ARTEK EXPLORATION LTD RTK
November 28, 2012 - 2:31pm EST by
cnk123
2012 2013
Price: 3.15 EPS $0.00 $0.00
Shares Out. (in M): 52 P/E 0.0x 0.0x
Market Cap (in M): 163 P/FCF 0.0x 0.0x
Net Debt (in M): 45 EBIT 0 0
TEV: 207 TEV/EBIT 0.0x 0.0x

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  • Oil and Gas
  • Canada
  • Western Canada
  • Energy
  • Insider Ownership
  • Sum Of The Parts (SOTP)
  • E&P
 

Description

 

Artek Exploration (“RTK” or the “Company”) represents an attractive risk/reward special situation opportunity with an interesting situational dynamic that somewhat de-risks the equity from a ‘vanilla’ E&P investment. 

 The Company is a 4,000 boe/d (2012E exit production) producer focused in two core areas, NE BC and WC AB.  While the Company has an attractive asset base with significant embedded optionality, what makes the opportunity unique is the fact that the Company’s partner in its core Inga Doig play, Celtic Exploration, is in the process of being acquired by Exxon Mobil and concurrently spinning out a new company called Kelt Exploration.  Kelt Exploration will hold a number of Celtic’s non-core assets and was designed as a ‘starter package’ for Celtic management and as an incremental incentive for Celtic shareholders in addition to the cash consideration received.  Kelt will begin its corporate life as a 3,300 boe/d producer with a 90% gas weighting, and most importantly as it relates to RTK, a 40% non-operated interest in Artek’s Inga Doig play in addition to the deeper Montney play where the companies have acquired a >58 gross section land base.  Based on current trading values of Celtic, the implied value for Kelt is ~$200 mm which implies 1.3x NAV, ~$60,000/flowing bb, $20/2P boe and >12x cash flow (based on street estimates), all well above RTK’s comparable metrics.

Lastly, the CEO of Celtic Exploration is a director of RTK and personally owns ~6.5% of the Company’s shares outstanding.

 In addition to being a compelling stand alone investment and as a prospective M&A target, a key lever of optionality resides in the fact that Kelt is going to begin trading independently with a very strong multiple and as such can be expected to use their currency to back-fill valuation through accretive acquisitions.  Given Kelt management’s strong reputation and focus on consolidating large, operated, high working interest properties, it stands to reason that RTK may become one of its initial targets given the very strong economics associated with the Inga Doig asset in addition to the significant optionality of the Montney acreage.  While acquiring a security strictly to speculate on M&A is a bit of a mug’s game, there are several key points that I would highlight that are supportive of the Company being acquired in the near term, whether by Kelt or a number of other issuers:

 -The Company is nearing its 5 year anniversary (several of which were as a private) which was an exit target for management; given the recent share price performance (due to the Celtic acquisition) the management team finally has a cost of capital with which to negotiate
-While the Company has adequate liquidity and generates run rate cash flow of ~$30 mm, their assets have high capital intensity and to fully optimize its asset base the Company would require significant capital, beyond its ability to accretively finance
-The Company has a significant amount of future capital booked and given that there is a substantial amount of ‘unbooked upside’, the Company’s ability to finance this development and thus trade at a reasonable discount to NAV is challenged in the near term
-Celtic/Kelt management are strongly regarded and have a keen interest in the Company’s core assets which will allow them to add both cash flow but significantly add to their undeveloped land base at accretive multiples
-Celtic/Kelt’s CEO personally owns 6.5% of the Company.  Small in the context of his net worth but material in terms of influencing the likely outcome
-Our work highlights a number of interested intermediate sized issuers that would have an interest in the Company’s assets including Paramount, Tourmaline, ARC, Pengrowth, etc

EV Summary:

Mkt Cap: ~$155 mm

Net Debt: ~$45 mm (PF recent equity raise)

EV: ~$200 mm

EV /

Run Rate CF: 5.5x

2012E production (exit):  $50k/flowing

2011A reserves: $8.75/boe

2011A Reserves (incl. FDC): $15.60/boe

Run Rate Netbacks: $25/boe

Inga Doig:

Given the materiality of this asset to the Company, a quick overview is warranted.

