Having done the technical due dilengence on both sides of takeovers, I thought I would share some of the technical considerations of company valuation(price of oil, debt, financing etc. will be left to others way more qualified than me).
3 main factors affect the value of an exploration(begining to produce oil) company
Net Production How many barrels a day (and the attendent profit from those barrels) affects the companies cash flow and at a certain point allows the company to expand without raising or unwanted debt. It is important to judge how wells will perform in the future (the decline rate) and even take a stab at when wells will not be profitable to pump and should be shut in.
Net Reserves More importantly are the reserves that the company has discovered. There are many ways to calculate these but the 2 main factors are level of certainty (usually proved, proved+probable, and proved+probable+possible or 1P,2P and 3P). These are calculated on the Oil in Place (OIP) which is a calculation of the volume of oil in the ground. Much harder to calculate is the recovery factor. How much of the oil in the ground can be brought to surface at ECONOMIC RATES. Note with infinite money and time all the oil could be brought to the surface. This is why some old fields on their last legs suddenly get a reserves upgrade since new technology or the price of oil makes further oil extraction profitable. A good example is the Canadian tars sands. At $20 a barrels the reserves are 0, at $100 a barrel Canada has the second largest reserve base in the world behind Saudi Arabia. Lots of oil in the ground but oil price determines how much oil is profitable to produce. The rules for calculating 1P and 2P are strict with 3P given more 'artistic' license but most companies buy on 1P, sell on 2P and hope that 1/2 the 3P is found by more drilling. The recovery factor is estimated initially by using simple fields in production and then adjusted once the field has produced for a few years.
Prospectivity and Net Acreage The hardest thing to define but in many cases for a small company, the most important factor is how many barrels are likely to be discovered when the rest of the known prospects are drilled. Using ITC as an example, they have 40% of two permits in which VicPet the operator has discovered at least 2 economic fields and are rumored to have a batch of similar prospects ready to drill shortly. Factors 1 and 2 above can be calculated to try and understand what Growler and Snatcher are worth but how many more fields like this are undiscovered. This is called 'blue sky' but in this case the success rate may be higher than 50%, making each undrilled prospect attractive. (btw, even undrilled development locations are not 100% and certain not appraisals, even with 3D, as witnessed in Charo 4).
So I have rambled on but how does this affect a takeover. The value a seller or buyer would calcuate is usually: - the cash generated from 1-3 years proven production, - the value of reserves (1P for buyer, 2P for seller) - the vaule of the rest of the reserves (3P-1P for buyer, 3P-2P for seller) times a magical success factor (in many cases this is 0 in the minds of the buyer)
So you can see why, in many cases, the buyer comes up with a lower value than the seller since the seller uses 2P for base value and likely values the blue sky more highly. Of course the market may not agree with the seller and a hostile takeover may be possible. But for friendly takeovers, the gap in calculated value will kill the deal.
What gets some takeovers over the line are commercial factors. They have the money to develop or can develop at a much better margin or they see oil futures more possitively. Many takeovers are size oriented. A company and its principles are great at recognizing unloved areas and making the first discoveries but not at monetizing existing discoveries and so is better off cashing in discoveries at a fair price and using the cash to go elsewhere to explore and let the purchasing company do what they do best maximizing the value of an existing field.
ITC Certainly many companies in the area would do the calculation and some might even move forward with a bid. The key factor in my mind is the value that ITC puts on their asset is likely more than any suitor is willing to pay. Obviously in the meanwhile all members of the JV want to see increased production, reserves (especially 1P) and no dry holes on future wildcats (nothing like a string of winners to get the value of the remaining blue sky as high as possible) so as to maximize the value of their company but some factor other than technical will be needed to get the deal over the line.
The rest of the year will be an adventure technically and corporately and the area should be fun to watch.
ITC Price at posting:
5.7¢ Sentiment: None Disclosure: Held
