Dana Petroleum: The goose that lays the golden eggs

Saturday, Jul 24 2010 by
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Dana Petroleum The goose that lays the golden eggs

Imagine you find a goose (or possibly a goosander?) that lays golden eggs. It usually produces 1 or 2 eggs every year usually on its birthday - known as the Annual Goose Month (AGM). Occasionally it has a bad year and lays no eggs. It is obvious that it will only continue to lay eggs if it is looked after really well by somebody that knows what they are doing so you have to be really careful how you feed it and how it is housed and watered and so on. Years go by and you become an expert in looking after this unusual and precious goose. Sometimes you even sing it a lullaby to help it get off to sleep at night.

You decide that in the short and medium term you will not sell any of the eggs in case that upsets the goose and the laying stops. Your cunning plan is to wait until the goose has laid all the golden eggs that you think it is capable of and then sell them all. Years pass and the goose's nest gradually fills up until it is half full of golden eggs. You think you are perhaps half way to the time when it will make sense to sell all the the eggs. But one day a wandering Korean sage knocks on your door, tells you he covets your goose and offers to buy it. What he wants is all the eggs that are in the nest AND the goose that has produced them. What he offers you is the market value for the existing eggs but nothing for those to come later this year, or next year or the year after.....

Why on earth would you sell? You have only to wait and eventually you will have a nest full of eggs worth twice the offer being made. If you take the money you will find it very difficult to find another goose that can lay golden eggs. Why not just keep on accumulating the eggs as you have done for the past 10 years? If you really want to sell the eggs why sell the goose as well? Especially when the price you've been offered includes next to nothing for the bird itself. Isn't the goose actually worth more than the eggs in the nest? Shouldn't an egg producing paragon (that's different from a polygon of course) be worth quite a lot? And what about the expertise on the part of the goose herd that enabled it to be so productive. Isn't that worth something too?

I see no rational basis for selling a business like Dana Petroleum Plc (LON:DNX) which has created substantial assets for no more than the value of the assets created to-date. What are the owners getting for the value generating capacity itself as distinct from the value already generated?

Disclosure of Interest: The author holds shares in Dana Petroleum Plc.


Filed Under: Oil,

Disclaimer:  

The author may hold shares in this company. All opinions are his own. You should check any statements that appear factual and seek independent professional advice before making any investment decision.


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38 Comments on this Article show/hide all

flyinghorse 24th Jul '10 1 of 38
3

I guess the problem is that Dana dont wholly own the goose-its a co-operative, and dissent starts weakness and the goose gets sold.

Without competition for the goose its a buyers market, or put another way your goose is cooked.

FH

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emptyend 24th Jul '10 2 of 38
14

I'm fairly surprised at the Schroeders comment yesterday. I can only assume that they have been encouraging Merrill/KNOC all along based on a modest valuation and were persuaded yesterday to put pressure on the Dana board before they heard Dana's side properly. I suspect that the head of UK equities at Schroeders knows very little about the intricacies of E&P businesses - he just knows that £18 would represent a 60% improvement on the market value of a few months ago.

But there's the rub.  The goose is largely owned by people who don't understand it and who care even less. This is even more the case since many of the existing goose-handlers piled out at £14 or so and handed their stakes over to some distant hedgefund foxes.

Paradoxically, these foxes DO generally understand some things better than the original owners of the goose. They understand that a nice plump goose with lots of egg-laying potential should be of interest to several different types of buyer....and they are prepared to lurk in the undergrowth to wait for developments before pouncing on an offer. Hedgefunds are experts in reading bid situations.

But they won't wait indefinitely.  If another buyer emerges then the foxes will sit back and wait for them to fight it out....but if no buyer emerges and the goose buyer can't be persuaded to pay a fair price - doesn't wish to pay a fair price for the value creation engine, existing opportunities and the change of control - then we'll see the feathers and fur fly.

Ultimately, of course, the goose will be cooked. But the path from free range to table may not be as clear as some might expect. We should see quite soon  whether the goose will end up on the Korean dinner table (or in their back yard for a while longer, continuing to lay happily) or whether another bidder will come in.

In my view there is plenty of room for another bidder to make a credible and financially-viable approach. There are roughly 2.75 barrels of 2P reserves for every Dana share (post Dutch deal)....which is only a smidge over $10 per 2P barrel at the indicated £18 a share price. That REALLY doesn't seem a high enough price (given the potential for further growth, utilising Dana as a European hub in KNOC's case)....and paying 20-25% more would still not constitute anything more than a fair price in my view.

