CHENIERE ENERGY INC LNG S
November 26, 2010 - 3:54pm EST by
Siren81
2010 2011
Price: 6.20 EPS $0.00 $0.00
Shares Out. (in M): 56 P/E 0.0x 0.0x
Market Cap (in $M): 345 P/FCF 0.0x 0.0x
Net Debt (in $M): 670 EBIT 0 0
TEV ($): 1,015 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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Description

 

Cheniere Energy, Inc., common stock is a likely terminal short with identified catalysts and multiple ways to win. A borrow is available in reasonable size at rates of about 4-5%.

By the company's own estimates, cash burn is $50mm/yr, total liquidity is $80mm and there is over $750mm of secured debt due in the next two years. Cheniere's stock has more than doubled in the last month on the hope that the company can build a plant to export liquefied natural gas (LNG). However, even if Cheniere can somehow restructure the $750mm of debt and obtain the required permits, contracts and over $3b of financing required to build export capacity, there is still little value left for common stock holders.

Company description
Cheniere Energy, Inc., owns 41% of the common interests and 100% of GP and subordinated equity of Cheniere Energy Partners, as well as the Creole Trail gas pipeline. Cheniere Energy Partners is a publicly traded (AMEX: CQP) MLP that owns the Sabine Pass LNG facility. Sabine Pass is the largest LNG receiving terminal in the US, with regasification (import) capacity of 4.0 Bcf/d and LNG storage capacity of 16.9 Bcf. Creole Trail is a 94-mile gas pipeline that connects to Sabine Pass and is effectively dormant. At current gas prices it is not economical for the US to import LNG, so CQP's only income is derived from capacity contracts with Chevron and Total, which require payment regardless of usage. These contracts provide for ≈$250mm of revenue per year.

Liquefaction
When Sabine Pass was conceived several years ago, most people assumed that the US would always need to import natural gas in order to meet the country's energy needs. Fast forward to today and this is clearly not the case. Rather, the US has an excess supply of gas, making LNG imports uneconomical. In response to this problem, Cheniere has proposed building a facility to turn natural gas produced in the US into LNG (a process called liquefaction) for export to Europe and Asia, where gas prices are higher and are linked to oil costs. Liquefaction is a complex process that requires purifying natural gas and cooling it to -161 °C. As such, permitting and construction of these facilities takes about 5yrs and costs several billion dollars.

Cash flow from a possible liquefaction project would accrue to the Cheniere Energy Partner's subordinated equity and thus create value for Cheniere Energy, Inc. The market is clearly excited about the liquefaction project, as evidenced by the recent stock price movement. However, a closer look at the numbers shows that the value of this project is not nearly as great as market prices imply. As shown in figure 1 below, even using rather aggressive assumptions the unlevered liquefaction project barley generates a positive NPV at a 10% cost of capital.

Figure 1: Liquefaction Expansion Economics ($mm unless otherwise indicated)

Assumptions

             

Project capex (1)

              3,000

Project Cash Flows

Cost of capital

10%

 

2011

2012

2013

2014

2015

2016+

mmBTU / Day capacity

      1,032,000

Revenue

0

0

0

0

      311

      622

mmBTU / year capacity

  376,680,000

Op costs

       

        45

90

Revenue per mmBTU (2)

 $ 1.65

Pre-tax income

       

      266

      531

Annual revenue

                  622

taxes

       

         -  

         -   

Opex & maint per mmBTU(3)

 $0.24

FCFF

0

0

0

0

      266

      531

Operating costs/yr

90

Perpetuity value (terminal yr)

0

0

0

0

266

  5,311

Tax rate (4)

0%

Project PV

$3,163

         
                 

(1) Please see Appendix A

               

(2) High-end of company provided range of $1.40 - $1.75

           

(3) Average O&M costs for 4 ton trains, plus adjustment for US labor costs and inflation

         

Source: http://www.zeuslibrary.com/lng/analysis/20091230_Cost-of-Liquefaction-Part-3.asp

         

(4) Assumes accelerated D&A + NOLs shield all taxes

           

 

Of course this all assumes that Cheniere can actually complete this project. Thus far, Cheniere does not have FERC approval, does not have contracts with customers and has not given any indication how they plan to raise $3 + billion.  A recent Citigroup report stated: "ENN seems skeptical about if an agreement can be reached. The concern is that the PRC Government, which has planned over 10 LNG terminals... might be reluctant to approve other import sources."  I think its important to remember just how far in the future this project truly is and that signing a MOU is much different than a true contract.

