Summary:

Cobalt has been pummeled since its last recommendation on VIC nine months ago.  The stock is down over 40% due to two dry holes at significant prospects in the Gulf of Mexico (GOM), disappointing (but inconclusive) results from the first well in a Total-operated field in offshore Gabon and, most importantly, bad market reaction due to results at the overly hyped Lontra well in Angola—which was both not as big and less oily than hoped for by the Street. 

Momentum money has now exited a stock with no traditional value characteristics, but with asset value based solely on existing discoveries in the $20-25 range I believe this creates an opportunity for patient investors.  Cobalt is holding its first Analysts’ Day on June 4, where I believe management will delineate the range of options they have to capitalize on a tremendous opportunity set. 

Background:

Cobalt is a Houston-based deepwater E&P company founded in 2005.  For excellent background and analysis I recommend reading the VIC analysis (and message string) by Mendoza in December, 2011.  I was not familiar with Cobalt until I read this and have followed progress at the company since, but only recently bought the stock.   

As Mendoza details, Cobalt has established world-class positions in both the GOM and Angola.  Notwithstanding the run of bad news described above, I believe that Cobalt is much more valuable today than at the beginning of 2012, when the stock was the same price.

Note:  I would recommend looking at the March Investor Presentation at this point; for some reason I cannot seem to provide a link but it is readily available on the Cobalt website.

Gulf of Mexico:

1. Heidelberg:  Anadarko is the operator and Cobalt has a 9.375% interest.  Production should begin in mid-2016, which will represent the first revenues for Cobalt. Netherland, Sewell estimates a range of 210-424MMBOE. As one data point, Marubeni acquired a 12.75% carried interest in Heidelberg from Anadarko for $860MM last year.  Heidelberg is the 7^th largest find in the Lower Tertiary/Miocene GOM since 2005 with an estimated ultimate recovery of 300+MMBOE.

1. Shenandoah:  This is an even bigger potential find than Heidelberg. (Cobalt shows 400MMBOE but some estimates are much higher).  Anadarko is also the operator but in this case Cobalt has a 20% interest.  Another appraisal well should show results by the end of this year.   Cobalt also has a 5.3% interest in the Yucatan appraisal well (Shell is the operator), which is adjacent to Shenandoah and spud in the first quarter.

1. North Platte:  Here, Cobalt is the operator with a 60% interest in a massive find from 2012, when Oil and Gas Investor selected it as the discovery of the year.  As the magazine noted, “The well transformed the Inboard Lower Tertiary from an emerging trend into a major subsalt industry objective.”  DeGolyer and MacNaughton before drilling estimated the potential at 400-800MMBOE.  WoodMackenzie estimates ultimate recovery of ~500MMBOE and identified it as the 2^nd largest find in the Lower Tertiary/Miocene.  Cobalt is in the process of analyzing 3_D seismic in and around North Platte and plans an appraisal well in early 2015. 

I believe that the current value of these 3 discoveries is roughly $10/share.

Cobalt has several other high-potential sites in the Inboard Lower Tertiary; plans are to drill 1-2 exploration wells annually.  In 2014, Cobalt will participate in 2-3 wells but is not the operator of any of them. Furthermore, the company continues to be active in GOM lease sales, recently winning 44/46 bids. 

Angola: 

In 2007 Cobalt was awarded 3 large offshore blocks.  The economics are not exactly the same among the 3 but in each case Cobalt is the operator and has a 40% interest.  Fast forward, the company has now had five major pre-salt discoveries in the Kwanza basin, totaling 1.1-2+ billion barrels of oil (gross).  On the most recent call the CEO opined, “T think with . . . growing confidence, we will be at the top end of that range.”  Orca, announced this February, has the greatest potential of all at 400-700 MM barrels.  Importantly, this well, along with another called Bicuar, confirmed the presence of oil in the Syn-rift reservoir.   Furthermore, the well was completed in 59 days, considerably shorter than the original estimate.  With drilling costs of over $1MM/day, this is significant.  Additionally, management believes that there are more than 20 undrilled pre-salt structures on company-operated blocks with greater than 2.5 billion barrels of potential. 

Cameia will be the first Cobalt well in Angola to reach production.  It should be sanctioned this year following results from a second appraisal well with first production as early as 2017.  The potential here is 300-500MMBO, with the low end of the range recently increased by management after additional findings.

As mentioned above, the Lontra well, which many had believed would truly be a monster, disappointed some in size and also because its gas content was higher than had been anticipated.  Nonetheless, it was the largest discovery in the world in 2013.  While the current arrangement with Angola precludes Cobalt from commercialization of the gas, management is hopeful that an agreement can be redrawn that would allow this.  Angola is short of electricity and offshore gas could expand local generation on terms that would make sense for both the oil industry and the country.  While that would improve the economics of Lontra, it is still a valuable well solely based on its oil content. 

Note that the SEC is investigating Cobalt in Angola, as there are connections between a local partner (Nazaki Oil and Gaz) and senior governmental officials.  This has been going on for over two years and is well documented.  Interestingly, and I have no idea what this means, Nazaki sold half of its interest in 2013 to Sonangol, the state oil company.

Gabon:

Here Total is the operator in the Diaba block; Marathon and Cobalt (21.25%) are partners.  The first well drilled in 2013 found gas and was deemed unexciting by the Street.  But this is a huge block with ample potential.  Cobalt is doing more 3-D seismic work this year and there will be additional exploration drilling in 2015; the company is also pursuing more licenses.

Finances:

Cobalt burns a lot of cash.  At the end of 2013 it had $1.8 billion in restricted and unrestricted cash, offset by $1.38 billion in a convertible note due in 2019 (convertible at $35.68/share).  There was no other debt. Cash expenditures for 2014 are estimated at $750-850MM.  Last week, Cobalt sold an additional $1.15 billion in converts (3.125%; due in 2024; convertible at $23.06).  So the company has at least 2 years in liquidity (or about until first production starts in the Gulf).  Asset sales/partnerships are always a possibility—and I think highly likely as Cobalt proves up more assets.

Ownership:

Goldman, First Reserve and Carlyle/Riverstone are the PE sponsors.  They have sold down their interests but still collectively own about 25% of the company.  Wellington is the largest shareholder at 14%; other large shareholders are BlackRock and Hotchkis & Wiley.

Valuation:

On the back of a string of good exploration events Cobalt traded to $30 twice.  While there have certainly been disappointments there has also been more good news:  Lontra may have disappointed the Street but Lontra and Orca together are probably as significant as anyone believed Lontra would be on its own. 

This is the kind of stock I like buying on disappointments and when it is out of favor.  I truly believe that the company has created a lot of value over time and is poised to create more going forward.  The recent convertible offering, I think, created another opportunity.