I am recommending a long position in CIE ($29.37) with a 4-6 month time horizon.  I see an upside of $15 points ($45 upside price target) and a downside of $5 ($25 downside price target).  CIE is an oil and gas company.  CIE currently has none of the traditional metrics of a value investment and would not screen well on any value screen.  It has zero revenue and a $11-$12 market cap.  I highly recommend people read Mendoza’s December 2011 recommendation when the stock was at $9.  The investment in CIE is based on asset value and potential increase in asset value driven by an active exploration corporate strategy.   

Business Description

• Cobalt International Energy (CIE) is an exploration play on oil and gas prospects in the deepwater Gulf of Mexico and especially offshore Angola and Gabon in West Africa, where its total leased acreage exceeds any other E&P company and where surveys suggest a continuation of the pre-salt formations like those in Brazil’s Tupi and Jupiter fields
• CIE has no production to date. 
• CIE has $1.5 billion of available cash to fund its drilling budget for the balance of 2013 and 2014.
• The drilling program for the next two years is dedicated entirely to exploration and appraisal, not development. 
• In fact, CIE lacks sufficient financial resources to develop the fields that it explores so its strategy will be to sell them.
• CIE was founded as a private equity venture play on exploring, appraising, and then selling its interests in a promising and focused portfolio of deepwater oil and gas prospects.

http://www.cobaltintl.com/investor-center/#publications

Catalyst

Exploration

CIE has 4 big exploration wells with results in the next 3-6 months

Ardennes Project in Gulf of Mexico

• Ardennes is similar in geographical extent to Shenandoah.  Shenandoah which is operated by Anadarko is one of the largest Gulf of Mexico oil discoveries.  CIE has a minority ownership interest in Shenandoah. 
• The Ardennes Prospect will drill both Miocene and Inboard Lower Tertiary targets.
• The total unrisked resource of these two targets has been appraised at up to 500mmboe
• Ensco 8503 rig.
• The well was spud in March and is estimated to take 155 days to drill. Well results in next 4-6 weeks. 
• A successful Ardennes well can add $4-$6 to CIE.
• Ardennes is CIE operated.

Diaman Well in Gabon

• Total operated well
• MRO a work interest partner like CIE has said the well has 250-800 mil. barrel potential and the whole structure has 3 bil. barrel potential.  
• The Diaman well on Gabon is testing Lower Cretaceous Gamba and Dentale Sandstones.
• This is the first well drilled in the Diaba block which is twice the size of a normal Angolan block.
• Diaman is currently being evaluated by Total the operator.
• Success at Diaman would add significant upside to CIE as well diversify its African portfolio. 
• A successful Diaman well also opens up a large portion of offshore Gabon in which CIE owns acerage so there is additional optionality and resource potential for CIE if Diaman is successful. 
• A successful Diaman well should be worth $7.50-$10 to CIE
• Total is evaluation the well so results should be expected in next 4-6 weeks.

Lontra Well in Angola 

• Lontra is probably the world’s most watched well and one with probably the greatest potential on a global basis for any company.
• In my conversations with CIE management their research and seismic works has made them very interested in Lontra’s potential. 
• Lontra is the largest 4-way pre-salt structure in the greater Kwanza Basin.
• The Lontra hydrocarbon structure will not be derisked by this one well. 
• CIE management has stated that Lontra well has an estimated resources potential of 1.5 bil. barrels.
• I expect there to be may wells in this structure if Lontra well is successful. 
• Lontra success would add between $10-$15 to CIE
• Lontra was spud 5/21/2013 and is estimated to take 120 days to drill. Results in next 6-8 weeks. 
• Lontra in CIE operated.

Mavinga in Angola

• CIE is drilling Mavinga, as an offset to the large Cameia discovery
• 5/3/31 spud with results in next 6-8 weeks.

CIE Optionality

Deepwater offshore drilling is a high risk venture.  There will be dry holes – not every well is successful.  Why do I like the risk return profile of CIE?  It is because its older discoveries have created a substantial asset base.  CIE discoveries in Gulf of Mexico and Angola give it a discovered asset value base of $22-$27 dollar.    CIE did not go from $9 to $29 without being successful with the drill bit.

What I like here is that for $5 of downside I am able to buy significant exploration upside.  The upside on hitting Lontra or Diaman would be a game changer in terms of CIE’s stock price.   I am much more comfortable taking expolartion convexity and risk with an asset floor built around North Platte, Shenandoah and Cameia.

Corporate Sale

I don’t expect CIE to be a public company in 12-24 months.  The size and potential of its asset base and its asset development are resources that can only be developed by a Major. 

 CIE normally has a slide and makes comments about high yield, farm outs, jv or other corporate strategies to develop their assets.  I personally think it is a joke.  These guys (CIE management) are exploration guys they don’t have the skill set, experience or ability to develop their asset base. 

http://www.bloomberg.com/news/2012-12-06/chevron-seen-eyeing-cobalt-to-kosmos-in-oil-hunt-real-m-a.html

http://www.bloomberg.com/news/2013-04-24/cobalt-s-oil-finds-seen-luring-shell-to-exxon-real-m-a.html

Management also has $500 mil. worth of equity interest in CIE and I think they probably want an exit and liquidity event over trying to build a mini XOM.

CIE private equity investors I thought would be pushing for a sale but they have reduced exposure in 2 separate billion dollar secondary sales.  For their remaining positions a corporate sale would be a great liquidity event. 

Any exploration success will bring additional talk of a sale to a major.    

Risks

• Exploration - There will be dry holes.  In the kind of exploration CIE is doing it only needs to hit 300 to get into the hall of game – a baseball analogy someone in the oil business told me about CIE.  I am not a baseball guy. 

• Angola - TIA - This is Africa.  There is country risk in Angola and Gabon. 

• Oil Commodity risk

• PE Selling - The Private equity holders already have the best PE investment every in the oil and gas space.  They are sitting on 6-8X and if there is exploration success with be holding 10X exisitng positions.  Do they seek liquidity via public markets instead of a sale of the company.

• Development Strategy - CIE management decides to build an empire around their asset base and undertakes massive development projects - $20 bil. plus.