I'd be very happy for the board to continue to resist strongly at £18 - and I think that Schroeders is just plain wrong to try to push them into dealing at that level. It isn't Dana's fault if Schroeders have been cuddling up to Merrill and their client and now risk some professional embarrassment.

ee

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Isaac 24th Jul '10 3 of 38
2

emptyend

How much do you think KNOC should pay for Dana? £20 or even £22?

So we are talking about another 15-23% increase with the risk of KNOC walking away and the price dropping to £12 or about 30%. I.e. Risk;Reward does'nt look as good as when t was at say £14.

Taking into accounbt Shroeders thinks Dana has a fair bid at £18 does that not meanthere is'nt that much upside to be had anyway?

I think people would be better off selling up and Buying Soco where the upside can be more then 100% in the next few months on the back of TGD and Nganzi. We are only about 3 weeks away from TD.....

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Isaac 24th Jul '10 4 of 38
3

A couple of years ago...Lonmin had

PROPOSED CASH OFFER FOR LONMIN PLC ('LONMIN') 

OF £33.00 PER SHARE

http://www.investegate.co.uk/Article.aspx?id=200808060700107290A

Shortly after the above announcement the company said

The Board of Lonmin Plc ('Lonmin' or the 'Company'), which is being advised by Citi and Greenhill, believes the unsolicited, pre-conditional offer for the Company announced yesterday by Xstrata is wholly inadequate. The Directors of Lonmin strongly advise shareholders to take no action in respect of the pre-conditional offer and to reject the approach

http://www.investegate.co.uk/Article.aspx?id=200808070700078153A

Today Lonmin trades around £15 .....

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emptyend 24th Jul '10 5 of 38
7

In reply to Isaac, post #3

How much do you think KNOC should pay for Dana? £20 or even £22?

Don't know at the moment. It depends in part on Anne Marie.

I do think, however, that KNOC would need to be £19+ if they are to get any sort of recommendation....which is what I've said all along..

Yes of course the risk/reward isn't as good as it was - but it is still a decent return annualised, providing a deal gets done.

And I don't buy this "the price will drop to £12" (or £10) line. Certainly there would be a big move by the arb accounts which would take the shares much lower (I'd guess £13 odd) if KNOC pulled out without any counter - but I don't think they would stay there for long and I do think that Anne Marie could bring forth fresh bidders within weeks if it succeeded, so I don't think the price would stay that low for long. DNX is now in play, either way.

I also think the drilling programme for 2011 has plenty of upside potential, so that will itself support the share price as we run up towards year-end. I'm content to support the management's view on the bid - after all, Tom Cross has reportedly got £34mn at stake - and he could do quite a bit with that himself, couldn't he?

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Isaac 24th Jul '10 6 of 38
1

emptyend

Ok fair point - Do you think people would be better of selling Dana now and buying Soco? At this point in time where is there more upside in your opinion?

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emptyend 24th Jul '10 7 of 38
8

In reply to Isaac, post #6

Oh, in gross terms there is no doubt that there is more upside potential in SOCO than Dana......but in risk-adjusted terms (for the next few days at least) I'd say that they are pretty equal.

Everyone will make their own assessment of relative risk and relative return though......

 

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thegreatgeraldo 24th Jul '10 8 of 38
9

Some of the eggs that have been laid have turned out to be covered in gold leaf when examined rather than being solid gold. I'd also suggest that other companies have more productive geese! Dana has not had an impressive hit rate with the drillbit over the years. Rinnes stands out, along with the Mauri finds, although they're still very much work in progress. It strikes me that much more of the value added comes from TC's dealmaking

What I can't fathom, assuming reports that the board are willing sellers, is why now? Anne Marie is fast approaching on the horizon & success there would be significant in its own right. However, given Dana's large acreage West of Shetland, both directly & via FPM, it seems an odd time to be selling. Especially given the recent developments sanctioned there. Similar comments apply to Mauri.

Maybe TC wants some time out? Maybe he wants to start all over again? Or maybe he's just adopted a pragmatic "£22 is fair valuie & I'll listen"? Or, of course, media reports about him bering a willing seller are simply wide of the mark?

