Cairn Energy CNE
January 19, 2012 - 12:01pm EST by
jso1123
2012 2013
Price: 2.56 EPS $0.00 $0.00
Shares Out. (in M): 1,408 P/E 0.0x 0.0x
Market Cap (in M): 3,600 P/FCF 0.0x 0.0x
Net Debt (in M): -3,000 EBIT 0 0
TEV: 600 TEV/EBIT 0.0x 0.0x

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  • Large Net Cash Position
  • Discount to NAV
  • Net-Net
  • Great management
  • Special Dividend
 

Description

**This was my application idea, so I apologize that it is a bit out of date**
 
We are long shares of Cairn Energy (CNE LN).  CNE LN is a special situation where the market is valuing the stock at a roughly ~30% discount to the net cash and investments on its balance sheet, despite the intention of management to return the vast majority of the cash to shareholders via a special dividend in January 2012.  As such, it presents an extraordinary risk/reward with a top notch management team that has a long history of value creation.

Cairn Energy, as it stands today, is a collection of:  (a) cash (£3 billion in net cash at year-end 2011 that is worth £2.12/share, or 82% of the current stock price); (b) a 22% stake in Cairn India (ticker: CAIR IN, $12 billion market cap) with a market value of £1.6 billion (£1.15/share) and (c) oil & gas exploration assets in Greenland, Spain, Lebanon, and Cyprus.  In recent years, the company has focused their exploration efforts in offshore Greenland, where they were the early entrant and accumulated a massive acreage position of ~25 million acres.  They have invested over £800 million (£0.60/share) in acreage, seismic, and the drilling of 8 frontier exploration wells over the last year (none of which were commercial).  Assuming no value for the unproven exploration assets, the NAV of the company is £3.27/share (2/3 cash and 1/3 the CAIR IN stake).  This compares to the current stock price of £2.56/share (28% upside).  [A quick side note on CAIR IN taxation:  if Cairn sells the remainder of their stake in the open market through secondaries they pay no taxes;  if they sell them in a private off-market transaction to a strategic player they will owe ~11% of the market value in taxes].  

The management team at Cairn has been together for over 20 years and has a strong track record of not only proving out and monetizing frontier exploration assets, but returning excess cash to shareholders.  Following early gas discoveries in Bangladesh, the company discovered the largest oil field in India (> 1 billion barrels of oil) and took the asset public in 2007 through CAIR IN (which currently has a ~$12 billion market cap).  Management’s stated strategy is to create value through frontier exploration (opening new basins), monetize the assets, and return cash to shareholders to shrink the company to a level that they think they can double over the next 5 years.  This is very atypical for oil & gas management teams that generally are more focused on growing volumes at the expense of growing value.  In 2007 following the IPO of CAIR IN, management returned a substantial chunk of capital (~$1 billion) via a special dividend.  The best evidence of the value creation track record of the company is in the stock price performance -- the stock has been a 20x investment since 2000.  

Having just monetized its controlling stake in CAIR IN through a sale to Vedanta (VED LN), Cairn earlier this month announced a $3.5 billion special dividend (£1.60/share, or 62% of the current share price) that will occur in January 2012.  This will occur via a “B-share scheme” identical to what Cairn did in 2007 (allows UK taxable residents to elect either capital gains or ordinary income treatment).  If you hold your investment via swap, there should be no dividend withholding for non-UK taxable investors.  

At a minimum, we think it makes sense for the shares to trade at the value of the cash on the balance sheet and the market value of the CAIR IN stake, which alone provides c. 28% upside.  Further, we think that the exploration assets have a lot of positive optionality given management’s successful long-term exploration track record.  

A bit of background on Greenland:  As the ice caps recede and deepwater drilling technology gets better and better, there is a lot of jockeying amongst oil & gas majors for access to the deepwater Arctic plays.  This was seen most recently in the public fight between BP and XOM to joint venture with Rosneft to access the Russian arctic.  The arctic represents one of the last untapped virgin oil regions with the potential for large mega-field finds.  Cairn recognized this early and leased vast swaths of offshore Greenland in middle of last decade.  To date, they are the only oil & gas company that has drilled wells there.  In the last bid round (earlier this year), all of the major oils showed up (Exxon, Royal Dutch, Statoil, etc) and licensed acreage around Cairn.  So it’s clear that the region has real prospectivity despite Cairn’s lack of success to date.  