Capital Structure / Cash Flow
Cheniere's capital structure is complex. I would refer you to page 30 of the company' recent investor presentation (link below) for an illustration.

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDAxMzg1fENoaWxkSUQ9NDA4Nzk4fFR5cGU9MQ==&t=1

As shown on page 28 of this presentation, Cheniere Energy, Inc., burns $45-$55mm per year. As of September, there is about $82mm of cash at the parent. The company's 12% convertible PIK notes are putable in August 2011 when the face value will be about $275mm. These notes are secured by Cheniere's CQP common stock. Even if Cheniere can redeem the PIK notes with remaining liquidity and a sale of the CQP shares, the company would be left with no cash flow or liquidity to deal with the $502mm of debt due in 2012. Thus creditors will likely end up owning the remaining assets, leaving nothing for equity.

As a side note: On Thursday, Moody's downgraded the Sabine Pass ("OpCo") bonds to B2 and placed the credit on review. A central reason given for this downgrade was the high risk of default at Cheniere Energy, Inc. when the PIK notes become putable.

Even in a "best case"... this stock is overvalued
So let's assume everything goes right for Cheniere; operationally, the liquefaction project is built on time, at a cost on the low end of estimates, and the company signs contracts at the high end of projections. On the financing side, the company retires the PIK notes with the CQP shares and remaining cash and raises $500mm of equity (85mm shares) to retire remaining debt on terms that are not punitive to current equity holders. In this highly unlikely case, the value of the liquefaction project would be split among 141mm shares, creating a fair value of ≈$4/share. This scenario is detailed in figure 2 below.

Figure 2: Cheniere is overvalued under optimistic assumptions (in millions)

Current shares

55.6

 

Shares required to raise $502mm

85.2

 - $6.20 stock price and 5% underwriter discount

Total shares after equity raise

140.8

 
     

Value of sub equity from liquefaction project

600

 - Value under aggressive assumptions.  See Appendix B

Value of GP shares

0

 - Assumes all GP cash flow is required to cover G&A

Total value

600

 
     

Total value / share

 $  4.26

 

 

Management
Cheniere is effectively controlled by Chairman/Founder/CEO Charif Souki. Mr. Souki is a former investment banker (perhaps not surprising after looking at the capital structure) described by many in the industry as a better salesmen and financial engineer than businessman. Certainly, much of Cheniere's communication surrounding the liquefaction project is aggressive and potentially misleading (although not to the point of being dishonest). Given that the liquefaction retrofit is the only source of equity value for Cheniere Energy, Inc., and the company needs to raise equity to survive, it is not surprising that management would aggressively "sell" this project.

Other risks
Cheniere has 2Bcf/d of unused import capacity. Given the industry utilization rate of <10% and the historically wide spread between US and European gas prices (currently about $4/mmBTU), it is reasonable to assume this capacity is worthless for the foreseeable future. That said, gas markets are highly volatile and the risk of this capacity becoming valuable is >0%. However, any "tail risk" here can be cheaply hedged using US/UK gas swap futures, or deep out-of-the-money calls on gas prices, or by the owning of other stocks that would benefit from higher US gas prices.

This stock price is highly volatile. It is highly possible that Cheniere could announce more progress toward the liquefaction expansion which sends the shares temporarily higher.

 

Appendix A- What will the Liquefaction Plan Cost?