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sirlurkalot 24th Jul '10 9 of 38
20

The Golden Goose concept, of a business that has in the past produced consistently supernormal profit/value growth (above cost of capital) and which therefore should never be sold for it's snapshot value at any one time (because it would be difficult to find a reinvestment opportunity as good) is an interesting one.

I have no dispute with the concept that over the last decade or so Dana Petroleum Plc (LON:DNX) has outperformed the broad FTSE indices. What has created this outperformance, and will those factors continue?

The big increase in the crude price over the last decade has been IMO a big factor in Dana's value growth. With hindsight, for any company getting lots of prospective acreage a decade ago will have been a great value-creating strategy. I doubt any of us years ago really expected crude to rise as much as it has, from single figures to current levels - perhaps some expected a bit of a rise but i don't think any of us expected the size of the rise. Will this crude price rise continue forward at the same rate? I doubt many readers here expect future rises from now to be as much a multiple of current price as they have been over the last decade, and therefore this reason for Dana to be as much of a Golden Goose is surely winding down.

Dana's strategy has been to acquire bits and pieces of fields and optimise production from them with good micromanagement. I'm not sure whether opinion here is that TC wants to personally exit now-ish, or whether the KNOC approach is completely unwanted. My feeling (to debate?) is that he must have in some way encouraged a bid, because there is not total rejection now, and so he himself (and presumably a good fraction of his senior team) is looking for a personal exit. If he personally wants to leave Aberdeen and enjoy his money on a sunny golf course, then the component of Dana's longer term GG value creation due to good micromanagement is coming to an end, so the viewpoint that Dana is a continuing Golden Goose is undermined by that. Do those who have met TC a few times think he wants to head for a sunny golf course soon? Why hasn't he completely rejected KNOC rather than offered to meet them?

Another reason for Dana's LT outperformance is that it was once small and could easily do transactions that were material to it, in a way that a midcap cannot so easily do. This aspect of outperformance might be coming to an end as Dana grows, and so those who want a GG to hold for the long term might be better off choosing another smallcap which might be better sized to maintain a good future growth rate.  Elephants cannot gallop.

Of course conventional business school thinking is that there cannot be such a thing as a Golden Goose, which continues to outgrow the wider economy for a very long time. If any industry appeared to be so attractive, it would suck in capital which would reduce returns on capital for existing participants to the point where returns reverted to those of the broader equity markets.

In summary, whilst it's indisputable that Dana has outperformed the broader market over the last decade, perhaps the factors that have caused that will not continue in the next decade, and so it's not right to think that the GG shouldn't be sold at it's snapshot value at any moment. It's interesting to discuss what sector/theme will be the big investment story of the next decade, but I doubt specifically Dana's outperformance will continue at the same rate. For those who think Oil E&P offers continuing outperformance, as many here probably do, perhaps the time is right (esp if management want to exit) to let KNOC have their Dana shares for the best price possible soon, and find another smallcap oil company to repeat the process over the next decade.

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marben100 24th Jul '10 10 of 38
11

In reply to Isaac, post #3

Hi Isaac,

So we are talking about another 15-23% increase with the risk of KNOC walking away and the price dropping to £12 or about 30%. I.e. Risk;Reward does'nt look as good as when t was at say £14.

I don't think the short-term risk is as large as you think. Now that the market has seen, officially, that a trade buyer is prepared to pay £18/share, I doubt that the SP would fall as low as £12 if the bid were called off. I'd say £14 is a more probable downside range. Clearly there could be a short-term overshoot to the downside, as all the hedgies pile out but £14 seems like a more probable medium-term target to me.

Hats off to tournesol & ee for their long term diligence in keeping a careful watch over this rather reclusive goose-herd. Though I have attended the last three Goose-Months, I have never felt that the goose-herd was as transparent about the egg-laying potential of the goose as I would wish, and I don't have tournesol & ee's regular contact with him. For that reason (unlike Soco) Dana has never been a core holding of mine. Rather I have tended to buy it when I felt it was clearly under valued and sell when the undervaluation was less clear. I haven't always got that assessment right.

I started accumulating late last year, having been "out" for the previous year, as the price fell for little good reason other than that Dana was "out of fashion" (once again giving the lie to the "falling knife" nonsense), trimmed & readded in April & May this year, as the price rose & fell for no particulary good reason, thus getting my average down to 1237p. When the price shot up to 1490p on the bid announcement (but with only rumours of a possible price), I trimmed again. Yesterday I sold the majority of my holding at around 1710p but am still retaining some - though I disagree a little with Isaac on the precise figures I do agree with him in principle: I don't feel very comfortable with possible upside from here relative to the downside risk. If the bid is called off and the SP drops back below £14, I'd be starting to add again. If not, I'll be happy to take profits on my last tranche when Tom Cross does (or is forced to).

