|Shares Out. (in M):||544||P/E||0||0|
|Market Cap (in $M):||114||P/FCF||0||0|
|Net Debt (in $M):||-3||EBIT||0||0|
|TEV (in $M):||111||TEV/EBIT||0||0|
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Madalena Energy (tickers: MDLNF and MVN CN) is an Argentina energy E&P with attractive assets and partnerships in Argentine shale plus a new management focused on producing FCF from conventional wells. The new management team has experience in both Argentina and shale production, and has developed a strategy in which they can produce attractive FCF that has the company on the path toward a valuation of approximately 14x 2018e FCF and less than 6x 2019e run rate cash flow. Madalena should also benefit from increasing interest in Argentina due to recent political progress accompanied by economic reforms and the company is well positioned to take advantage of that with an expected Argentina listing.
Madalena has an interesting history with recent transformative management changes initiated by its 20% owner Maglan Capital. The company has always been intriguing given its substantial acreage in Argentina’s shale basins, but there always seemed too many disconnects between its assets and a path toward realizing its potential. Most notably, these included a Canada based management team for Argentina assets, inefficiently high SG&A, and the lack of a strategic plan that could be self-funded. It also did not help that Argentina had a dysfunctional market economy with odd rules given to capricious political changes.
At $0.21 per share, Maglan Capital has a market cap of approximately $114M. There is currently little to no debt or cash, making market cap and EV roughly similar at the moment. Management has given recent guidance for FCF and production, which guides how we estimate the path forward:
Expectations are for a $700k/month run rate, which is approximately $8.4M per year based on 2200 barrels per day.
Over 18 to 24 months they want to jump production to 5000 bbl/day. If that production rate is accompanied by a likewise increase in FCF, then that would correspond to nearly $20M/year.
Both FCF run rates are compelling for a $110M market cap company whose Net Contingent Resources dwarf its current drilling program.
Admittedly, as credit lines are drawn down and if reference is made to the production JV’s being funded recourse to the assets in the shale play, then an adjusted EV would perhaps look quite different.
Another way to look at the ability to grow cash flow is to think of the expansion of conventional drilling as meeting their required 25% to 30% ROI. Using the $16M credit line set aside for conventional expansion, that would be approximately a $4M addition at the 25% ROI. Given that the 5000 barrels/day target referenced above seems to include additional shale production as it comes on line, the combination seems more than capable to reach estimated mid-to-late 2019 run rate targets.
While the company has given a valuation framework for the shale play based on an NPV10 of one shale area, it has not detailed the JV economics of its farm out deals with Pan American Energy. It has however commented that it expects the next JV deal to have better terms for Madalena. At some point when drilling unconventional wells no longer exposes the company to outsized risk, they can likewise seek increasingly more attractive JV terms.
We look at the path toward realizing the value of its assets as having gone from nebulous to attractive, and Madalena’s philosophy of self-funding its conventional wells while ramping its shale production on the financial back of its partners should put Madalena in an advantageous position two years from now.
At that point, only a modest amount of today’s NPV10 $635M of Net Contingent Resources will have been partnered away and Madalena will be in a stronger position for negotiating partnership terms and utilizing their additional excess cash flow and funding for developing conventional wells. Along the way, the management team and workforce will have developed valuable local experience and expertise.
It also should not be underestimated how much the Argentina political situation cleared up as a result of the October mid-term elections. This view from the company:
…first of all, I would like to discuss what is happening with Argentina being in the news quite a bit and this is because we are living through historic juncture in its history as a country something that is extremely relevant for the wider Latin American region.
In October, Macri's correlation led by the 12 party had extremely significant positive results in the mid-term elections. These are the most significant mid-term election since 1985, and the message is very clear, the message is Macri's political movements and policies are here to stay in Argentina. He will have a working situation in Congress to be able to deepen his reforms but I think the overarching message is, we will see continuity.
It is likely that he will be reelected, and we can confidently believe that we will have six more years the opportunity for this administration to continue to deepen its reforms which aim to open up the economy, create a competitive situation internally where it tracks capital from foreign countries and continues to open the capital markets aspect in Argentina, continues to deepen the labor reform where we will see an increased advantage for business in lowering costs, and is also going to focus on tax reform which is something that that is already proposed
The new management has put its initial emphasis on restructuring. Among the milestones and their impact:
Increasing conventional production by adding additional surface pumps and other tools
Reaching agreements with the unions to reduce headcounts in the fields, which in one case will represent a $7 per barrel increase in their netback
Engaging with the regulatory authorities to make sure that they are able to double list the stock without it becoming an excessive reporting burden on the company
Removal of the “going concern” language in their financial documents, which they expect to be able to remove those effectively for Q4 (quarter ending 12/31/17)
In general, moving toward a philosophy of self-funding all capital expenditures without reliance on outside equity financing—operating like a private company as management puts it
Having completed these restructuring steps, management can now turn their focus toward growth:
Pan American (which is essentially British Petroleum partnered locally) has carried Madalena on their first two shale wells for a total cost of $15.6M. The first well results were released in July and were successful at a preliminary stabilized 125 boe per day. The second well has been cased.
