Capital ManagementWhere to from Here (originally written Feb 27,...

Capital Management

Where to from Here (originally written Feb 27, 2022 - prior to Oil Price spike)

Net Cash

Dependant on Oil Price, production rates of existing assets, and when 12-8-East commences production and at what rate, HZN could have around USD$40m (or AUD$55m or more than AUD$0.03 / share) Net Cash by June 30th, 2022 based on current assumptions including POO around USD$85.

12-8-E performance is the elephant in the room

• When production commences (early Q2,22). This will likely have a modest impact on the cash balance as at June 30th as cash receipts for June 2022 production will be received July 30th.

• The production rate is anticipated by HZN to average 1,000+ bopd to HZN for the first 12 months.

  • The rate will be much higher initially, and will have a relatively rapid decline. Hence the cash flow will be front loaded.

  • There is potential for the higher production rates and for significantly more oil to be recovered.
    In a presentation (2020 AGM?), in response to a question it was stated that CNOOC’s budget has higher numbers for production rates, and for oil to be recovered.
    Given the nature of the field (viscous oil; and difficult to predict when water will break through), there is the real prospect that even the higher CNOOC numbers are exceeded by a significant margin.

  • Of course It may also be a lemon, in which case we will be sad.

What Will HZN Do with this cash?

Whilst my preference would be for a cash distribution of, say $0.02 or $0.025 (capital return or unfranked dividend), I think that we are much more likely to see a BuyBack for the first tranche of shareholder returns. I think that there are two main reasons for this, 1) tax considerations, and 2) we need closer to 12 months to get a better understanding of likely 12-8-E performance.

What could a Buyback program look like?

An initial On Market Buyback (max 10% or about 160m shares) at an average price of $0.15 / share would cost cica. AUD$24m, leaving plenty of cash in the kitty. A kitty that would quickly be replenished if production meets budget.

HZN’s current NPV would likely be north of $0.25 at current oil prices. Buying back shares up to $0.175 (30% discount to current NPV) would increase the NPV for the remaining shares by more than $0.01 / share.

Depending on the outcome of an on market buyback (quantity and share price impact), an Off Market Buyback could follow.

This would also be timed to allow approval of approached at the 2022 AGM.

Cash Harvesting and Distribution (and/or M&A)

Continue to maximise cash generation from existing assets in China and New Zealand, and reduce costs further..

Sell China and Return (and/or Redeploy) Capital

A sale should only be contemplated once the potential for the Beibu Gulf is better understood, most importantly, the likely recoverable oil of the 12-8-E field. I anticipate that this would likely be in the March-June 2023 timeframe.

Sovereign risk assessment (China invades Taiwan) may feed into timing considerations.

The WACC Differential Opportunity

Our Beibu Gulf asset should be very saleable to a Chinese company. The Chinese have a track record of paying a decent price for Chinese based assets, e.g., Fosum’s purchase of ROC.

I believe that this relates to the differential in the underlying cost of capital (or indirectly the applicable discount rate) of the Seller (Us) and the Acquirer (ChinaCo).

If my assertion is correct, then ChinaCo would view a sale price that reflects a full (plus) NPV to us, as a bargain to them.

Therein lies a great opportunity.

What to Do With China Sale Proceeds

• Return Capital. This would likely get approval as a Capital Return from ATO, i.e., unlikely to be deemed an unfranked dividend.

• Redeploy Capital. Assuming that my “achieve a ‘full NPV’ sale” thesis is correct, we would likely be able to use the sale proceeds to acquire an asset with a substantially higher NPV than that of our China asset. A near doubling of value is not inconceivable.

• A Hybrid: Acquire an Asset and Return Capital. Alternatively, an asset with a similar NPV/cashflows could be acquired, and potentially significant excess capital returned to shareholders.

Put HZN up for sale.

Make it known that offers for the company will be given serious consideration.

Put simply, receiving a premium to a current share price allows shareholders

• To redeploy cash/capital to great advantage in another undervalued company, or

• To benefit from a higher NPV discount on the script of the acquirer