Description

This is a reasonably simple story, so I’ll try to keep this write-up reasonably brief. Barnwell is a fascinating combination of Canadian oil & natural gas properties and Hawaiian resort land development properties. You immediately see the strategic fit, of course. There’s also a small contract drilling operation that drills water wells in Hawaii, but that’s an immaterial business and I’ll ignore it here. Despite the incongruities, this is an interesting company because the sum of the parts appears to exceed the value of the whole -- as represented by the stock price. And there are catalysts that could drive the stock price higher over the next year or so.

One of the easiest ways to approach Barnwell’s value is via the value of its assets. Barnwell’s enterprise value of about $54 million appears to be more than covered by the value of its key assets, which can be summarized and estimated as follows:

1. Oil & natural gas properties – Barnwell estimated the net present value of these properties at 9/30/03 at $49.5 million using a 10% discount rate. This calculation assumed natural gas prices at the then-current level of around $5.00 per MCF. With natural gas prices now well over $6.00, the NPV would be quite a bit higher today though, of course, there’s no assurance that natural gas prices will remain high.

2. Land development rights – At 9/30/03, Barnwell had 110 acres of land on the island of Hawaii under option to a Japanese developer with a total of $21.25 million due in eight annual payments. This land is adjacent to the Four Seasons resort, which was developed on land formerly controlled by Barnwell. Using a 10% discount rate and adjusting for commissions and minority interest, the value of the option payments (including a payment made in late December) is approximately $11 million.

3. Hawaii leasehold interest – Adjacent to Barnwell’s other property (and to the Kona Village Resort), Barnwell holds the leasehold interest on 684 acres of land that can be developed for resort and residential uses. Barnwell has been in negotiations with prospective developers and with the holder of the fee title to arrange a transaction that would allow a developer to acquire the property in fee simple. The negotiations are likely complex, since Barnwell is currently paying only a modest rent on this property, the leasehold agreement extends to 2026, and the lease payments are subject to renegotiation at the end of 2005. The fee simple interest in this property could be worth up to $70 million (roughly $100,000 per developable acre), but the splits between Barnwell and the fee owner are yet to be determined. I estimate that Barnwell’s interest is likely to be worth at least the $6.5 million book value, and there is obviously quite a bit of potential upside.

The total of these estimates is $67 million. Deducting net debt of $9 million yields an equity value of $58.5 million or $44 per share ($41 fully diluted). The values of the oil & gas properties and the leasehold interest could be significantly higher, however.

Additional factors to consider are earnings and cash flow. Last year, Barnwell generated $10.5 million of operating cash flow (including an option payment) and reported diluted earnings of $1.69 per share. Enterprise value is therefore only about 5 times cash flow and the P/E is 19.

Cash flow will likely improve to some degree this year, primarily because of higher petroleum prices. Earnings should improve for the same reason, as well as the fact that Barnwell will now be taking into income 100% of its interest in the option payment. In 2003, Barnwell finished expensing the book value of the development rights and recognized only $720,000 of revenue from the $2.1 million option payment. This year, revenue from the option payment will be $2.5 million and pretax income (net of minority interest) will total about $1.9 million. I estimate that the increase in option revenue will improve EPS by at least $0.30, and it could be quite a bit more if my tax estimate is too high.

One last factor to consider is the reinvestment of cash flow. Barnwell has been pumping most of its available cash flow into oil & gas exploration and development. Proved reserves have nearly kept up with production, but it’s not clear that this use of cash has added more shareholder value than additional stock buybacks or dividends. It will be important to monitor the company’s capital allocation decisions going forward.

Catalyst

1. Increasing earnings and cash flow from higher petroleum prices and option revenue.
2. Conclusion of an agreement to realize the value of the Hawaii leasehold interest.