Carnarvon Petroleum (CVN AU) is an interesting event-driven opportunity to make a small investment in as events over the last few weeks protect your downside and an event over the next 1-2 months could mean several times your money. Insiders have been buying steadily. The write-up is short as it’s relatively simple. All $ are AUD $.

CVN has three assets: producing oil assets in Thailand, a large scale exploration project off the coast of Australia, and $20M of cash. Market cap is $96M and there is no debt.

Let’s start with the downside protection first. In the last few weeks, CVN closed on a deal to sell half of their Thai assets for ~ $36M up-front and a 12% royalty on future revenue until they receive another ~ $36M. The royalty stream needs to be discounted because the current revenue run-rate is so small that at the current rate it will take many years before the cap of $36M is reached. The clear plan with the new buyer is that production can increase significantly with further cap ex investment, and there are significant exploration assets that over time could increase the annual production further. If we conservatively value the royalty at $10M which is just the PV at the current production rate, that is ~ $46M total deal value or $92M value in total to CVN between up-front cash, royalty, and remaining 50% of their Thai assets they still hold. Including the $20M of cash, that is $112M of value vs. a $96M market cap; per CVN their tax advisors PwC have indicated there will be no capital gains tax liability on the up-front portion of the sale in either Thailand or Australia. There is upside that production will increase which will significantly increase the value not only of the existing royalty but the remaining 50% interest; 2P reserve value is over $250M vs. the $92M in Thai value in our math above. On the downside, there is the risk the Thai political situation gets so bad that the government no longer supports oil/gas exploration in the country impacting CVN’s remaining 50% ownership, but we think this is remote as previous turmoil hasn’t impacted the asset and clearly the buyer decided to proceed with the closing despite the political issues. Furthermore, the market is not viewing the turmoil as a negative (Thai stock index unchanged over the last several weeks and up meaningfully from the beginning of the year) as many investors see it as actually improving stability from the political uncertainty last year.

With cash + Thai asset value protecting the downside, what you get for free is the major asset of the company which is the exploration project. CVN has four permits covering over 21K square kilometers in a basin off the coast of Australia called the Northwest Shelf (NWS). There is enough geological data supporting the area that CVN has recently attracted Apache as its JV partner to drill two wells for $70M a piece, in return Apache is granted 40% of the project, CVN 20-30% depending on the specific permit (in two permits they will retain 20%, in the other two they retain 30%), and other partners have the remainder. Apache will be the operator. The first well, the Phoenix South-1, has spudded literally yesterday and results will be known over the next few months. The well to be drilled after that is the Roc well and per CVN, Apache is planning to drill the Roc well even if the Phoenix South-1 is not commercial, but Apache hasn’t confirmed this.  

At a simple level, if $140M buys you 40%, Apache is valuing the project pre any drilling at $350M so if CVN has on average 25% ownership, that is $88M of value. If you assume what Apache really is committing to is only the $70M for the Phoenix 1, then the value implied to CVN would be $44M. If either well is successful, the project goes from exploration stage to appraisal stage and Apache will drill several more wells to map out the full extent of the reserves. After that, they then go into full scale development.

Per CVN they have no plans to stick around for the appraisal stage or the development stage as the capital requirements are massive. Upon exploration success they will be looking to monetize their ownership stake, do a major special dividend, and keep some amount of capital to re-invest in early stage projects which they have had a good track record of. For example, they invested $20M in total in the Thai asset at an early stage and have gotten $36M of up-front cash + the royalty + the remaining 50% of the asset + $43M in free cash from the project to date.  They also have invested ~ $4M in the Australia exploration project and have managed to attract Apache to spend $70M per well in testing out the project for them + reimbursing them for all expenses spent to date.

The value uplift if the project moves from exploration stage to appraisal stage is large as you would expect given the high risk – per an industry executive we spoke with familiar with Australia offshore exploration and precedent transactions, if one of the two wells are successful it would take the value of CVN’s stake to $250M to $300M+. Given the history of past exploration in the area and what he knows about this specific basin, he puts the odds that the Phoenix well is successful at 25%. Assuming Apache proceeds with Roc even if Phoenix is not successful, he puts the odds that one of the two wells is successful at 35% (not completely independent probabilities in which case the odds would be 50%).  

So to summarize, the market cap is $96M, pro-forma for the Thai sale cash is ~ $55M and they have no need to spend any of that to explore their Australian asset. On top of that there is the 12% royalty and the remaining 50% of the Thai asset. Even if the Apache wells are duds, you should have limited capital loss whereas you have strong upside optionality with clear and imminent catalysts.

If you assume a 25% probability for a $300M value uplift, that would add $75M of value on a probability adjusted basis (which is in the same ballpark that Apache is valuing the project at today pre-exploration). At $75M, this takes total company asset value to close to $200M on a probability adjusted basis suggesting a mispriced security.