Following the special dividend, the company will pay out $3.5 billion (£1.60/share) and retain $1.2 billion (£0.53/share) in net cash which will likely be reinvested into M&A.  Management has committed to spend no more money in Greenland until they get a major oil partner (farm-out discussions under way, goal is to conclude a deal by summer 2012).  Overhead for the business is minimal at ~$30mm/yr.  The current stock price of £2.56/share implies an ex-dividend price of £0.96/share.  This compares to £1.15 /share for CAIR IN stake + £0.53/share in residual net cash = £1.68/share in core NAV before assigning any value to Cairn’s exploration assets.  Said another way, post-distribution the shares would need to appreciate 75% just to value the exploration assets at zero.  

Key risks:  
-       Reinvestment of $1.2 billion in capital
-       Downside to CAIR IN stock price (however we feel like the risks are to the upside on this one – CAIR IN has ~$1 billion in net cash, is on path to double its oil production over the next 2 years organically, trades at 6-7x 2012 P/E and 5x 2012 EBITDA, and sells its oil for Brent pricing with opex costs of <$5/barrel)

Catalyst

Special dividend in January that further highlights the substantial discount to cash and investments
Farm out agreement in Greenland

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    Description

    **This was my application idea, so I apologize that it is a bit out of date**
     
    We are long shares of Cairn Energy (CNE LN).  CNE LN is a special situation where the market is valuing the stock at a roughly ~30% discount to the net cash and investments on its balance sheet, despite the intention of management to return the vast majority of the cash to shareholders via a special dividend in January 2012.  As such, it presents an extraordinary risk/reward with a top notch management team that has a long history of value creation.

    Cairn Energy, as it stands today, is a collection of:  (a) cash (£3 billion in net cash at year-end 2011 that is worth £2.12/share, or 82% of the current stock price); (b) a 22% stake in Cairn India (ticker: CAIR IN, $12 billion market cap) with a market value of £1.6 billion (£1.15/share) and (c) oil & gas exploration assets in Greenland, Spain, Lebanon, and Cyprus.  In recent years, the company has focused their exploration efforts in offshore Greenland, where they were the early entrant and accumulated a massive acreage position of ~25 million acres.  They have invested over £800 million (£0.60/share) in acreage, seismic, and the drilling of 8 frontier exploration wells over the last year (none of which were commercial).  Assuming no value for the unproven exploration assets, the NAV of the company is £3.27/share (2/3 cash and 1/3 the CAIR IN stake).  This compares to the current stock price of £2.56/share (28% upside).  [A quick side note on CAIR IN taxation:  if Cairn sells the remainder of their stake in the open market through secondaries they pay no taxes;  if they sell them in a private off-market transaction to a strategic player they will owe ~11% of the market value in taxes].  

    The management team at Cairn has been together for over 20 years and has a strong track record of not only proving out and monetizing frontier exploration assets, but returning excess cash to shareholders.  Following early gas discoveries in Bangladesh, the company discovered the largest oil field in India (> 1 billion barrels of oil) and took the asset public in 2007 through CAIR IN (which currently has a ~$12 billion market cap).  Management’s stated strategy is to create value through frontier exploration (opening new basins), monetize the assets, and return cash to shareholders to shrink the company to a level that they think they can double over the next 5 years.  This is very atypical for oil & gas management teams that generally are more focused on growing volumes at the expense of growing value.  In 2007 following the IPO of CAIR IN, management returned a substantial chunk of capital (~$1 billion) via a special dividend.  The best evidence of the value creation track record of the company is in the stock price performance -- the stock has been a 20x investment since 2000.  

