Liquefied Natural Gas Ltd. LNG AU
July 27, 2008 - 10:37pm EST by
2008 2009
Price: 0.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 130 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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LNG Ltd. is an extraordinary off-the-radar opportunity to invest at the critical inflection point of a major Australian LNG liquefaction project. Shares offer dramatic upside opportunity as well as downside protection via long-term take-or-pay contracts.  Conservatively assuming only $80 oil and aggressively doubling management’s capex guidance, we believe LNG will begin generating contracted revenues in 2011 and ramp to $0.45 of EPS annually from 2012 forward.  Given that the Company will be providing LNG to an investment grade buyer under a 12 year contract (renewable to 25+ years), we believe such a steady earnings stream deserves a 15x multiple, in line with similar energy infrastructure operators.  Our base case analysis results in a $6.75 share price, a 650% increase over the current.
While we believe a $6.75 stock price is completely realistic, we recognize that LNG’s earnings power will not be fully realized for a few years.  To arrive at a fair value for the shares today, we have conservatively assumed that the project is delayed by one additional year and then applied a further cost of capital discount of 15% per annum over the next four years.  The result is a $3.85 fair value for the shares today – a 325% increase over today’s stock price.
While these price targets are already clearly eye-popping, we believe they actually ignore additional significant upside optionality:
1)  Earnings benefit greatly from higher energy prices.  At $130 oil, LNG would earn over $0.70 of EPS, implying a share price of $10.50, a 12x return.
2)  Potential exists to add another 2+ LNG trains to the project.  This is highly likely as the resource base feeding LNG’s plant is extensive and estimated to support 25+ years of production.  Adding 2 additional trains at $130 oil would yield EPS of $1.25 and a share price of $18.00, a 20x return.
3)  The long-term upside lies in LNG’s ability to replicate its success in any of the hundreds of stranded gas fields across the globe.  An additional 4 liquefaction projects at $130 oil would generate over $5.00 in earnings power during the latter half of the next decade, implying a $75 share price or 83x the current level.
The Story:
LNG Ltd. (LNG AU) is an early-stage developer and operator of mid scale liquefied natural gas (“LNG”) plants.  The Company currently manages several projects across the globe that are in the early, prospective stages of development.  However, its key project and greatest source of current value revolves around its proposed LNG liquefaction plant in Gladstone, Australia.  Within the next 2 weeks, the Company expects to receive its official Site License Agreement to build a facility capable of running two 1.5 million tonne LNG trains.  LNG has also already secured a Heads of Agreement (essentially an MOU) to source its gas feedstock from Arrow Energy (AOE AU) and is expected to announce an off-take agreement for its LNG supply in the next 1-2 months (which will include a majority stake investment by a multi-national off-taker).  Concurrent with the signing of the off-take agreement, Arrow (the gas supplier) is expected to exercise its option to become a 20% owner in the project.  With all interests aligned in the project, LNG shareholders stand to benefit the most.
Investment Thesis:
Completely Under-Followed
LNG is a micro-cap Australian listed equity only recently picked up by a single local Australian brokerage house (Bell Potter).  Very few appreciate that this project is on the final cusp of becoming a significant reality.  Furthermore, the entire Queensland coal bed gas field (the source of Arrow’s gas supply) is a recent phenomenon that has only recently gained any investor notice since British Gas Group made its hostile bid for Origin Energy in April.  Yet, despite this headline grabbing news, the tremendous upside economics of the entire Queensland gas play remain virtually completely unknown outside of Australia.  We believe many of these early stage Australian gas players (such as Arrow) represent extremely attractive investment opportunities.  However, LNG provides an even more attractive payoff structure with greater leverage to the upside potential of this developing liquefied natural gas play.
First Mover = 1-3 Year Head Start
A bit of a visionary, Maurice Brand (LNG’s CEO) secured the current site 4 years ago when hardly anyone could contemplate the potential for a worldwide LNG market, much less the potential of the Queensland coal bed gas fields to become such a valuable resource base.  After multiple years of permitting, LNG will very shortly receive its full Site License Agreement for the Gladstone site.  For perspective on the significance of this Site License Agreement, the Curtis Island site currently being proposed by nearby Santos (STO AU) and Queensland Gas (QGC AU) is not yet zoned for building a liquefaction plant and it is estimated that the licensing process will take approximately two years, delaying final production until roughly 2014.
