Description

Madalena Energy (MVN CN, MDLNF US) is a small cap Canadian E&P company with a 135,000 net acre position in the Neuquén basin of southwest Argentina and a 100,000 net acre position in the Greater Paddle River area of west-central Alberta. The Neuquén basin contains the world’s second-largest shale gas and the fourth-largest shale oil formation.  The Argentine acreage appears to be worth two to three times the stock price, so we get the Canadian assets for free.

The stock is cheap because Argentine energy assets have fallen out of favor.  However, this Saturday (12/14/13) Barons wrote a feature story related to a shift in sentiment entitled, “An Educated Bet on Argentina.” Madalena has retained RBC to sell or to find a JV partner for roughly 50,000 acres in Argentina, and I would expect news of a deal to be a catalyst for the stock.

Link to Barons article (best to read this first): https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/Barrons%20-%20An%20Educated%20Bet%20on%20Argentina%2012.15.13.pdf 

Capitalization

Madalena has no debt, net cash of $20mm and $13mm of revolver availability. With 364mm shares outstanding at 60c/share, the market cap is $218mm and total enterprise value is $198mm.  In addition to their position in Argentina (which produces 189 boe/d from exploratory wells), they have new and growing production (1,604 boe/d) from five wells in Alberta.  Both their Canadian and Argentine operating entities are breakeven, and the company does not expect to raise additional equity. Comparable Canadian companies trade on $40,000/boe (on the low end) so the value of the Canadian production alone accounts for $0.17/share. That value should rise to 31c as they bring another 1,200 boe/d online in 2014E. But as before, we sort of don’t care because we get this for free.

I took note of this situation because (1) the company is self-sustaining (2) the Argentine resource base has been independently confirmed by a well know petroleum industry consultant, (3) they have a JV with Apache in Argentina on one of their three holdings already, and (4) the Chairman of Madalena (Ray Smith) is the CEO of a $1bn market cap company called Bellatrix. Bellatrix is also in the Canadian E&P space, and its shares have appreciated 70% this year (to $7.30 as of 12/12/13 from $4.30 on 1/2/13) largely because Smith attracted JV partners from abroad (Korea) to develop the company’s Canadian assets. Aside from Smith, two other Bellatrix board members also sit on MVN’s board.

Canadian Assets

MVN holds a 78% average working interest in 200 sections (128,000 acres gross, 99,840 net) in the greater Paddle River area of west-central Alberta. The company has interests in three separate horizontal plays, (1) medium risk Ostracod light oil, (2) lower risk liquids rich Mannville channel, and (3) the emerging oil and liquids rich Nordegg. In addition, MVN controls roughly 100 sections for the emerging Duvernay unconventional oil play.

MVN has 5 producing horizontal wells in Ostracod and is drilling two more in 4Q13. Four of the five wells they have drilled produce 266 boe/day on average, but their most recent well is flowing at over 600 boe/day. Next year if we get the full year benefit of five new wells, at say 240 boe/day, that would imply incremental production of roughly 1,200 boe/day.  That production valued at $40,000/boe would be worth $0.14/share.  So, existing production (17c/share) and production we expect to come online in 2014 (14c/share) account for 31c, as mentioned earlier.

Argentine Assets

Madalena’s 135,000 Argentine acres are divided into three separate parcels: (1) Corion Amargo, (2) Curamhuele and (3) Cortadera.  The table below contains a valuation of these assets based on $1.00/boe equivalent and the P90 evaluation drawn from a report by a petroleum consulting firm called Ryder Scott.  Ryder Scott has done work for most of the major oil companies in the basin, including YPF and Chevron. Madalena selected Ryder in part because they knew that potential buyers would respect the assessment.

Link to Ryder Scott report:

https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/MVN%20Press%20Release%20-Resources%20April%2030%202013%20FINAL.pdf

Although the price of oil is in the $90/barrel range, I assumed that the value to the company of an undeveloped barrel of oil equivalent was $1.00, to reflect the cost, risk and time value associated with production and development. In addition, I chose to multiply $1.00 by the P90 estimates. The consultant’s P90 estimate represents the amount of BOE equivalent recoverable with 90% probability. These assumptions turn out to be internally consistent with the price per acre implied by recent transactions (see pp. 20-21 of the Haywood report from October 17th).