RTK maintains a 31.5 net section position at Inga/Fireweed.  Prospective wells generate $5 – 10 mm NPVs on our math, owing to very high flush rates of production and associated liquids yields (200 bbls/mmcf, large % of free condensate), which translates to very rapid payouts of 8 – 16 months and strong IRRs.  The Company has booked ~11 undeveloped locations in its reserve report with 7 producing wells (gross).  During 2012, the Company expects to drill a total of 4.2 net wells (3 already producing).  Looking forward, the Company expects the project to move to 3 – 4 wells/section, at the low end and after backing out existing bookings, there are ~75 potential unbooked locations which would translate to >$375 mm of unrisked, undiscounted NPV or >2.0x the existing share price.  The rub is that the wells are very capital intensive at $6 – 7 mm/well, given a cash flow base (run rate) of ~$35 mm, the Company would not be able to drive PV forward into its equity value to the same extent a better capitalized entity could.  Further, at some point, the notional acquirer may choose to expand existing infrastructure to provide ‘deep cut’ capability to further optimize liquids yields, which would also not be feasible given the size of the Company’s balance sheet.

Additionally, the Company, along with Celtic, has been active in acquiring ‘deep rights’ in an exploration play underlying the Doig, in what is widely presumed to be the Montney.  58 gross sections have been disclosed (35 net).  Illustratively, using similar spacing assumptions, this play could ultimately represent future capital of ~$685 mm or ~3.4x the current EV of the Company.  The Company is undercapitalized and exposes its shareholders to dilution or increased financial risk (due to PF leverage) in any attempt to capitalize the asset base appropriately, as such, we believe the asset best lends itself to a delineate and sell model and we believe management to be of the same mind in this regard.

Valuation:

Below is a SOTP valuation.  I believe the most likely scenario is the independent sale of Inga, Leduc Woodbend and the Peace River Arch assets to different buyers with the spin out the Deep Basin assets to shareholders with current management running those assets.  I would note that 2011A year end NAV was $4.40/share - the pushback here would be that the price deck was escalated well above current gas prices and there is $157 mm of future capital booked to the assets (i.e. much of the inventory at YE, ex-Inga, was booked) but the NAV highlights the embedded value of the asset base with significant optionality in the Inga asset.
    Valuation Scenario                
                         
Asset:   Downside Base Upside Notes:              
                         
Inga/Fireweed Doig Reserves   $75.0 $90.0 $105.0 2011A 2P valuation of   ~$91 mm          
Inga/Fireweed Doig Unbooked   $37.5 $50.0 $75.0 Unbooked locations risked   at 10, 15 and 20% in downside, base and upside case respectively
Total Inga/Fireweed   $112.5 $140.0 $180.0                
                         
Leduc Woodbend   $40.0 $40.0 $40.0 Implied value of retained   interest, confirmed by 2P valuation    
Peace River Arch   $10.0 $15.0 $15.0 400 boe/d $25k/flowing   and $37.5k/flowing; 22% liquids, but contains emerging oil play
Deep Basin Gas   $20.0 $20.0 $20.0 $0.05/mcf reflected to   prospective Deep Basin reserves, materially below booked value
Inga/Fireweed Montney   $15.0 $30.0 $50.0 Upside case is 15% risked          
Total   $197.5 $245.0 $305.0                
Less: Net Debt   $45.0 $45.0 $45.0 PF recent equity issuance          
Implied Equity Value   $152.5 $200.0 $260.0                
FD S/O   51.6 51.6 51.6                
SOTP Value   $2.96 $3.88 $5.04                
% Premium/Discount to Current   -6.2% 23.0% 60.0%                

There are two key risks in this opportunity, aside from a material decrease in commodity prices.
1) Longer dated timeline to corporate sale
=>The Company is well capitalized for its 2013E program but ultimately the stock is at risk of drifting if a transaction is not completed during the year, specifically if Kelt acquires a series of other assets/companies in the interim period as there is clearly some element of 'takeover speculation' in the stock price (as evidenced by the ~50% increase since the CLT deal was announced)

2) Delay or substandard results associated with the intial Inga/Fireweed Montney wells
=>Based on management discussion, the play appears to be more geologically pervasive/have greater aerial extent than the Doig which is seismically defined.  There are analogs producing relatively close to RTK's land position, having said that, the first few wells are clearly key.  While I've reflected the Montney at conservative values (downside case is $500/acre), the key to a robust valuation in an M&A scenario will be demonstrating the prospectivity and repeatability of the Montney

Catalysts:

-Impending well results on 2 Inga Doig wells and potentially 1 Inga Montney well (early Dec)

-Close of XOM/CLT transaction and spin out of Kelt Exploration to CLT shareholders

-Q1 Montney well results

-Potential strategic review/transaction in H1 2013

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 

Catalysts:

-Impending well results on 2 Inga Doig wells and potentially 1 Inga Montney well (early Dec)

-Close of XOM/CLT transaction and spin out of Kelt Exploration to CLT shareholders

-Q1 Montney well results

-Potential strategic review/transaction in H1 2013

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    Description

     

    Artek Exploration (“RTK” or the “Company”) represents an attractive risk/reward special situation opportunity with an interesting situational dynamic that somewhat de-risks the equity from a ‘vanilla’ E&P investment. 

