Description

(all figures in USD as FAR's reporting currency unless otherwise indicated)

Thesis summary: FAR Limited (FAR), an Australian-listed, busted oil exploration junior now in quasi-runoff mode, offers at least a ~35% gross return and potentially a ~69% IRR over a likely 12 month period or less, with little or no permanent capital impairment risk. This opportunity exists because 1) the company has not formally announced a full liquidation/wind-up yet (even though all the signs are there); 2) there remains skepticism management will return the huge excess cash on the balance sheet; 3) there is some art to valuing the remaining core asset, an earnout on an as-yet unproducing new oilfield in Senegal; and 4) this is a small-cap, limited liquidity security listed in Australia, with a checkered history.

Notwithstanding these concerns, the valuation case is straightforward, and unlike other sum-of-the-parts unlock stories, there are a number of motivated activists involved here (including myself), highly incentivized to see shareholder value maximized as expeditiously as possible. Whilst not as cheap as it was, given the change in management, and the ongoing highly confirmatory tone of the company's public statements (in the direction of crystallizing value), I consider this amongst the best risk/rewards in the small-cap event/special situations space I cover.

FAR trades ~400k AUD ADV so this is for small funds or PAs only.

Quick background: there are many hundreds of small- and micro-cap mining or oil exploration companies listed in Australia. Most of them end up raising a bunch of money for greenfield exploration or mining of some kind, promising the world; before 99% of them flame out and die. Such is the circle of small-cap speculation at this end of the market pool.

FAR was historically one of these companies - but unlike most of the others they actually found a massive asset, the Sangomar field offshore Senegal, which in 2014 was billed as the largest conventional oil discovery in the world. Over the ensuing years, in order to fund development to production, FAR successively farmed down their stake and brought in a number of other partners over the years. Before COVID arrived, the three main owners of the field were Woodside (the Australian major); Cairn (now Capricorn); and FAR (down to a 13.7% stake in the core RSSD area after many rounds of dilution).

COVID happened at the worst possible time for a small-cap like FAR. The operator (Woodside) had already taken FID and the Sangomar asset had moved into the pre-production phase (when infrastructure + FPSO build costs, etc would come due), mostly derisked on the hydrocarbons but not on the project financing. FAR had been horribly mismanaged and despite raising a boatload of equity capital, had not locked down their debt financing for their share of the project costs in advance o COVID - which of course seized up the market as oil went negative, forcing FAR (and, incidentally, Cairn) to look for a 'mercy bid' from Woodside as they could not meet their project funding commitments. 

The end result was FAR sold their 13.7% interest in Sangomar - a multi-decade asset that as soon as late 2023 should be producing at 100k boepd at <$30/bbl - for cents on the dollar - just $126mm and up to a $55mm earnout (which we shall discuss). For context, this price was less than half of the implied price Cairn got for selling their own stake in the exact same project, at approximately the same time, due to a number of tactical blunders committed by the former FAR CEO (see here for a fuller discussion).

Post the sale of Sangomar, FAR was left with some exploration assets in The Gambia, and in particular one ongoing exploration well (Bambo), that was drilled at the end of 2021; a bunch of the residual cash from the Sangomar sale; and nothing else. Then, December 2021, the Bambo well - drilled at a cost of >$30mm net to FAR! - came up dry, a total disaster, essentially putting the company's only exploration asset value into serious doubt. The stock traded down to below net cash backing as the equity market assumed all remaining value would simply be burnt on more fruitless wildcatting.

But in early-February, an Australian deep value activist, Samuel Terry Asset Management (STAM), launched a 45c bid for the company - less than net cash alone, let alone the value of the earnout - and whilst the bid failed, it attracted the attention of other activists. STAM no doubt intended to put the company into runoff/wind-up and simply sell off the pieces. Indeed these were the basic asks from the activists in general: the removal of the horrid legacy CEO, Ms Cath Norman, and the pursuit of capital returns and value maximization from the existing financing assets within the company (namely excess cash and Woodside earnout value). Additionally a large legacy shareholder, Meridian (19% stake), also publically expressed a value desiring the spin-out, or otherwise monetization, of the Woodside earnout.