Haywood analyst: https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/Haywood%20MDLNF%2010.17.13.pdf

Recent transactions in the Curamhuele area have been done in the $5,000 to $10,000/acre range. So, at $5,000-$10,000/acre, Curamhuele alone is worth $0.69-$1.38; note that the midpoint of this range is $1.04 and the valuation I arrived at in the table below is $1.05.  By making conservative assumptions I independently calculated a figure that agrees with the mid-range of the comparable per-acre transaction prices, so I like this approach given that E&P valuation is as much art as it is science.

Corion Amargo is likely to be sold and Cortadera is already stated net of an existing JV with Apache. Curanhuele may be either farmed out or sold. If it’s sold, then I estimate the value at the $1.05 stated in the table above. If it is farmed out, however, then Madalena may have to give up some working interest. Let’s say they give up 50%, so Curamhuele would then contribute only 53c to the valuation instead of $1.05. That would mean the stock is worth $0.36 + $1.05 / 2 + 0.90 = $1.79 instead of $2.31. So, under these assumptions, if they sell Curamhuele the stock is a triple, and if they JV it out, then the stock is a double.

Notes on the blocks:

Corion Amargo:

• 100% of 3D seismic done, 10 exploratory wells drilled on property
• Royal Dutch Shell owns two adjacent blocks and Shell Argentina announced increase shale capex to $500mm in ’14E from $170mm in ’13A.

Curamhuele:

• Chevron, Total, Exxon and Apache hold adjacent blocks
• RBC retained to sell or find JV partner for farm-out

Cortadera:

• Apache is 60% partner, leaving Madalena 49,600 net acres of 124,00 total
• Apache is delivering on its obligation to spend capex in 2014

Although Argentina requires 80% of petroleum profits to be re-invested, Madalena can get around this because their Canadian subsidiary can receive payment from an entity of a major oil company (i.e. buyer/partner) located outside of Argentina.  The company does not like to go advertising this fact, but it’s a reality – and in the end Argentina still gets its resource developed and still gets its revenue from the major oil company that ultimately takes over production.

Conclusion

Madalena is a self-sustaining company with a credible resource base, a deal savvy chairman, a JV with Apache and a team of bankers at RBC marketing 50,000 acres in the leading shale play in Latin America. The stock is 60c while the Canadian assets are worth 31c and the Argentine assets are worth between $2.31 and $1.79. So the stock overall is worth $2.10-$2.62, implying 250%-336% upside. If Argentina is worth nothing, then the downside is 31c (-48%), the upside is 250%-336%, and the ratio of risk/reward is 5.2x-6.7x. This bet is not for the faint of heart, but the environment for the oil and gas business is Argentina is improving, and Madalena’s management is focused on unlocking the value of its assets for the benefit of all shareholders.

Comps: America’s Petrogas (BOE CN, APEOF US), Crown Point Energy (CWV CN, CWVLF US), Apco Oil and Gas (APAGF US)

Trading Axe:

Mike Dilay (mdilay@haywood.com)

Haywood analyst: https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/Haywood%20MDLNF%2010.17.13.pdf

https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/Haywood%20MDLNF%2012.6.13.pdf

Mackie analyst: https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/Mackie%20MDLNF%2012.5.13.pdf

Ryder Scott resource report:

https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/MVN%20Press%20Release%20-Resources%20April%2030%202013%20FINAL.pdf

Corporate presentation:

https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/MVN%20Press%20Release%20-Resources%20April%2030%202013%20FINAL.pdf

3Q13 MD&A:

http://www.madalenaenergy.com/download/Madalena%20September%2030%202013%20MDA%20-%20final%20(3).pdf

Shell Argentina announced increase shale capex to $500mm in ’14 from $170mm in ’13:

https://dl.dropboxusercontent.com/u/67048947/MVN%20CN/Bloomberg%20-%20Shell%20Argentina%20to%20Triple%20Shale%20Capex%20as%20Winds%20Change%2C%20CEO%20Says%2012.10.13.pdf

Catalyst