Following completion of the second shale well the focus will shift in 2018 to the next $100M pilot program with financing in place from Pan American.
Management is additionally focused on funding two additional JV’s for their assets in Curamhuele and Valle Morado.
For additional background, Maglan Capital has written about Madalena numerous times through the years, and links to their letters are available online. Maglan gives some insight into their current analysis in this Seeking Alpha piece on November 6th: https://seekingalpha.com/article/4121130-madalena-energy-2_0-junior-e-and-p-player-argentina-primed-growth. Their influence in getting new management on board and implementing a sensible growth strategy should prove to be transformative for this investment.
The most important part of that write-up is the link at the end to a ten minute presentation given by Jose Penafiel, CEO of Madalena Energy, at the Subscriber Investor Summit in Vancouver on October 3, 2017: https://www.youtube.com/watch?v=lRhztwdCDDE&feature=youtu.behttps://www.youtube.com/watch?v=lRhztwdCDDE&feature=youtu.be, which we’ve roughly transcribed below. It is easy to skip this brief talk as there is so much information to gather on Madalena, but of all the pieces to the puzzle, the CEO’s brief presentation is by far the most valuable.
For some background, the new management team had been in Argentina until they left in 2013 and subsequently turned their operations and investments to the Permian basin since that time. They were recently attracted back into Argentina by the political change and wanted to use Madalena Energy as their base. In their own words:
We’re always looking for the ideal target, which is existing production, cash flow, running room on the conventional side to grow cash flow, and high impact exploration.
Madalena Energy—we injected $23M into the company—it didn’t need the cash as it was basically cash flow positive. Instead of only focusing on the high impact shale and drilling $10M exploratory wells, we said we have to have a two-pronged approach to this. We have to protect our cash flow and grow it by making sure we are managing our conventional assets appropriately and grow that conventional production. And we will also develop our shale properties.
And that’s what we have been doing. In four months we reduced our G&A by half, going from $10M to under $5M on an annual basis. The company was cash flow negative, now we are making $400,000 per month.
We drilled a successful well in the Vaca Muerta with our partners Pan American Energy which is basically British Petroleum. It was a 1000 meter lateral that IP’d at 420 barrels 30 day average. We’re drilling another well this month.
At the same time we have been cultivating our conventional production by going after the low hanging fruit—work overs…setting additional surface pumps…we are bringing private practices with a team that is used to protecting its cash flow and living off its cash flow (for survival) to a public company that has great assets and so many things in its favor.
The company doesn’t need any additional financing. We have a great farm-out deal with the BP company Pan American Energy. They are carrying us on two wells, one of which we have drilled and is productive, the second one we are spudding this month.
There is a credit facility from BP which gives us $40M for development. Next year we’ll be starting on a ten well development plan in the Vaca Muerta shale at Coiron Amargo.
Our cost basis has gone down significantly and we have about a million net acres in Argentina.
I’ve talked about the Vaca Muerta play, but we also have really interesting assets in the Northwestern Basin in Salta and Formosa provinces. So next year we’ll be focusing on additional farm-outs. We have had already had several expressions of interest from majors that want to come in and do something with us in Curamhuele which is also in the Neuquen basis which has three potential benches that have already been tested vertically so that we know that there is production there.
We have been making $400,000 per month. Our target is really to get up to $700,000 per month. I think by the end of Q1 we will probably be there. We are in the sweet spot. We are the only publicly traded company that is heavy on Vaca Muerta where you can have direct exposure to that play. YPF obviously is a big player but they have all sorts of assets and it's not as focused. We have two concessions there—one which we are already developing with Pan American (as I’ve already mentioned) and we have a 90% working interest in Curamhuele which is in the wet condensate window…we’re going to do a farm-out deal next year, probably much better than the deal we got with Pan American in the Coiron Amargo Sureste.
We are in the right zip code. We have production all around us. Shell is very active immediately southwest adjacent to us. We’re relatively close to where Chevron is also drilling their wells in the Vaca Muerta.