv the land out. I haven't seen any reserve report so I'll assign a value of 50M to their land position and production (land both in Texas and Quebec). That means a total valuation of 117M (at least) or 0.47 a share.

They also trade at a large discount to any reasonable NAV. They trade basically at cash value.

MPO & ARN:

What would be a reasonable merger? If we assign 117M of value to MPO and 117M of value to ARN (partially accounting for reserve value) then the combined company would have a total value of 234M.

Let's say the new company has 50M shares outstanding, a TSX listing and possibly an Australian or US listing. A would prefer a US listing since I think the company will trade at a premium to a Canadian listing.

If it traded at a market cap of ~234M (4.68 a share) then MPO shareholders would own 0.5 of the company or 1 newco share per 11.4 MPO shares. That's 0.42 in current MPO share pricing.

ARN holders would get 1 newco: 3.92 current ARN. That's 1.19 per current ARN share.

The upside is coming in two ways: the MPO cash will viewed as "useful" since it can be deployed in a play with good recycle ratio so it should finally be accorded some value for its Texas production. G&A costs will not simply burn up the cash. ARN will get more credit for its reserve value since it will have more cash and flexibility to develop the play.

I think this is conservative: MPO has substantial upside to this estimate from its Texas land, while ARN is getting credited with a very small fraction of its reserve value. It could easily be double this valuation.

Bank debt would be 85M with convertibles still hanging around. They could float 20M more shares at $4.5 to kill the debt. Funding capex out of cash flow (or close) would make the share price fly. They could even fund a small dividend possibly in a fiscally responsible way. I think the investor interest would be enormous.

If they could do a deal with convertible holders (at added dilution) to get rid of the convertibles then we would really be in business. Nevertheless, those are many years away and this course of action will bring a lot of excitement back to a play which is one of the few huge light oil deposits in Canada."