Why am I mentioning this? Just to point out that buying & selling decisions don't have to be all or nothing. Over the last couple of years of market volatility I have found that a strategy of:

 a) getting to know your investments really well, forming a clear view of fair value, and adjusting that view as each news release or meeting  with management provides an opportunity to reassess;

b) adding in small (but increasing by quantity) tranches as the SP of your investments falls increasingly below fair value;

c) trimming as the price rises back towards fair value

has worked really well for me. To take account of the fact that I, like all of us, may not know as much as I think I do and am sometimes caught out, I also spread my portfolio over a fair number of investments and when there are strong gains in any one investment, even though those gains may be justified, I will not allow that investment to become disproportionately large, thus putting too much of my personal NAV at stake in that one investment.

Just in case anyone is curious, I have used some of my Dana ISA gains to add to my holding of HG Capital Trust (LON:HGT) which is currently trading at a larger than usual discount to NAV and which, I feel, has decent prospects over the next 5 years. As a private equity investment trust, its managers were shrewd enough to sell a large proportion of its holdings in the run up to the GFC in 2007, thus being well cashed up, and now are now progressively deploying that cash to acquire good businesses at what they consider to be good prices.

I do retain plenty of cash in reserve, so that I can grasp opportunities if and when they arise. Who knows where these crazy markets are going next.? ;0)

Regards,

Mark

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thegreatgeraldo 24th Jul '10 11 of 38
4

Dana's strategy has been to acquire bits and pieces of fields and optimise production from them with good micromanagement

  I'd say that's a fairly common misconception, albeit last year's Bow Valley deal did bring on board small stakes in a number of recent  NS field developments. The BV deal strikes me as opportunistically taking advantage of a distressed company.


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emptyend 24th Jul '10 12 of 38
6

In reply to thegreatgeraldo, post #8

What I can't fathom, assuming reports that the board are willing sellers, is why now? Anne Marie is fast approaching on the horizon & success there would be significant in its own right. However, given Dana's large acreage West of Shetland, both directly & via FPM, it seems an odd time to be selling. Especially given the recent developments sanctioned there. Similar comments apply to Mauri.

I think it is VERY important to note that the precise timing isn't of Dana's choosing. In a perfect world I'd think TC would certainly want to get results from both the major wells coming up.But we all know the world isn't perfect - and I'm sure TC will be pragmatic on that.

It is certainly my strong first-hand understanding that he isn't unwilling to sell. However, that is not the same as being willing to give the shop away for no recompense - especially with drilling so close on Anne Marie!

As to SirL's question about TC retiring - I don't think that is at all likely. If Dana is bought out then I'd put money on him gearing up another business (in or near Aberdeen, despite being a Londoner by birth) within a year of being released from Dana (whenever that might be). Good point, of course that elephants cannot gallop - and I've no doubt that this is one reason why there has been a change of heart in the last 6-9 months re willingness to consider a sale.

KNOC's approach is, in principle, a potential win/win for both parties. But it IS to a large degree a matter of price - because the team are all young enough to carry on building value if KNOC don't step up to the plate. A fair price is absolutely essential - otherwise they could build more value by continuing at Dana and executing more of the (still extensive) drilling programme for the next 18 months. Management's assessment seems to be that fair value lies somewhat higher than KNOC's current indicative proposal. I agree with them. A bare $10 per 2P barrel (implied by £18 a share) when there is the possibility of the next two big wells giving up to a further 380mn* boe of net resources, to add to the 400mn boe (ish) of net resources (after the Dutch deal), really doesn't seem to cut it!

* Anne Marie could be up to 300-350mn bbls (ENI at one point suggested 600mn) and Dana own a net 28.5% (allowing for the portion held via FPM). Cormoran is considered to be between 400 and 780mn boe and Dana own 36%; there is some possibility that this may be oil rather than gas (per AGM comments).

ee

 

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JoeRussell 24th Jul '10 13 of 38
2

In reply to emptyend, post #12

" If Dana is bought out then I'd put money on him gearing up another business (in or near Aberdeen, despite being a Londoner by birth) within a year of being released from Dana (whenever that might be)"

Could this be the "raison d'etre" of Parkmead set up by TC and chairman Goodall?
Joe

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Groundhog 24th Jul '10 14 of 38
2

Is this KNOC offer bad news for SOCO holders? Surely Mr Poo Bum Suc (sic) was sniffing SOCO some time ago? What does his interest in DANA indicate about possible interest in SOCO???

