Description

Not an energy expert by any means, but found myself involved in this situation and was curious what the VIC community thought:

Harbour Energy is a North Sea focused recent combination/go-public sponsored by energy-focused private equity fund EIG.  Harbour was created through a reverse merger with the former bankrupt Premier Oil shell and the assets of EIG-owned Chrysaor that began trading in April 2021.  Harbour appears to be undervalued related to peers Lundin and Aker BP and has near-term catalysts that may help close the value gap, with upside in the 25-60% zip code.  

Company Overview

Chrysaor Holdings Ltd, was an acquisition vehicle used by EIG to purchase $3.2bn of upstream UK North Sea oil and gas assets (the “Assets” or the “Portfolio”) beginning in April 2017. At the time of acquisition, the Portfolio represented the fifth largest reserve base (349mmboe; 54% oil, 46% gas) and the largest production platform in the region.

In April 2021 Harbour merged with Premier Oil plc and began trading on the London Stock exchange under the ticker HBR.  Post Premier merger, Harbour is the largest producer in the U.K.:

Valuation discount to main trading peers Lundin (Sweden) and AkerBP (Norway)

HBR’s main comparables are Lundin Energy (LUNE) and Aker BP (AKRBP). Both are midcap publicly traded E&P companies with similar scale and exposure to the North Sea.

HBR is currently trading in line with peers on a 2021 and 2022 EV/EBITDA basis, however at a discount of 1.2– 5.6x on EV/Debt Adjusted FCF, which management and equity research are focsued on as the key metric to value a mid-stream E&P company.

This discount can be partially explained by a number of factors:

• HBR’s 8.8 years 2P reserve life is shorter than the reserve life of both Lundin (9.8 years) and AkerBP (10.7 years).

• Both Lundin and AkerBP have extensive trading history (public since 2001 and 2007, respectively), an established capital allocation framework (i.e., consistent dividend payouts) and demonstrated experience managing cycles in public markets

• Lundin and AkerBP are both investment grade credits.  It appears Management views an IG rating as a future priority.

• HBR has been adversely impacted by a technical overhang, driven by the following:

--    Former Premier Creditors – As part of the initial merger agreement, former Premier creditors agreed to debt-for-equity swaps.  These shareholders have been selling over the last six months as their shares were not under lockup.

─    September 30, 2021 Lockup expiry – It is estimated that 36% of HBR’s shareholders came off lockup on September 30, 2021.  The vast majority of these investors were early investors in Chrysaor and have generated significant profit on the investment. 

─    March 31, 2022 Lockups – EIG’s 37% interest will come off lockup in 1Q 2022.  EIG is subject to an orderly selldown agreement.  It does not appear that the EIG lockup expiry is adversely impacting HBR at this point, but may do so closer to the expiration date.

Consensus equity research indicates that over time the valuation gap relative to peers is expected to close.  The most significant near-term catalysts will be announcement of a dividend (expected in December), clarity around M&A strategy and expiration of the EIG lockup.  The amount of upside in HBR shares varies significantly across the Street:

BofA appears to be an outlier as their reserach indicates it will wait for execution before assigning a premium valuation. MS, Barcap and Jefferies are corporate brokers for Harbour.

Assuming 2022E debt levels, a re-rating in the coming years to 3.5-4.5x EV / 2022EDACF (assuming no growth) could produce attractive returns:

European Oil Trading

The energy market dynamics of the last six to nine months are well documented.  Supply shortages coupled with capital leaving industry related to environmental priorities have driven Brent crude and other oil prices upward, some to all-time highs which is expected to continue through the coming months.  LTM Brent spot prices have increased 78%, and the other peers have followed: Lundin is up 70% and Aker is up 40%.  HBR in the same period is down 10%.  While HBR’s underperformance can be partially explained by the factors discussed above, HBR does employ a more aggressive hedging strategy and has not benefitted as much from the increase in Brent prices as peers.

Near-term catalyst assessment

Shareholders are looking for clarity in several areas from HBR Management at the Capital Markets Day scheduled for December 9 and beyond:

While the lockups should improve liquidity in the near-term, it is unclear if there is a stable buyer base.  In addition, while HBR may over time demonstrate that an opportunistic M&A strategy with a smaller dividend will be value accretive, there is a scenario where it could take years for investors to accept this thesis.

Potential Neptune Transaction

Among the near-term catalysts, it has been rumored that Neptune Energy (Carlyle investment) is evaluating a potential merger with Harbour Energy.  The two companies are similar in terms of 2P reserves (~600mmboe each), with Neptune being more exposed to gas (at 72% to 50%, respectively).  If the merger came to fruition, the combined company would double the size of Harbour, providing it with the scale to reach the FTSE 100 (widens investor base), lengthen 2P reserve life, potentially gain an investment grade rating and likely create cost synergies.  However, while Neptune would provide the above benefits, the merger would have a high level of complexity (while HBR is already integrating with Premier), likely will require increased leverage and/or dilutive equity financing and will not help HBR reach its stated goal of developing a scaled platform in a new geography and may delay ability to pay a dividend.  While HBR traded up initially on news of the potential merger, one research analyst appeared skeptical that investors will be receptive to a transaction like this.

Catalyst

See analysis in main writeup