I believe the capital cost of Cheniere's liquefaction facility is about $3-$4B (≈$400-$500/ton), based on conversations with experts in the industry and comparable projects. A number of government and private reports cite capex requirements of about $600-$700/ton.1,3 The projection for InterOil's Papua New Guinea plant of a similar size to Cheniere's is $6B.4 Cheniere's retrofit could cost less, however, as certain storage and marine infrastructure is already in place. However, these costs represent less than 25% of total project costs and Cheniere's project will have much higher labor costs than those of comparable plants in developing economies.2

In company presentations, Cheniere shows "comparable" projects in the $200-$300/ton range. However, such comparisons are not appropriate, as these projects were started nearly 10yrs ago5 when capital costs were about half what they are now.1 Costs today are largely unchanged from 20082.

The Freeport, TX terminal undertaking a similar (if slightly larger) retrofit to Cheniere. In a press release announcing the project the Freeport cited "over $2 billion of direct investment".  Some have interpreted this to mean that the total project will cost $2b. However, I believe there is some confusion between total capex and "direct investment" which refers to only a portion of total costs.

Sources:

  • (1) From August 2007 report by the California Energy Commission: "Norway's Snohvit, Russia's Sakhalin II projects and a new Iranian North Pars construction bid are reported in the trade press to have costs in the range of $1,000 to $1,222 per ton of liquefaction capacity. A reasonable range of costs for these projects in a year 2000 construction environment might have been $250 to $300 and with the 2007 costs utilized in this study $450 to $575. (After completion of this report for the Energy Commission, Jensen Associates updated their cost estimates as part of their ongoing consulting work. The 2007 costs are now $600 to $650 instead of $450 to $575.)"
  • (2) From conversation with head of LNG projects at a major EPC firm
  • (3) June 2008 report by ICF international for Jordan Cove Energy project, L.P.
  • (4) From InterOil's website: "The proposed LNG plant is a two train plant with a nominal 4 million metric ton per annum processing capacity for each train. The mid-point of current cost estimate for the two-train plant is approximately $6 billion, and first LNG production is anticipated in 2014/2015"
  • (5) http://abarrelfull.wikidot.com/elng-idco-lng-terminal , http://abarrelfull.wikidot.com/darwin-lng-terminal

 

Appendix B - Equity value of the Liquefaction Project

In a "best case" scenario, I believe a 100% debt financed liquefaction project could create at most $600mm of equity value. Details are below:

Assumptions

 

2011

2012

2013

2014

2015

2016+

Project capex (1)

              3,000

Revenue

0

0

0

0

      311

      622

Financing cost (2)

10%

Op costs

0

0

0

0

        45

90

mmBTU / Day capacity

      1,032,000

EBITDA

0

0

0

0

      266

      531

mmBTU / year capacity

  376,680,000

Financing costs

         -  

    (300)

    (300)

    (300)

    (300)

    (300)

Revenue per mmBTU (3)

 $ 1.65

Pre-tax income

         -  

    (300)

    (300)

    (300)

      (34)

      231

Annual revenue

                  622

taxes

0

0

0

0

0

0

Opex & maint per mmBTU(4)

 $  0.24

Cash flow to equity

         -  

    (300)

    (300)

    (300)

      (34)

      231

Operating costs/yr

90

Perpetuity value

         -  

    (300)

    (300)

    (300)

      (34)

  2,311

Tax rate (5)

0%

             

Cost of equity

10%

Equity Value Created

$605

         
                 

(1) Please see Appendix A

               

(2) Assumed cost of debt given credit risk of Cheniere's counterparties, construction risk and likely PIK component

   

(3) High-end of company provided range of $1.40 - $1.75

           

(4) Average O&M costs for 4 ton trains, plus adjustment for US labor costs and inflation

         
Source: http://www.zeuslibrary.com/lng/analysis/20091230_Cost-of-Liquefaction-Part-3.asp
         

(5) Assumes accelerated D&A + NOLs shield all taxes

           

Catalyst

 Upcoming Debt Maturities:
August 2011 - $275mm secured PIK debt
May 2012 - $298mm secured term loan
August 2012 - $204mm unsecured convertible bonds

Confirmed details of the liquefaction capex / contracts are provided

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