Premier's Rockhopper move not without risks

12th Jul 2012 08:55

Shares of FTSE 250 oil and gas firm Premier Oil rose after it announced that it is buying a majority stake in Rockhopper Exploration's licence in the Falkland Islands.Premier is paying $231m for a 60% stake in Rockhopper's North Falkland Basin licences. An initial payment of $231m will be made in cash plus an exploration carry of up to $48m. Subject to field development plan approval it will also pay a development carry of up to $722m, bringing the total payment to $1bn.Rockhopper's licence interests in the Falkland Islands include the Sea Lion development, pretty much the only licence area in the Falklands to show any commercial potential thus far. Premier will take over as operator of the Sea Lion development.Premier chief executive Simon Lockett said: "Rockhopper has made excellent progress in commercialising the Sea Lion project which offers attractive returns and fits well with Premier's proven operating and development skills.""This transaction extends our strong growth profile beyond 2015 and offers both exploration and development upside for our shareholders. We look forward to working closely with Rockhopper and the Falkland Island Government on this very exciting project."Premier said the deal will be funded from a combination of Premier's existing cash resources, facilities and cash flow from operations. From Rockhopper's point of view, the deal means it will be fully funded on its share of the Sea Lion development through the development carry and a standby financing arrangement provided by Premier, plus it retains the option to secure third party financing in place of the standby financing arrangement, if it chooses."This is an excellent transaction for the company and its shareholders," claimed Sam Moody, Chief Executive of Rockhopper. The market was not so sure, as Rockhopper's shares eased on the announcement."It helps crystallise the value of our discoveries in the North Falkland Basin area centred on the Sea Lion field, as well as providing the funds to examine further the remaining potential of our acreage in the region. The transaction also presents the opportunity to pursue other exploration prospects in countries where there are geological similarities to the Falkland Islands and where our sub-surface skill sets can potentially create additional value," Moody added.Premier and Rockhopper have also agreed to pursue joint exploration opportunities in the Falkland Islands and in selected areas offshore Southern Africa.Merchant Securities retained its "buy" recommendation for Rockhopper after the deal was announced but cut its target price from 428p to 379p, though there is a good chance that figure will be revised again once the broker ha had to chance to assess the transaction in detail. "The combined cash costs of $1,001m equates to circa 379p/share (based on an exchange rate of 1.55p/share)," according to calculation by Brendan Long, an investment analyst at Merchant Securities. "Long hints that the deal looks more favourable to Premier than Rockhopper and notes that the agreement between the two companies is conditional."Whereas the implied gross valuation of $1.7bn falls short of Gaffney Cline's fundamental valuation ($4.7Bn), we expected a deal to occur at a significant discount to the fundamental valuation because i) this is the first oil project to occur in the Falkland Islands and ii) the main field, Sea Lion, appears challenging from an engineering perspective," Long said."Investors are now faced with the decision to i) hold onto the shares for the long-term to capture the full value of the assets and to gain exposure to crude oil or ii) take advantage of the liquidity event created by this transformational deal," Long concluded.Westhouse Securities, meanwhile, reckons the proposed deal raises a number of questions and challenges for Premier.The broker thinks that Premier will need to create a "mini Aberdeen" - the Scottish city used as a base for North Sea oil operations - close to, or on the Falkland Islands.Argentina's claim to sovereignty over the islands also overshadows the deal, and Westhouse wonders whether choosing a British partner for development of the licences will just add to the political tensions."Given the geo-political issues surrounding the Falkland Islands the involvement of an oil major, such as Exxon or Chevron, would have been better farm-in partner in our opinion in order to establish an oil industry and all its supporting infrastructure on the islands," the broker opines.Westhouse thinks that there are less troublesome projects out there which Premier could have acquired."We would argue that given the recent equity performance of much of the mid-cap oil & gas sector there are plenty of other opportunities within the sector that Premier could pursue to acquire contingent resources, or indeed 2P [proved + probable] reserves, at attractive valuations without the many issues that are specific to the Falkland Islands. "In our view there are several opportunities within the UK North Sea and offshore West Africa that would complement Premier's existing portfolio and deliver cash flow on a shorter time-scale that the Sea Lion field," the broker said.CJ