question for dbk, page-7

This is what I have to say
Took me about 2 hours of reading and an hour of typing up
May be spelling errors, may be factually wrong in some places in which I gracefully ask the experts for their correction
Furthermore I still need to get into contact with the company in regards to some of the economics and reserves of Matinda

Introduction

North Matanda:
Report assumes reserves of 60million barrels as a mean. Reasonable considering the studies done by Gruy and associates as well as the opinion of Dr. Michael Smith.
The total costs of this acquisition 40% net interest in Matanda:
o US$5.8million (US$1.3million + US$4.5million)
o Half of the NPV of from 20% of the stake is forfeited
o $15.5million in shares to be issued. (Using a 22 cent average share price – this will be approximately 70million shares).

Capital structure of the company:
Currently 262,984,848 million shares on issue
o Add 70 million shares for additional 20% in Matada
o Add 52.6 million shares assuming all loyalty options are exercised
o Add 17.6million shares for other options on issue
Total shares on issue: 403,184,848
Market capitalization at 30 cents: $120,955,454
$4million in cash as of 30/09/2007
o Add $2million cash (assume costs of 200k to raise funds)
Total cash position: $6,000,000

This is the capital structure in terms of all deals relating to Matanda. Other dilution or payments which may occur as a result of other projects has been ignored.

Now, for the valuation:

There are a number of ways you can look at this; on an NPV basis, on a reserve to market cap basis and finally on a ‘potential’ basis in terms of further exploration success.

NPV Basis

A ballpark $500million NPV has been suggested by Dr. Michael Smith for North Matanda for both wells in PH-72. I tried to ring the company in regards to seek their opinion of the accuracy of such an NPV, I was told that Smyth was in London and the technical expert was in Angola. I will follow through with some questions via email to seek further clarification.

The benefits to CVI, including and not including lead time
$500million NPV * 0.4 = $200million
Correction from previously – Half of the NPV is only payable on 20% of the 40% interest
Hence NPV is $150million, not $100million
Minus US$5.8million (cash outlay for acquisitions at year 0)
= US$144.2million
With 403,184,848 shares on issue (fully diluted) this leaves free cashflows of 35.77 cents per share (rounded to 2dp)

This assumes the NPV model already took into consideration the likely lead time required for production. If this is not the case the total NPV of the project becomes $500million / 1.21 (assuming WACC of 0.1) with a lead time of 2 years (I am being generous). If this was not the case then the NPV per share of CVI becomes 29.56cps (rounded to 2dp; 35.77/1.21).

This NPV model makes a number of assumptions:
Gas is not vented (as it had been previouslythere) but is actually sold instead.
That this is free cashflows AFTER tax, and not before tax. [Not sure what tax is like over there anyway].
Development costs have been ignored as they have also assumed to be accounted as a cash outflow as part of the NPV
Assumes the government will not demand tax/royalties for the project, or even a piece of the pie for themselves.
Assumes reserves are certified at approximately 60million barrels (could be more or less, but this appears to be the approximate figure and was the basis of the NPV made by Dr. Michael Smith).
Financing considerations of what mix of debt/equity is unknown (not disclosed by Dr. Michael Smith).
Although not part of the NPV it does not include country risk, i.e. chances of nationalization of assets, war, famine, and so on. (On most world scales Cameroon’s business risk is considered MEDIUM to HIGH).

Reserve basis evaluation:

A number of you pointed out that NDO’s market capitalization seems disproportionate to the market capitalization of CVI on a direct comparison on reserve/market cap basis.You are all correct. It does look disproportionate. However there are a number of things that makes this inappropriate to solely base an investment decision off:
o Certification for the 60million barrel of reserves is still pending. Although likely to be in this range there is a risk this may deviate.
o A direct reserve/market cap comparison ignores CVI’s agreement for the first 20% that half of the NPV will be given up to the original seller. In the case of NDO’s stake the benefits flow to them entirely.
o NDO’s first cash flow from Galoc is in the first calendar quarter of 2008. In the case of CVI they still need EPA clearance, engineering studies, scoping studies, pre-feasibility studies, feasibility studies, and bank feasibility studies done until they ever see their first cash flow. This may mean 2, 3, or even 4 years until production for CVI. This then means the project is subject to price risk – i.e. unexpected changes in the price of the commodity in question. NDO does not have the risk as its production is sooner rather than later. Hence it has been fully priced in the case of NDO.
o NDO are expecting in the range of 17.5kbopd from the project. This means that 4kbopd goes directly to NDO. A problem with CVI is that although it may look like a large reserve the flow rates may not be as high as NDO’s (it could be a long life asset that produces over possibly 100’s of years). This is a question I need to raise with the company.
o Country risk is different from the Philippines and Cameroon… Furthermore the massive surge in NDO was a Supreme Court ruling in 2004 allowing the 100% ownership of assets by foreigners. Not sure what it is like in Cameroon??
o The Galoc area covers 3million hectares in prospective oil leases. This equates to 30,000 square kilometers. This compares to CVI’s 1,137 square km’s for Matinda
o NDO have identified 100 targets to follow up on at Galoc. CVI have six at Matinda.

I will note that it is projected that Galoc will flow 1.4 million barrels in year 1, 1.4million barrels in year 2, 0.8 million barrels in year 3 and 0.5 million barrels in year 4. Taking into account NDO’s 22.28% stake, this discounted at 0.1 is the equivalent of $295million. Combined with the current cash reserves this already justified NDO’s current market capitalization. So NDO is not necessarily under or over valued at the moment which makes it suitable to compare to.

The direct comparison ignores all other projects that NDO or CVI hold.
Assumes management teams for both companies are at par with one another

Exploration potential evaluation

I believe this would require very specific knowledge of the areas involved with both NDO and CVI if one was to compare them and such I do not possess this I will not even attempt it. By its very nature exploration is speculative and it’s difficult to assess values if drilling in both Galoc and Matinda were successful. Exploration potential for Matinda (if the reports are correct) does look promising.

Conclusion

All and all I still have the same stance I hold before. Unless CVI hits the jack pot in terms of “potential” acquisitions this is still very much largely a pure risk/reward play, and as such I do not see it as legitimately undervalued at current market prices.

All IMO, would appreciate feed back

Have a good weekend all!!