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emptyend 25th Jul '10 15 of 38
2

In reply to Groundhog, post #14

What does his interest in DANA indicate about possible interest in SOCO???

Nothing. Except that the eventual price implications for the sector of the bid for Dana will cause the price of bid targets (such as SOCO) to be reappraised. The whole sector is too cheap (and has been for nearly two years).

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emptyend 25th Jul '10 16 of 38
7

In reply to emptyend, post #12

Correction to the post above, thanks to Marben remining me elsewhere about the debt (which is a more significant element than I had remembered):

I'd overlooked the debt on a quick back-of-envelope calc in haste (knew it should be taken into account but it makes more difference than I'd supposed without running the numbers). I had also been somewhat misled by the AGM presentation debt number which I had correctly remembered as negligible (£24mn) but one reinspection I see refers to net bank debt....so the convertible is on top (and the new deal).
Nevertheless, the £500mn pro-forma figure Mark pointed out in the new DNX Circular, is a gross number not a net number - and the rest of the pro-forma balance sheet includes items such as cash (£66.5mn, being part of £100mn of net current assets) and the FPM investment at cost (£50.395mn) rather than market value (which would add a further £21mn or so, at present).....
...so that probably works through to $12.50 or thereabouts per 2P barrel - which I would still argue isn't "overpaying" for a strategic deal, especially given the development pipeline and the upcoming drlling which has the potential to nearly double total (3P) resources!

Some in the City might argue that they shouldn't pay up for Anne Marie and Cormoran - but if they don't pay something and Anne Marie comes in, then it would certainly be a missed opportunity. Much better, I would think, to pay a "sensible" price now for the immediate (but not quite yet drilled) prospects and then they could enjoy the benefits of next year's drilling programme.

The more I think about it, it is a very well-timed approach by KNOC....turning up at a point where institutions are pretty jaundiced and just before some pivotal wells get drilled.

ee

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tournesol 26th Jul '10 17 of 38
3

In reply to sirlurkalot, post #9

Sir L

I doubt any of us years ago really expected crude to rise as much as it has, from single figures to current levels - perhaps some expected a bit of a rise but i don't think any of us expected the size of the rise.

speak for yourself :~))

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sirlurkalot 26th Jul '10 18 of 38
5

Tournesol,

Chapeau to you if you really thought a decade ago that crude would rise as much as it has. Personally on principle I wouldn't base an investment portfolio around that sort of macro call anyway, even if I thought it, but maybe people differ on that. Do you think crude will rise, proportionately as a multiple, in the next decade as much as it has in the last?

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About tournesol

I'm an active private investor specialising in the oil and gas sector. I decided to focus on this area after having a disastrous experience 10 years ago when I naively delegated investment to a "professional" who subsequently lost most of my life savings and my pension. That experience taught me that it was foolhardy to invest in industries/companies you don't understand properly and that many "professionals" are doing just that, often based on the most superficial analysis and the most inadequate understanding of the underlying business. I decided that I'd take my financial destiny into my own hands.   I chose oil as a specialist focus partly because it was the industry I'd spent most of my career in over many years in >25 countries all over the world. That prior experience gave me a good  understanding of E&P from an operational perspective and I've subsequently leveraged that into an appreciation of the sector from an investment perspective - quite a different thing. But the one really helps the other.   I find that my background and my specialist focus help me get access to management and help me talk to them when I get in.  I've been seriously astonished at the open-ness and responsiveness of many top managers in this industry. Sensible questions, asked in a sensible manner almost always receive a very full response. (I have to single out Tom Cross of Dana for his readiness to go the extra mile to help small PI's understand his business).   Of course the other reason I chose to specialise in oil was that ten years ago it was very easy to figure out that the price was going to rise in a sustained manner over a long period. I still find it hard to believe that everybody else didn't see that coming at that time. I certainly can't claim any credit for doing so. It was just too obvious to miss - provided that is you looked at things from the right perspective. (there's an article to be written on this topic when I can find time........) more »



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