Existing Infrastructure = Lowest Cost
For a typical LNG liquefaction plant, approximately 50% of capital costs are usually for liquefaction equipment and the other 50% for site specific infrastructure build-out (utilities, storage tanks, loading jetties).  However, the Gladstone project has secured an abandoned port site where jetties and land infrastructure is already in place (significantly reducing the costs).  In comparison, the sites being proposed by Santos and Queensland are completely undeveloped and will require all of the necessary bridges, docks and jetties as well as channel dredging.
Significant Credible Insider Ownership
Arrow Energy owns 10% of the shares outstanding (which is separate from their option to become a 20% owner of the Gladstone project) and Golar LNG (GOL NO) owns an additional 16%.  Golar is a $3 billion enterprise value LNG shipping company that is 45% owned by John Fredrickson – the visionary that turned Frontline (FRO) and SeaDrill (SDRL NO) into multi-billion dollar companies.  The top 3 members of management and the Chairman of the Board own over 23% of the shares outstanding.
Impressive Management
Despite its micro-cap size, LNG has assembled an impressive set of Directors, proving that is not a ‘fly-by-night’ operation.
LNG Ltd. Board Members
1.      Chairman – Phil Harvey – Former CEO of Alinta, Australia’s largest power and gas transmission company, which he sold to Singapore Power Limited for over $6 billion
2.      Nick Davies – CEO of Arrow Energy
3.      Gary Smith – CEO of Golar LNG
4.      Bill Hornaday – COO of Niko Resources – a $4.5 billion oil and gas exploration and development company
5.      Richard Beresford – Former Head of Gas Strategy and Development for China Light & Power
Superior Process Solution
LNG is proposing a modular approach using existing technologies (ie, standard turbines vs. custom built and concrete tanks vs. stainless steel) that will provide tangible cost savings with no adverse impact on quality.  Further, providing an economically attractive liquefaction solution for mid-sized gas fields would be a game-changer in the energy industry.
Additional Projects not included in Valuation
  • Indonesia – Mitsubishi originally had won a contract with Pertamina to provide an LNG terminal (LNG Ltd. had placed 2nd).  However, the contract has just recently been terminated due to Mitsubishi’s inability to commit to its original submitted terms.  LNG has been invited to reengage in conversations and a project team is currently on the ground in Indonesia.
  • Others – Papua New Guinea, Iran
Compelling Valuation:
Upon project completion, Gladstone will produce a significant and stable earnings stream under a wide array of assumptions, with a contractual floor at $40 oil prices that provides considerable downside protection.  Management estimates that the first train should be completed in 2011, with the second train coming online in the following year.  The annual recurring earnings sensitivity analysis below assumes that the project only contains these two initial trains.
 Annual EPS Potential
 Oil Price
Tremendous Upside:
The following sensitivity table represents the upside share price potential from current levels at various oil prices and under a range of capital expenditure assumptions (recall that management estimates a total cost of $600 million for the two train project we have analyzed and our base case has fully doubled their capex assumption for conservatism).
 Share Price Upside from Current at 15x P/E
 Oil Price
Detailed Earnings Analysis
Below is a more detailed calculation of LNG Ltd.’s earnings potential (using $100 oil and management's capex estimates).  The calculations of the revenue share between Gladstone and Arrow have been confirmed by the management teams of both LNG and Arrow as roughly correct.  This analysis also assumes that the project is financed with 75% project debt, a reasonable assumption given that an investment grade off-taker will be the majority owner of the Gladstone project (we assume the Off-taker will own 50% and Arrow Energy will own 20% of Gladstone).  Further, we have assumed that LNG is able to issue equity $1.50 after the final project terms have been announced to the market.
