Motive, means and opportunity
We don’t for a moment doubt that the Karoon board believes their goals will deliver shareholder value. No one sets out to destroy shareholder value. To paraphrase the old adage: the road to shareholder value destruction is paved with good intentions (and misaligned incentives).
For shareholder value destruction to occur, three things are needed: mis-guided and mis-aligned motives, the financial means and opportunity.
At Karoon, the “motive” of the Board is clear – to deliver on the company’s mantra of long-term reserve and production growth that it believes will create shareholder value. It does not shy away from this objective.
We consider the motive of the board, while well-intentioned, to be mis-guided and mis-aligned. We consider returning meaningful amounts of capital to shareholders as a better, less risky means of creating shareholder value. Growing, as the Board would like to do, involves shareholders facing significant risks. We simply need to look at the share price since the Who Dat acquisition was announced.
Karoon recently completed an issue of new debt instruments, raising a total of USD350 million. We note that the investors who bought those bonds are being rewarded with a 10.5% per annum interest rate, paid every six months. When including the existing reserves-based lending facility, we estimate Karoon has the capacity to borrow up to ~USD700 million.
Now, with a freshly-minted bond issue combined with the existing unutilised debt capacity, Karoon has the “means” to execute its growth strategy.
All that is now required is the “opportunity” to make an acquisition. Shareholders are now being told acquisitions are unlikely until at least next year, which is only a little over 6 months away.
Karoon is clearly keen to make an acquisition to meet its target production of 50,000 barrels of oil per day. The CEO made that clear in a press interview during the week. You can read that interview here.
The poor performance of both the Who Dat acquisition and the share price means that shareholders should oppose any new acquisition until both have improved substantially. Further, if these criteria can be satisfied, then in our view only exceptional acquisitions that are accretive to shareholder distributions (not just a vague shareholder value criterium) should be considered.
Increased debt means greater risks to shareholders
While Karoon’s share price languishes well below the issue price of last year’s widely-criticised capital raising, any new equity issuances will be challenging. This means Karoon will need to rely almost entirely on debt funding for any acquisition it might make. As noted above, that debt is now available.
We consider that any debt funded acquisitions will substantially increase the risks to Karoon’s shareholders. The unexpected production issues at both Bauna and Who Dat serve to remind us all that drilling for oil is a risky endeavour. Even with the most competent teams, unexpected, unforeseen events can occur, particularly in a technically complex and highly cyclical industry such as oil and gas. Adding large amounts of debt into the mix adds substantial financial risks; risks that are ultimately borne by shareholders.
Whatever Mr Botten and his fellow directors might like you to believe, the market’s verdict on Karoon’s strategy appears clear.
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