     The Company is a 4,000 boe/d (2012E exit production) producer focused in two core areas, NE BC and WC AB.  While the Company has an attractive asset base with significant embedded optionality, what makes the opportunity unique is the fact that the Company’s partner in its core Inga Doig play, Celtic Exploration, is in the process of being acquired by Exxon Mobil and concurrently spinning out a new company called Kelt Exploration.  Kelt Exploration will hold a number of Celtic’s non-core assets and was designed as a ‘starter package’ for Celtic management and as an incremental incentive for Celtic shareholders in addition to the cash consideration received.  Kelt will begin its corporate life as a 3,300 boe/d producer with a 90% gas weighting, and most importantly as it relates to RTK, a 40% non-operated interest in Artek’s Inga Doig play in addition to the deeper Montney play where the companies have acquired a >58 gross section land base.  Based on current trading values of Celtic, the implied value for Kelt is ~$200 mm which implies 1.3x NAV, ~$60,000/flowing bb, $20/2P boe and >12x cash flow (based on street estimates), all well above RTK’s comparable metrics.

    Lastly, the CEO of Celtic Exploration is a director of RTK and personally owns ~6.5% of the Company’s shares outstanding.

     In addition to being a compelling stand alone investment and as a prospective M&A target, a key lever of optionality resides in the fact that Kelt is going to begin trading independently with a very strong multiple and as such can be expected to use their currency to back-fill valuation through accretive acquisitions.  Given Kelt management’s strong reputation and focus on consolidating large, operated, high working interest properties, it stands to reason that RTK may become one of its initial targets given the very strong economics associated with the Inga Doig asset in addition to the significant optionality of the Montney acreage.  While acquiring a security strictly to speculate on M&A is a bit of a mug’s game, there are several key points that I would highlight that are supportive of the Company being acquired in the near term, whether by Kelt or a number of other issuers:

     -The Company is nearing its 5 year anniversary (several of which were as a private) which was an exit target for management; given the recent share price performance (due to the Celtic acquisition) the management team finally has a cost of capital with which to negotiate
    -While the Company has adequate liquidity and generates run rate cash flow of ~$30 mm, their assets have high capital intensity and to fully optimize its asset base the Company would require significant capital, beyond its ability to accretively finance
    -The Company has a significant amount of future capital booked and given that there is a substantial amount of ‘unbooked upside’, the Company’s ability to finance this development and thus trade at a reasonable discount to NAV is challenged in the near term
    -Celtic/Kelt management are strongly regarded and have a keen interest in the Company’s core assets which will allow them to add both cash flow but significantly add to their undeveloped land base at accretive multiples
    -Celtic/Kelt’s CEO personally owns 6.5% of the Company.  Small in the context of his net worth but material in terms of influencing the likely outcome
    -Our work highlights a number of interested intermediate sized issuers that would have an interest in the Company’s assets including Paramount, Tourmaline, ARC, Pengrowth, etc

    EV Summary:

    Mkt Cap: ~$155 mm

    Net Debt: ~$45 mm (PF recent equity raise)

    EV: ~$200 mm

    EV /

    Run Rate CF: 5.5x

    2012E production (exit):  $50k/flowing

    2011A reserves: $8.75/boe

    2011A Reserves (incl. FDC): $15.60/boe

    Run Rate Netbacks: $25/boe

    Inga Doig:

    Given the materiality of this asset to the Company, a quick overview is warranted.

    RTK maintains a 31.5 net section position at Inga/Fireweed.  Prospective wells generate $5 – 10 mm NPVs on our math, owing to very high flush rates of production and associated liquids yields (200 bbls/mmcf, large % of free condensate), which translates to very rapid payouts of 8 – 16 months and strong IRRs.  The Company has booked ~11 undeveloped locations in its reserve report with 7 producing wells (gross).  During 2012, the Company expects to drill a total of 4.2 net wells (3 already producing).  Looking forward, the Company expects the project to move to 3 – 4 wells/section, at the low end and after backing out existing bookings, there are ~75 potential unbooked locations which would translate to >$375 mm of unrisked, undiscounted NPV or >2.0x the existing share price.  The rub is that the wells are very capital intensive at $6 – 7 mm/well, given a cash flow base (run rate) of ~$35 mm, the Company would not be able to drive PV forward into its equity value to the same extent a better capitalized entity could.  Further, at some point, the notional acquirer may choose to expand existing infrastructure to provide ‘deep cut’ capability to further optimize liquids yields, which would also not be feasible given the size of the Company’s balance sheet.