Hence, there was a rapid realignment of the shareholder register, away from small-cap Aussie punters, towards value-focused, method-agnostic activists. The Chairman - newly brought in last year after the Sangomar sale debacle resulted in a furious shareholder vote against the old board at the AGM - saw the writing on the wall and fired the legacy CEO; abandoned some of the other African drilling licences; announced a plan to farm out The Gambia assets such that FAR would not spend any more cash of their own on drilling; started cutting costs; and committed to a program of getting the market to 'refect the 'fundamental value in the FAR share', to borrow a phrase that has been repeated a number of times in recent public communications. This is basically where we stand today.

FAR's intrinsic value today

FAR today consists of just three things: a bunch of cash ($37.7mm as of 2Q); the Woodside earnout resulting from the Sangomar sale (to be discussed); and the rights to drill a number of blocks offshore The Gambia (A2 and A5) which are in the process of being farmed out or sold. There are no operating assets, and very few full-time employees (the board has 3 members, they have a handful of engineers in The Gambia, and that's about it). Valuing FAR in a wind-down scenario is therefore quite straightforward:

- Cash: $37.7mm as of Jun'22. Management has clarified that a further $3.6mm will be spent, net, in 2022, mostly on The Gambia farm out process along with other one-time wind-up type costs (remuneration for former now fired execs, etc), and that $2mm net is the max SG&A run-rate from 2023. Since I believe this will all be resolved by mid-2023 latest, I incorporate a net $4.7mm charge against this $37.7mm cash balance;

- The Gambia licences: currently being farmed out for either cash, a free carry on a well to be drilled, or (in my view) equity in another junior, I carry this value at $3mm, which is essentially just the extra cost FAR has invested in the last 6 months to prepare the data package coming out of the Bambo well and extend the necessary permits for another two years beyond this September. Management has guided that any successful farm out should at least recoup these already spent costs, so I view this number as a bare minimum;

- the Woodside earnout at $42mm, being the estimated NPV of the earnings stream, using a 10% discount rate (the Woodside earnout will be discussed shortly below).

Adding it all up, you get $1.12 AUD of value per share (using 0.7 FX), against a 0.835 stock price today, hence ~35% gross upside. Note that net cash - considering all residual 2022 and 1H'23 prospective wind-down costs - are still ~48c per share, ie covering ~58% of the equity price today.

Understanding the Woodside earnout

FAR's remaining earnout in the Sangomar field is described thus in the latest 2Q report:

Unlike most other earnouts, FAR's is capped (unfortunately), but at least it is deep, deep in the money at current and forward Brent prices. Essentially FAR is long a 2-4yr, $58-70 Brent call spread. Still, valuing this earnout is not exactly easy, because we need to solve for two variables - the oil price and the execution by Woodside of the production ramp up. The oil price is so deep in the money that the Brent forward curve is well north of $70 out for the next five years (and is thus easily hedgeable for any prospective buyer of the earnout) - so whilst there is certainly an element of price risk, execution risk/geopolitical delays may be more worrisome to the market at this point. As it stands, Woodside has stated the project is on schedule, the FPSO is due to arrive in-country in October, and the previous production schedule was for a ramp up to 100k boepd by the end of 2023. Thus, this is not some five year-out, high-risk development, but a multi-billion ($4bn+) project where Woodside is 'pot committed' and intent on pushing forward the project as quickly as possible. If Woodside were to produce at FID-announced rates, and assuming no late delays, FAR's earnout would be totally earned (ie, $55mm would have been generated), probably within the first full two years of production - that is, by mid-2025. 

The difficulty arises in understanding the right discount rate to apply to these prospective cashflows. FAR uses a 9.5% rate, given the near-term nature of the development; the quality of the counterparty (Woodside); and their assessment of the development risks (moderate) as opposed to price risks (given the shape of the curve and the market, low). No doubt some could push back and say this is far too low (note that I use 10%). Certainly with global interest rates higher, you could argue a higher discount rate is needed (say 12%?) but then oil prices are much higher now as well than back in February, which derisks the price part of the equation. Still, even using say a 12% discount and allowing for no accretion between now and when the field comes online mid-next year, the value of FAR's equity is still 1.09. Since the prospective cashflows are so near-term, basically 2 and 3yrs from today, respectively, you really need to take a hatchet to your discount rate assumptions to get an implied valuation that meets the market price today (25% or so).

