Cairn Energy (CNE) has today announced an agreed 450p a share cash bid for Nautical Petroleum (NPE). This is a 51% premium to the share price pre-talks but a discount to where some folks value Nautical (Westhouse reckons it is worth 550p and that a higher offer may emerge). What does this tell us about AIM listed oil stocks and also where to hunt for value.
Well firstly, even at $86 oil the bigger producers are chucking off a lot of cash. Exploration is high risk (even with modern technology) and so with AIM small-mid caps pretty bombed out it is probably safer to bulk up reserves by “drilling in the City.” Hence the recent Shell bid for Cove and Dragon’s move on Bowleven and Premier’s bid for Encore. Remember also the Total bid for Wessex which its board ( for reasons I simply cannot fathom) rejected. There will be more bids.
Will a higher offer come in for Nautical? It might. A 462p share price suggests that it is possible – effectively folk are buying an option at 12p on a higher bid. I am not sure that I’d fill my boots on that trade but there are worse ideas. But there are also better ideas. See below.
Secondly, even at $86 oil the smaller producers are also making money but valuations are bombed out. I write the other day about how Northern Petroleum (NOP) was arguably valued at less than the value of its cash/Guyane assets and had vast (profitable) Dutch assets, small UK producing assets and huge Italian exploration upside in for less than nothing. It is profitable.
Ernst & Young recently wrote that the whole mid cap sector is “in play.” Who is next? I have no idea whatsoever. Lansdowne, Sterling, Petroceltic, Northern Petroleum, Aurelian – take your pick. I am sure that there are others. I would add a caveat that a company short of cash will be more desperate to find a suitor (Lansdowne) but its bargaining hand if an offer arrives is weaker. And if there is no suitor a cash strapped entity will struggle to refinance in a market where E&P stocks are so unloved. Those with shed loads of cash & a bolshie management (Northern) may try to fight off any approach. Having said that if a cash bid for Northern came in at 120p (or even 105p) I think the management might find it hard to defend.
So I offer up 4 suggestions as potential targets: Sterling, Petroceltic, Aurelian and Northern. If you have a nibble at all 4 you only need one to come good at a 51% premium and you will be feeling pretty chirpy. The others will probably be re-rated after the next bid.
Now some may say – what if the oil price keeps falling? Well I suspect that it will not. Yes, demand growth in Asia and the West is slipping and so there may be short term weakness but demand is still growing and will continue to grow inextricably year on year unless some loon like Chris Huhne or the idiots who run the EU implement global policies to return us to the stone age in order to combat global warming. Supply will not increase to match growing demand and so in the long run we should expect a crude price of $80-140.
The market is valuing mid cap E&Ps incorrectly. After a spate of bids it is clear that the industry is aware of that. This is your opportunity.