LNG Ltd. Economics
Number of LNG Trains at Gladstone
     LNG Tonnes per Train
     LNG Tonnes per mmBTU
Total mmBTUs
Oil Price
Gladstone % of price per bbl of Oil above $40
Gladstone Revenue per mmBTU
     Cost per mmBTU paid to Arrow for Feed Gas
Gladstone Gross Margin per mmBTU
     Liquefaction Costs
Gladstone Pre-Tax Profit per mmBTU
     x Total mmBTUs
Total Gladstone Revenue 
     x LNG Ltd. Ownership %
LNG Ltd. Revenue
     LNG Ltd. SG&A
     LNG Ltd. Share of Debt Interest Cost
Pre-tax Earnings
     Taxes (30%)
LNG Ltd. Net Income
Pro Forma Shares (post equity raise)
Oil Prices
LNG’s revenues will be directly linked to global oil prices.  The $40 contractual floor provides a significant level of downside protection.
Future CapEx Requirements
LNG liquefaction projects are notorious for going over budget and we believe this is the key risk to the LNG Ltd. story.  Management’s current cost estimates for the project estimate $400 million for first train and $200 million for each incremental train (the above model depicts a two train solution – likely the initial configuration).  However, for conservatism, we have assumed that the Gladstone project suffers from 100% cost overruns.  It is also important to note that while some liquefaction projects will likely end up costing greater than $800/tonne, it is not accurate to draw a read-through to LNG Ltd. as many of these projects (such as the Gorgon and PNG projects) are located offshore in extremely remote locations with little to no access to existing infrastructure or skilled labor.  Queensland, Australia is a major industrial center with a skilled labor pool and LNG is leveraging an existing port site for its project, greatly reducing the required capital investment.
Raising Project Financing
Despite the recent credit crisis, the market for infrastructure projects continues to be strong.  We do not anticipate issues around financing as the Gladstone project will be led by an investment grade off-take partner who will also be the majority owner in the project.
Project Execution
LNG Ltd. is building a mid-sized LNG plant, which has never been attempted before.  To date, major oil companies have only focused on building LNG plants for large natural gas fields and as such have been forced to custom build equipment to exact specifications that can support such large projects.  LNG’s ability to successfully build an economically feasible mid-scale plant would be a real game changer for the industry as the number of medium-size stranded gas fields is substantially larger than the number of large stranded gas fields.
Arrow not Honoring its HOA with LNG Ltd.
We believe this to be an extremely remote possibility.  We have spoken directly and extensively to both the CEO and the President of Australian Operations for Arrow and both have firmly stated their unwavering support for LNG’s Gladstone project.  Arrow points to the fact that they just purchased a 10% stake in LNG Ltd. in December 2007 as tangible proof that they place great value in the Gladstone site as the best solution for the entire Queensland gas play.  Finally, while a deal is never fully guaranteed until the money crosses the wire and the final contracts are signed, the HOA contains multiple provisions that would make it difficult for Arrow not to honor their intentions.  Additionally, by their own admission, Arrow does not currently have a realistic alternative that would not require the Company to spend at least an additional 24 months finding and attempting to permit and develop another site.
Environmental Permits
LNG’s Environmental Impact Study (EIS) is more than 50% complete and the Company does not anticipate any problems finalizing it by the end of this year.  The Gladstone site is located in a heavily industrialized area with a number of high pollutant factories (e.g. - smelters).  Even in the remote chance that the EIS identifies an issue, it is highly likely that any deficiency could be quickly cured as the Queensland government continues to show its strong support for the various proposals to build LNG liquefaction plants in the region.


1. Over the next 30-60 days, we anticipate that LNG Ltd. will announce an HOA for a 12 year off-take agreement with a major multi-national E&P player (e.g. - Shell) or directly with an end user (e.g. - a Japanese utility). The Company has already received four proposals and is currently waiting to receive a proposal from Shell before making a final decision.

2. Reaching Final Investment Decision by April 2009. After signing the off-take agreement, the remaining next steps will be:
December – Arrow Reserve Certification
December – Environmental Impact Study (EIS) finalized
December (following Arrow Reserve report and EIS) – Final Signing of Gas Sales Agreement with Arrow and LNG off-take agreement
Q1 2009 – Bankable Feasibility Study
April 2009 – Final Investment Decision and Financial Close
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