Description
On Sept 23, 2004, Midnight agreed to acquire Vintage Canada for C$350 million. The reorganization became effective today (Nov 30) whereby each shareholder of old Midnight will get one unit of Daylight, a new energy trust, and one share of Midnight exploration. These two units will trade separately on Dec 2 and jointly offer about a 10% upside in the short term and about a 35% upside over 12 months. I expect the Trust to trade at about c$11.50 in the near term and about $12.50 by end 2005. The exploreco should trade at about $2 when separated and $4 by end 2005 (pre a 2:1 consolidation).
The acquisition of Vintage was a tremendous coup for Midnight. Vintage had acquired these properties in Q1 2001 through the acquisition of Genesis Exploration. On expiry of the non-compete agreements, the top management of Genesis departed and the properties were neglected and operated in a 'blowdown' mode. For example, at Sturgeon lake, one of the major properties, Genesis had been able to increase oil production by 100% in the 1st year and gas production by 170%. However, under Vintage, oil production declined by 30%/yr while gas declined by 40%/yr. This neglect will allow the trust and exploreco to both maintain and increase production through relatively straightforward techniques such as infill drilling, waterflood re-activation and exploit the 500,000 undeveloped acres. Similarly, costs will be better controlled through power optimization, battery/gas processing consolidation etc.
Vintage was acquired at about a 30-40% discount to similar acquistions in 2004 - $10.18 per proved & probable reserves and 5x DACF. I believe that this discount occurred because some of the gas is sour, because the assets had been completely neglected and Midnight was able to come up with a creative equity and convetible debt financing package. The management of Midnight certainly has the right credentials - they sold the previous company, Ulster, for $900 million and have grown production per share at 160% in Midnight over the last two years.
The Daylight Energy Trust (DAY.UN CN) will have production of 15,000 boe/d (73% gas) and cash flow of $118 million - based on cash distribution of $1.44/unit (44 million units), the Trust will be distributing 54% of cash flow. At a 13% initial yield, the Trust should trade at about $11.09. The average trust currently yields less than 12% and distributes about 70% of cash flow. By re-investing 46% of cash flow, Daylight should be able to implement some synergies and also grow production to about 15,500 boe/d by end 2005. In q4 2005, cash flow should annualize to $1.50/unit and at a 12% yield, each Trust unit should trade at $12.50.
Midnight oil exploration (exploreco - MOX CN) will have 750 boe of initial production. The predecessor company, Midnight, traded at $7.25 with a NAV of $2.75 prior to the Vintage acquisition for a NAV multiple of 2.6. If the same multiple is applied to MOX's NAV of $.75, it should trade at about $2, before the 2:1 consolidation. I expect exit 2005 production to be north of 2000 boe and NAV to increase to $1.60 which should lead to a price in excess of $4 at the same multiple.
To summarise, valuations are as follow:
On Split or by Dec 2004: Trust - $11.09, Exploreco $2, Total $13.09
Dec 2005: Trust - $12.50, Exploreco $4, Total $16.50
Catalyst
1. Midnight Oil & Gas will split into two companies, Daylight Trust and Midnight exploreco, both of which will trade separately from Dec 2 on the TSX.
2. In the current low interest rate environment, O&G Trusts have done spectacularly due to the high yield. The Daylight Trust is assumed to stabilize around a 13% yield in the short term and a 12% yield in the intermediate term. The exploreco has very significant land assets and will grow very strongly over the next year.
3. Management was able to acquire the Vintage Canada assets at a very significant discount to fair value.