By Mark Parfitt and Richard Jennings CFA

It is probably be fair to say that the situation at Gulf Keystone Petroleum Limited (GKP) still remains in a state of flux with investor sentiment being driven principally by raw emotion rather than hard facts as qualified comments remain thin on the ground while brokers and analysts (the few that are still following the stock that is) re-assess their respective positions.

Let us try and assess what is presently publically known in trying to ascertain what the current pricing of the equity may actually mean from an investment perspective for holders of the stock:

– The controversial debt to equity conversion has now been completed with the current issued share capital being enlarged to some 22,942,956,605 common shares. Trading of the new stock commenced on the 14^th October 2016 and at the close of play on the 17^th October 2016 the new market capitalisation amounts to just under £300m.

– Outstanding debt has been reduced from over $600m to $100m while GKP retains the option to defer interest on this re-instated debt for two years. Investors have also authorised management to solicit additional debt financing of up to $45m through new senior facilities.

– $25m of new funds were raised in the open offer which, together with the last-reported cash balance of $79.6m on the 29 September, results in current cash of approx $104.6m.

– Challenges in receiving monies from the Kurdistan Ministry of Natural Resources are actively being addressed with receivables returning on a roughly 90-day payment cycle. As at the 20^th June 2016 the Company revealed a sum of $28m that was outstanding.

– GKP expects the draft of the Second Shaikan Amendment to be executed and this negotiation is an integral part of the recovery of back-costs etc.

– Vitally, oil production rates remain on-track with the engineering at 36-40,000bopd and earlier production guidance expected to be met at a revised annualised (cross) average rate of 31-35,000bopd.

– An interim plan, termed the ‘Bridge to the FDP (Field Development Plan)’ for phases 1-2 may now be executed with the immediate financial crisis averted. This means GKP have until the end of 2017 to reach a final development decision for full field development and to have necessary financing(s) in-place.

– Active work may now be undertaken on the field to install electrical submersible pumps in H1 2017 to mitigate short term production declines; facilities are also being upgraded to ‘debottleneck production’ to a 55,000bopd capacity with a new well to be potentially drilled to further support production and ongoing cash-flows before final commitment to the phase 1-2 plan by end 2017.

– The CPR for this ‘bridge to the FDP’ (published in June) was compiled by ERC Equipoise and gives significant detailing on the potential value of the asset within the company. This was a key investment document pertaining both to the restructuring decisions and the open offer and as such warrants detailed scrutiny.

– David H Thomas and Garrett Soden have been appointed to the Board of Gulf Keystone as Non-Executive Directors with immediate effect and Canaccord Genuity Limited appointed as the Company’s sole corporate broker.

– Norwegian based DNO’s woefully inadequate low-ball bid has been initially rejected but does serve to underline the technical worth of the field.

Todd Kozel

For many private investors that swallowed whole the Todd Kozel “blue sky” scenario during the go-go years of 2011-2014, the debt for equity swap that has left them with a minority stake in the restructured entity is a bitter bill to swallow. Gone are stories of £5,6,7+ takeovers as the shenanigans at the KRG on payment flows has well and truly up ended the EV equation such that the company has been, to all intents and purposes, handed to the bond holders.

The good news however is that key Shaikan asset is still very much intact and producing.

Shaikan fields

Production at the field is running at between 36k & 40k bopd with data amassed to put flesh on the engineering bones of the field model. Every given day of production that has gone to pass, more data has been accrued all of which provides detail on lifting mechanisms to attune the engineering model, adds confidence to predicted recovery profiles and underpins the investment case for a 2017 decision on the full field development.

GKP now simply needs to pass through the maelstrom of the torrid past to get through to the next stage.

Renewed stability for the company and its investors will come from cash-flow and the stage 1-2 development of Shaikan. Real cash-flow risks do remain however given the regional operational practicalities but the payment arrears appear now to be actively being addressed with the clear support of the Kurdistan Regional Government. The ongoing progress towards ratification of the bilateral agreement and the reduction negotiations on oil-price discounting demonstrate that the interests of all parties are aligned, as it were, with a full field development everybody’s aim.

Yes, the company is now a ‘one trick pony’ which does concentrate investment risk. And no, we don’t really understand why they relinquished the Sheikh Adi block either, but a counter-argument may be made that this also makes it easier for an acquisitive party to make a single-asset investment decision – look no further than DNO’s low-ball bid in illustration of this fact.

So, back to the current equity pricing and what the implied equity value by the market is saying right now:

If, in quick-look terms we examine the base case from the engineering presented in the ERC Equipoise CPR, we see that it details the ‘Bridge to the FDP plan’ (using the latest engineering) with the 58% working interest assumption (and associated costings) and an August oil pricing profile (lower than it is today we point out) then the following figures are derived:

If you then take on board gross figures from the latest cash statement (29^th Sept) of $79.6m; add in $25m gross from the open offer proceeds and take a view that the $28m receivables will be paid within the year (discounting this back at a 10% WACC for one year to $25m) you have gross a cash figure of $129.6m. Debt is currently $100m and we may assume 18 months gross GG&A costs at $15m pa prior to the decision gate on the investment plan (before the end of calendar 2017). With these gross assumptions we can roughly unpick the engineering to run an enterprise valuation calculation to work out what risks are actually being priced into the current share price compared to the asset and corporate values.

* EV adjustment – $29.6m = 0.106 pence per share
(#) CCOS – Commercial Chance of Success

If we simply risk the 1P & 2P reserves with a standard 90% geological chance of success using the ‘best case’ NPV10 discounted figures given above, and apply an enterprise value adjustment, we can thus establish that the chance of commercial success implied in the share price at the moment is around 38%. An implied 38% CCOS that a refunded asset with strong engineering and a recent (albeit cheeky bid) highlighting the value to a corporate buyer with intimate knowledge of the region looks way too low to us.

If one assumes a still conservative 60% probability of success (highlighted in table) then a shade over 2p per share drops out and so forth.  To us, this 2p level is the base valuation of “new” GKP equity and a price point that, absent a renewed collapse in the oil price, we expect the stock price to gravitate towards or management to make the case for an “acceptable” bid figure.

It is early days for the new stock price and management has still yet to respond officially to the derisory DNO offer (stating more recently that they wanted to conclude the restructuring first) but with the share price trading up to 1.41p on the 17^th October on decent volume we see very little likelihood of this opening salvo succeeding given the DNO offer values the stock at just 1.08p (at the current FX rate).

We would also not be surprised to see an activist investor mop up stock naturally in the market or indeed take out a good slug of the Senior Bond holders stock that many of these new holders will be keen to exit now as their mandates do not allow for them to hold equity and an acquirer use this as a platform to extract a more realistic valuation out of DNO or other potentially interested parties. In fact we strongly suspect that Genel Energy still harbours ambitions to consolidate their stronghold on the Kurdistan fields and we would not discount a merger proposal from them given both equity bases are at rock bottom valuations relative to other global regions.

To conclude we estimate near term realistic value for GKP “new” equity based on current oil prices of around 2p per share.

CLEAR DISCLOSURE – A Director of Align Research Ltd holds a personal interest in both Genel Energy & Gulf Keystone equity and is bound to Align Research’s company dealing policy ensuring open and adequate disclosure. Full details can be found on our website here (“Legals”).

• Genel Energy
• Gulf Keystone
• Oil