At the end of the day, the market is likely to be the arbiter, as FAR has suggested they will look to monetize the Woodside earnout next year, in the leadup to first production. In reality, I expect this means they will go back to Woodside to sell them back the earnout, at a discount - but one that is probably within the context of current NPV, perhaps slightly wider but given the ability to hedge and the immaterial nature of the earnout to Woodside's overall PnL (they are a $40bn company), I do not expect a distressed price. In any case in my sounding of third-parties, given the size of the earnout and its eminent hedgeability (through put spreads) I expect third-party bids of interest at low-teens discount rate sometime early next year, if or when the asset is put up for sale by the company.

Will the board act in the best interests of shareholders?

Much of the uncertainty still evident in the discounted price here relates both to the history of value incineration, and the Board's lack of meaningful share ownership. Are we truly sure the Board won't 'go rogue' and simply hang on to their jobs as long as possible? I draw confidence in this regard from the rapid reconstitution of the register, and most importantly through recent board actions. It was the current Chairman - a newcomer - who fired the problem CEO and set about unwinding the entire entity, thus far. He has been in the executive chair only a matter of months, and has already and consistently repeated the same message regarding 'reflecting the value underlying the FAR share.' Moreover, he has seen two company employees - the CFO and the Secretary - leave, to be replaced either with a temporary staff on retainer (the CFO), or an existing employee stepping up at no incremental cost (the Secretary). When a new Board member joined to replace the CEO (the only geologist previously on the Board), all other Board salaries were cut such that no incremental cost would be borne by the company. It is also worth noting that the Chairman lives full time in Perth, and is only commuting to Melbourne (the HQ for FAR) - a fiendishly long way to travel all for a $100k salary. I doubt he views this as his sinecure for the next 5 years.

FAR has made noises with regard to 'considering new business opportunities' but I believe this is just cover for The Gambia negotiations whilst in reality as soon as The Gambia is farmed out or sold, most all the excess cash in the company will either be returned as a capital return (that is, not a dividend, ie tax free) or, more likely, a very large tender offer will be conducted to accrete further value to anyone who remains a shareholder through the Woodside earnout monetization. This was specifically called for by some of the activists involved in the case. Note that FAR used to have a very long tail of small 'unmarketable' shareholders (value less than $500), which was just cleaned up through a buy-back at 78.5c. The Chairman expressly noted in his AGM presentation that cleaning up ~7000 shareholders makes any subsequent capital management action much more efficient - further suggesting that a larger-scale capital management exercise is probably just around the corner.

As it stands, basically all the major shareholders at this point are pushing for all the cash to be sent back or otherwise used for an accretive tender. I expect this to be announced to the market sometime in early Q4, given the timing of The Gambia extension/sale (which should be completed near the end of 3Q). African government relationships are obviously sensitive, I don't think it would be prudent to empty the company of cash and say 'we are liquidating' before that negotiation is concluded, but that is part of the opportunity here.

Because so much of the value of the equity is coming back so soon (I estimate late October), the implied IRR here is much higher than the headline gross returns - EVEN in the case where there is simply a return of capital and no accretion through a tender. For example, if we simply expect 75% of the net cash to be returned - that is, $35.4mm - in early November in one way or another, followed by a full realization by July next year at my assumed value of $1.12 a share, the IRR will be 69%, almost double the headline gross returns. Indeed even if The Gambia turns out to be a total zero and they end up selling Woodside at a much higher implied discount rate (20%??), getting back so much of our capital quickly will still generate a highly attractive return - in this example, still a 22% IRR on an 11% gross return.

Conclusion

That is all to say, there are higher absolute return names in my book but none with this combination of still-high gross returns; a likely very high IRR; a near-term set of hard catalysts; an aligned shareholder base generally pushing for the same thing; and a high degree of protection against permanent capital impairment. Indeed, to lose money on this investment (permanently, given the longevity of the earnout) you would need some combination of 1) a massive, immediate, and mid-term sustained collapse in oil prices (extremely hard to foresee in the current environment and given the shape of the curve); 2) FAR management to massively backflip and blow all their cash on some acquisition that destroys value even though all their shareholders are telling them to return capital in the next couple of quarters; and 3) the AUD to go to the moon (since they own USD assets). None of these seem at all likely, meaning even if we get a few of the asset value assumptions a little wrong (higher discount rate on Woodside, for example, or slightly longer to unwind it all and return the cash), the returns will still be more than acceptable.

Catalyst

The Gambia farm out or sale in next 1-2 months

Announcement of large return of capital and/or tender offer for >1/3 of the company in next 3 months

Sale of Woodside earnout back to Woodside or third party in 6-8 months

Wind-up of the company in 9-12 months