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Brazil IPO Launched

Karoon Gas Australia has launched its Brazil based initial public offering (IPO) for 31.9% (prior guidance 25% to 30%) of its South American (SA) assets. Karoon?s expected price range is US$603m - US$750m from the IPO.

Following an institutional book build process, the final pricing of the offer is expected to be achieved by 10 Nov. Risks associated with the IPO include lower than expected pricing, or in a worst case the offering may not proceed.

If Karoon?s pricing guidance is correct, it implies an estimated value of US$1.89bn to US$2.35bn for 100% of Karoon's SA exploration assets. Based on independent consultant DeGolyer & MacNaughton?s (D&M) assessment of Karoon?s net mean prospective SA resources (drilling prospects) of around 588 mmbbl, the Karoon Brazil listing equates to a value of around US$3.21/bbl to US$4/bbl. For reference purposes, D&M has previously valued Karoon?s South American exploration assets at US$5.92/bbl (30 May 2010).

After diluting Karoon for the most recent institutional and retail equity raising(we now assume 218.45m shares are on issue), the Brazil IPO pricing range highlighted by Karoon equates to a value of US$8.65/KAR share to US$10.76/KAR share for 100% of the SA assets. For comparison purposes, Table 1 below highlights a range of potential values that we think could be realised from the South American IPO.


UBS Karoon Valuation

Our Karoon base valuation is from an assessment of the potential value of the future development of the Greater Poseidon gas field to support ConocoPhillips operated Darwin LNG T-2 expansion. Exploration assets are included in our share price target only.

After three well penetrations in the Greater Poseidon complex, the resource is still not highly defined. For the purposes of our Karoon base valuation modelling, we have assumed enough gas is ultimately proven up (5 TCF gross) at Poseidon to support a 4.25 mmtpa LNG train expansion at the ConocoPhillips-operated Darwin LNG plant. While there is a risk our gas volume assumption for Greater Poseidon is not confirmed, we believe the preliminary drilling results to date support the potential for a substantial gas accumulation at Greater Poseidon that could possibly support an LNG development. Karoon estimates Poseidon contains 3 ? 15 TCF of gas with a mean recoverable estimate of 7 TCF (gross).

Our analysis suggests the potential development of a 5 TCF Greater Poseidon gas field to support Darwin LNG T-2 expansion generates a project IRR of 13.5% (including royalty), which results in a value for Poseidon of A$5.86/Karoon share. This assumes Darwin LNG T-2 capacity of 4.25 mmtpa, project capex of US$10.8bn (A$13.5bn) and 2018 start-up

Our Karoon net asset value (NAV) is A$6.95/share after including net cash of A$1.46/share and adjusting for overheads and corporate costs. However, Greater Poseidon is a recent discovery that is undergoing evaluation and it has not been committed to support Darwin LNG expansion. Its future potential go-ahead in support of Darwin LNG expansion is dependant on multiple issues, which include resource definition, final project scope and cost, and LNG buyer support. We expect the 4-5 well Greater Poseidon area exploration and appraisal program planned to start from 1Q 2011 to play a key role in helping to define the critical Poseidon resource base by confirming reservoir quality, gas flow capability and content.

On the basis of the above, we conservatively assume the market is prepared to value Poseidon at 50% of the UBS estimated value, than our NAV is reduced to A$4.01/share. If we add in the low case US$1.89bn (A$8.92/share at A$/US$0.97) Brazil IPO value for Karoon?s SA exploration assets then a value for Karoon of A$12.93/share can be justified. The key question must then be - Will Karoon realise US$3 - US$4/bbl for its Brazil listing? Even if Karoon only gets US$2.5/bbl for the SA assets listed in Brazil, and after cutting the UBS Poseidon valuation by 50%, it equates to a A$10.94/share price value.

Exploration Upside
Karoon intends to use the proceeds from the Brazil IPO to fund a substantial exploration program in the Santos Basin, Brazil and Peru. We see major upside to Karoon from the future evaluation of the company?s exploration assets in Brazil and Peru on the basis of the following drilling program over the next 18 months. Karoon also intends to farm-out equity in Brazil and Peru prior to committing to its major drilling program.

Maruja Exploration Well
Maruja is a multi reservoir salt related (post salt) prospect that we assume is close to target reservoir depth (3900m PTD). Karoon estimates Maruja has potential to contain 38 mmbbls and 100 mmbbls of potential gross mean recoverable oil (unrisked) in Oligocene and Campanian reservoir. The most recent 31 August 2010 DeGolyer & MacNaughton estimate of Karoon?s gross prospective oil resources places Maruja as a potential 194 mmbbl field.

We rate the Maruja prospect as having a 35% probability of success (POS), and on a 138 mmbbl success basis we value Maruja at A$1.02/KAR share (unrisked). Maruja correlates well to seismic amplitude variable offset (AVO) anomalies seen at Sidon and Tiro. In our view, these anomalies form a good lead indicator that the Maruja prospect contains hydrocarbons. Maruja is expected to cost around US$54m (gross) to drill, or around US$19m net to Karoon.


Investment Case

We continue to see potential value add from the Brazil stock exchange listing of 31.9% of Karoon?s South American asset portfolio. This listing consists of five 100% and two 20% owned exploration blocks in the Santos Basin offshore Brazil, plus the offshore Tumbes Z38 (KAR 75%) and onshore Maranon Basin 144 (KAR 100%) in Peru. D&M estimates the net mean prospective resources in these assets is around 588 mmbbls. Karoon?s expected price range from the IPO is US$603m - US$750m, which implies an estimated value of US$1.89bn to US$2.35bn for 100% of Karoon's SA exploration assets. If we assume the market is valuing Poseidon at 50% of the UBS estimated value, and after adding in the low case US$1.89bn (A$8.92/KAR share at A$/US$0.97) Brazil IPO value justifies a Karoon price target of A$12.93/KAR share. In our view, recent Karoon share price weakness is largely related to the Karoon Share Purchase Plan (issue price of A$7/share), where shares were issued to eligible investors today (Wednesday 27 October), but are not expected to commence trading on the Australian Stock Exchange until Friday 29 October.