    Having just monetized its controlling stake in CAIR IN through a sale to Vedanta (VED LN), Cairn earlier this month announced a $3.5 billion special dividend (£1.60/share, or 62% of the current share price) that will occur in January 2012.  This will occur via a “B-share scheme” identical to what Cairn did in 2007 (allows UK taxable residents to elect either capital gains or ordinary income treatment).  If you hold your investment via swap, there should be no dividend withholding for non-UK taxable investors.  

    At a minimum, we think it makes sense for the shares to trade at the value of the cash on the balance sheet and the market value of the CAIR IN stake, which alone provides c. 28% upside.  Further, we think that the exploration assets have a lot of positive optionality given management’s successful long-term exploration track record.  

    A bit of background on Greenland:  As the ice caps recede and deepwater drilling technology gets better and better, there is a lot of jockeying amongst oil & gas majors for access to the deepwater Arctic plays.  This was seen most recently in the public fight between BP and XOM to joint venture with Rosneft to access the Russian arctic.  The arctic represents one of the last untapped virgin oil regions with the potential for large mega-field finds.  Cairn recognized this early and leased vast swaths of offshore Greenland in middle of last decade.  To date, they are the only oil & gas company that has drilled wells there.  In the last bid round (earlier this year), all of the major oils showed up (Exxon, Royal Dutch, Statoil, etc) and licensed acreage around Cairn.  So it’s clear that the region has real prospectivity despite Cairn’s lack of success to date.  

    Following the special dividend, the company will pay out $3.5 billion (£1.60/share) and retain $1.2 billion (£0.53/share) in net cash which will likely be reinvested into M&A.  Management has committed to spend no more money in Greenland until they get a major oil partner (farm-out discussions under way, goal is to conclude a deal by summer 2012).  Overhead for the business is minimal at ~$30mm/yr.  The current stock price of £2.56/share implies an ex-dividend price of £0.96/share.  This compares to £1.15 /share for CAIR IN stake + £0.53/share in residual net cash = £1.68/share in core NAV before assigning any value to Cairn’s exploration assets.  Said another way, post-distribution the shares would need to appreciate 75% just to value the exploration assets at zero.  

    Key risks:  
    -       Reinvestment of $1.2 billion in capital
    -       Downside to CAIR IN stock price (however we feel like the risks are to the upside on this one – CAIR IN has ~$1 billion in net cash, is on path to double its oil production over the next 2 years organically, trades at 6-7x 2012 P/E and 5x 2012 EBITDA, and sells its oil for Brent pricing with opex costs of <$5/barrel)

    Catalyst

    Special dividend in January that further highlights the substantial discount to cash and investments
    Farm out agreement in Greenland

    Messages


    SubjectRE: Future
    Entry01/19/2012 01:14 PM
    Memberjso1123
    Utah - You raise fair questions, the biggest of which is where they deploy their M&A dollars.  My answer to all of that is it's in the price and then some.  The NAV of the stock right now is P3.50/share assuming Greenland has no value (so cash plus Cairn India).  So you're getting Greenland and their remaining $1.2 billion in cash (after the special dividend) for free.  When the stock gets back to P3.50/share we can revisit how much (if any) value we should assign to Greenland. 
     
    In terms of the future:
     
    -  Greenland farm-out:  they haven't had success but the play isn't dead.  If you look at the last licensing round (early 2011), virtually every big deepwater player (Exxon, Shell, Statoil, etc) took down acreage all around them.  If any of these guys are looking to drill wells (which they have said they are), you would place value on Cairn's data (the only 8 wellbores drilled, seismic, etc).  As you know these frontier exploration plays can take a way to figure out - look at early success rates in offshore GoM or West Africa. 
     
    - M&A:  they have said they will deploy their remaining $1.2 billion in cash toward M&A.  That does leave the risk that they overpay for something but i think that's well discounted in the price (you're getting the cash for free! so the market has already priced in full value destruction).  I would argue this management team has been one of the best capital allocators in the sector over time - this is the second special dividend they've paid (their internal goal is to create value in frontier exploration, harvest the value, distribute cash to shrink the company down to something that can always double in 3-5 years).  Look at the long-term stock chart - these guys have been good capital allocators. 
     
