By Tom Winnifrith | Tuesday 11 October 2016
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.
The City's top oil analyst, Zac "the Knife" Phillips of SP Angel has today issued a stark warning on the risks in holding shares in Gulf Keystone (GKP). As it happens I think Zac is being rather too nice on this occassion, he misses a trick. First to Zac, with the shares now trading at 2.23p, but, he warns, worth as little as 0.65p. "The Knife" writes:
The extent of Gulf Keystone’s debt conversion has been disclosed today, and the approximate 22 billion shares issued effectively wipes out existing shareholders. Although this is unsurprising, what is a little bit more disappointing is the fact that approximately $100mm of debt remains on the balance sheet. There is little doubt that the last two years of been a torrid time for the Company, and today’s announcement should hopefully see close to this turbulent period.
While we are still currently finalising our valuation of the Company, we believe that at the current price that the Company is trading towards the top of our valuation range, which is $203 – 519mm (0.65 – 1.66p).
This is in part also due to the fact that the Company has now become in effect a “one trick pony” following the relinquishment of all of its licence areas outside of Shaikan. While we understand the rationale for the majority of the licence blocks, we cannot understand this approach with respect to the Sheikh Adi block, which abutted Shaikan block.
We believe that given the staggered payment terms from the KRG for the sale of its export crude, that leverage could have been brought to bear to restructure the term of the PSC covering the field, or at the very least utilise the existing infrastructure to significantly reduce the overall cost of development for both licence blocks.
Following this restructuring, we believe that the residual debt in combination with the fact that it is now a single asset company raises the risks associated with its valuation. Save for the 3P reserve case, the relinquishment of all other licence areas has left the Company with little or no running room left, which now makes the Company a significant target for acquisitive predator.
Over the range of the development scenarios the valuation ranges up to $680mm (3P), which when set against a backdrop of a rising oil price environment, can make an argument for an acquisition at these levels. As a consequence, while there is little motivation or reasoning behind the share price appreciating considerably from the current level, we feel that there is some protection against it declining to our “core” valuation of 0.65p.
While our current valuation would suggest that investors should reduce their interest in the stock, we believe that the M&A potential makes it at least a hold, and that any addition to a shareholding post this restructuring will be driven by individual belief in a takeout price that would be materially above the current level, sufficient to justify the risk associated with out holding. We are initiating coverage today with a HOLD Recommendation, but given that our valuation range stretches from 0.65 – 1.66p, that investors understand the implicit risks associated with this recommendation.
Yes, Zac is correct in that there may be a bid. But those who own 66% of the equity ( former bondholders) will be "in the money" at 1.1p or better. Any predator would have no need to offer much more than that to get its offer across the line. Moreover the bond holders are not penny stock investors and as such they will sell any shares they can at more than 1.1p to reduce their exposure while gettting out at a profit.
That natural arb will see the shares melt down. And that is why Zac is being far too charitable on this occassion although his fundamental valuation range, IMHO, is not far wrong.
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