    Additionally, the Company, along with Celtic, has been active in acquiring ‘deep rights’ in an exploration play underlying the Doig, in what is widely presumed to be the Montney.  58 gross sections have been disclosed (35 net).  Illustratively, using similar spacing assumptions, this play could ultimately represent future capital of ~$685 mm or ~3.4x the current EV of the Company.  The Company is undercapitalized and exposes its shareholders to dilution or increased financial risk (due to PF leverage) in any attempt to capitalize the asset base appropriately, as such, we believe the asset best lends itself to a delineate and sell model and we believe management to be of the same mind in this regard.

    Valuation:

    Below is a SOTP valuation.  I believe the most likely scenario is the independent sale of Inga, Leduc Woodbend and the Peace River Arch assets to different buyers with the spin out the Deep Basin assets to shareholders with current management running those assets.  I would note that 2011A year end NAV was $4.40/share - the pushback here would be that the price deck was escalated well above current gas prices and there is $157 mm of future capital booked to the assets (i.e. much of the inventory at YE, ex-Inga, was booked) but the NAV highlights the embedded value of the asset base with significant optionality in the Inga asset.
        Valuation Scenario                
                             
    Asset:   Downside Base Upside Notes:              
                             
    Inga/Fireweed Doig Reserves   $75.0 $90.0 $105.0 2011A 2P valuation of   ~$91 mm          
    Inga/Fireweed Doig Unbooked   $37.5 $50.0 $75.0 Unbooked locations risked   at 10, 15 and 20% in downside, base and upside case respectively
    Total Inga/Fireweed   $112.5 $140.0 $180.0                
                             
    Leduc Woodbend   $40.0 $40.0 $40.0 Implied value of retained   interest, confirmed by 2P valuation    
    Peace River Arch   $10.0 $15.0 $15.0 400 boe/d $25k/flowing   and $37.5k/flowing; 22% liquids, but contains emerging oil play
    Deep Basin Gas   $20.0 $20.0 $20.0 $0.05/mcf reflected to   prospective Deep Basin reserves, materially below booked value
    Inga/Fireweed Montney   $15.0 $30.0 $50.0 Upside case is 15% risked          
    Total   $197.5 $245.0 $305.0                
    Less: Net Debt   $45.0 $45.0 $45.0 PF recent equity issuance          
    Implied Equity Value   $152.5 $200.0 $260.0                
    FD S/O   51.6 51.6 51.6                
    SOTP Value   $2.96 $3.88 $5.04                
    % Premium/Discount to Current   -6.2% 23.0% 60.0%                

    There are two key risks in this opportunity, aside from a material decrease in commodity prices.
    1) Longer dated timeline to corporate sale
    =>The Company is well capitalized for its 2013E program but ultimately the stock is at risk of drifting if a transaction is not completed during the year, specifically if Kelt acquires a series of other assets/companies in the interim period as there is clearly some element of 'takeover speculation' in the stock price (as evidenced by the ~50% increase since the CLT deal was announced)

    2) Delay or substandard results associated with the intial Inga/Fireweed Montney wells
    =>Based on management discussion, the play appears to be more geologically pervasive/have greater aerial extent than the Doig which is seismically defined.  There are analogs producing relatively close to RTK's land position, having said that, the first few wells are clearly key.  While I've reflected the Montney at conservative values (downside case is $500/acre), the key to a robust valuation in an M&A scenario will be demonstrating the prospectivity and repeatability of the Montney

    Catalysts:

    -Impending well results on 2 Inga Doig wells and potentially 1 Inga Montney well (early Dec)

    -Close of XOM/CLT transaction and spin out of Kelt Exploration to CLT shareholders

    -Q1 Montney well results

    -Potential strategic review/transaction in H1 2013

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

     

    Catalysts:

    -Impending well results on 2 Inga Doig wells and potentially 1 Inga Montney well (early Dec)

    -Close of XOM/CLT transaction and spin out of Kelt Exploration to CLT shareholders

    -Q1 Montney well results

    -Potential strategic review/transaction in H1 2013

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