    - Cairn India:  you still have most of your NAV leveraged to this asset which has a great future - big net cash position, doubling production over the next 2 years, trading at 7x P/E, realizes Brent and has $3/bbl lifting costs, highly prospective/underexplored region, etc.  I think CAIR IN has been held back by the uncertainty in getting this deal done and now that its done you've seen how the stock has reacted, and this morning it was announced that they received government approval (finally) to start the production ramp (showing that the government and ONGC are on board). 
     
     
     

    SubjectCouple of updates
    Entry01/24/2012 08:55 PM
    Memberjso1123
    1) Strong earnings out of Cairn India - Net cash balance is now $1.2 billion;  they will double production over the next 2 years while generating ~$1.5 billion of FCF in 2012 on a ~$13 billion market cap (so ~12-13% FCF yield ex-cash); they are going to initiate a dividend this year (discussed on the call).  They are realizing 8% less than Brent (~$100/bbl in CYQ4) and lifting costs were $2.50/bbl - very strong economics. 
     
    2) They announced their first Greenland farm-out - Statoil took 31% of one of their blocks in return for a cash payment, reimbursement of prior costs (lease and seismic costs), and a promote on any future wells.  Value was undisclosed (b/c they are in discussions with other operators about similar deals on the other blocks) however the important point is that one of the largest North Sea deep water operators is committing capital to the play which in my mind is a validation of the optionality that still exists there. 
     
     

    SubjectIndex selling
    Entry01/26/2012 11:08 AM
    Memberjso1123
    One thing I forgot to highlight in the write-up was the impact of index selling.  CNE is going to be removed from the MSCI (announced at the beginning of this week, triggered huge volume).  This technical pressure is also working to hold down the stock and we think that alleviates a the end of next week. 
     
    Cairn is also in the FTSE 100 and will likely be kicked out and moved into the FTSE 250.  However this won't happen until March/April and net selling is minimal. 

    SubjectRE: Index selling
    Entry01/26/2012 05:03 PM
    Membergs1
    Thanks for the update, helpful detail.  Was there an official statement re: the MSCI index deletion?  I see an Exane research report mentioning it, but nothing else - mind sharing a link if you have it?
     
    How many shares do you think have to be sold as a result of the index change?

    SubjectRE: RE: Index selling
    Entry02/02/2012 04:14 PM
    Memberjso1123
    The MSCI ejection triggered an estimated 50-100mm shares of selling - a huge number relative to daily volume of ~8mm normally (across all exchanges).  We think the market has been absorbing this over the last week and a half since it was announced (volume has been very heavy - it spiked to 43mm on Tuesday last week when it was announced and has run ~15-25mm/day since then). I think this has been a major drag on the stock.  The good news is that this pressure alleviates next week.  The MSCI ejection happens tomorrow evening and completes at the close on Monday (2/6). 
     
    There has also been tax selling in advance of the dividend.  That obviously goes away as well next week.
     
     

    SubjectUpdate
    Entry02/06/2012 03:10 PM
    Memberjso1123
    Special dividend happened today and stock executed the reverse split.  So the forced selling associated with the dividend (tax considerations) and the index ejection (MSCI) are now (finally) behind us. 
     
    Pro forma, the company has $1.2b in net cash (135p/share), $3.0b stake in Cairn India at market (345p/share) = 480p/share.  The stock closed at 345p/share, implying +40% upside to net cash and assigning no value to their exploration assets. 
     
    The $1.3b (150p/share) they invested in Greenland is gravy - large optionality if the play works out and no downside if it doesn't.  As I mentioned earlier, Statoil farmed into one of their blocks two weeks ago.  Also the CEO of Shell was out last week (Dow Jones article) saying that they are very focused on the Arctic offshore play and are concentrating their efforts on Alaska and Greenland.  So clearly there are strategics who place value on Greenland. 
     
     
     
     
     
     
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