Hi GuysFrom Macquarie this morningMonday, 25 October 2010Karoon...

Hi Guys

From Macquarie this morning

Monday, 25 October 2010

Karoon Gas
Recommendation downgraded

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Volatility Index: Very high
Recommendation: Neutral

Price 22 Oct 10 $10.88
Event
After a strong run (up 77% since June), we are downgrading Karoon Gas (KAR) to Neutral ahead of the impending listing of the company's South American assets on the Brazilian stock exchange.
Impact
Mission accomplished: Management's primary motivation for pursuing the Brazilian IPO was to crystallise the value of the South American portfolio which was not receiving sufficient recognition in the share price. After an initial slump, KAR's share price is now up 46% since making this initial public offering (IPO) announcement as the market bets on a high listing price to provide an attractive look-though valuation for the overall business. To this end, it appears management has already gone some way towards achieving its goal.
Less obvious upside from here: We estimate the current KAR share price reflects an implied valuation of U$2.7/bbl of risked prospective resource in South America. This leaves limited upside to management's target listing valuation of U$3-4/bbl. We recognise however that our valuation is inflated by our below consensus estimate of the value of the Poseidon discovery in Australia. If instead we put what we believe to be a nearer consensus valuation for this asset, the implied value falls to around U$2/bbl.
KAR likely to trade at a discount to OGX: Brazilian independent OGX (which has a similar exploration focused asset base) floated on the local market in June 2008 at an implied price of U$4.6/bbl of risked prospective resource. Yet we note that the OGX IPO was overwhelmingly oversubscribed during the peak of the 2008 oil price cycle and the company boasts a management team made up of the who's who of the Brazilian upstream industry. Consequently, we think KAR may struggle to receive a valuation much above U$3.0-3.5/bbl. This view is further supported by the tepid reception received by HRT last week (Brazil's most recent upstream IPO).
Earnings and target price revision
We have not changed our KAR earnings estimates.
We have raised our KAR target price by 35% to $11.75. This new target price implies a listing price for KAR's Brazilian assets of U$3/bbl (at spot currency (fx) rates) which is in line with the bottom of management's IPO target range.
Price catalyst
12-month price target: $11.75.
Catalyst: KAR is approaching total depth (TD) at the Maruja well offshore Brazil with a result expected within the next week; however, we believe this is a reasonably small target. After this, the share price will be driven by developments surrounding the IPO which should be completed by Christmas.
Action and recommendation
Downgrade to Neutral: Overall, we think management may well be able to secure a listing valuation of U$3.0-3.5/bbl of risked prospective resource which would imply a price of $11.5-13/share. We believe, however, this is likely to be a best case scenario and so with the share price already almost $11, while there is clearly still significant upside potential, the risks are less obviously positively skewed and hence our downgrade to Neutral.