Pending a near-term potential asset sale, Molopo’s equity currently trades at a meaningful discount to the pro-forma net cash on its balance sheet and offers a 100%+ return to our conservative estimate of its liquidation value.  This idea was written up in May 2011 by sugar1; please see that write-up for further background. 

While this may look like a value trap being down 50% since sugar's writeup and still trading close to cash value, much has changed over the last year.  We post this with some urgency as there are several imminent catalysts that could wake the market up to the value here.   

Company Overview

Molopo Energy is an Australia-based oil and gas company with exploration and production assets in the Permian Basin, Western Canada, Queensland Australia, South Africa and Quebec.  Molopo has a 25-year history, beginning as a mineral acquisition company, and making A$313 million of acquisitions over the last five years.  After pursuing a strategy of acquire and flip for most of its history, Molopo recently adopted the strategy of holding assets through full-scale development.  The first asset to go into full development is the Permian Basin Fiesta Project, the company’s primary focus area and the largest use of capital this year.

Capital Structure

Molopo has approximately 250 million fully diluted shares outstanding and $90 million in net cash as at March 31, 2012.  The company expects to exit 2012 with approximately $25 million in net cash.

Molopo initiated an on market share buyback program in May 2011 when the share price was A$0.79, as management and the board believed that the company was extremely undervalued.  The company cancelled the program in April 2012.  In total, the company repurchased 5.6 million shares at a cost of A$4.3 million (A$0.76 average). 

Management Background

Tim Granger - CEO - was appointed in November 2011.  Previously Granger was CEO of Compton Petroleum, COO of PrimeWest Energy and Managing Director at TAQA North. Granger brought several members of his technical team from Compton with him to Molopo, including Ms. Shannon Ouellette (current Molopo COO).  While not responsible for the destruction of shareholder value at Compton, Granger failed to execute on the turnaround strategy he was brought in to execute.  Compton is currently the subject of a tender takeover (expiring August 16) by MFC Industrial (MIL) that is supported by Compton’s Board.  MIL is apparently purchasing Compton at or near the value of Compton’s tax pools.  As Granger’s background is primarily in production management, it remains to be seen how successful he will be running an exploration company.   

Management and Board Turnover 

In January 2011 a shareholder group led by Max Beck, founder of Becton Property Group, moved to replace chairman Donald Beard and non-executive chairman David Hobday because of share price underperformance and a “lack of direction”.  The stock was trading around A$1 per share at the time.  After an overwhelming victory at the special meeting, Beck and his appointee Gregory Lewin joined the board in February 2011, the latter as chairman.  They immediately replaced CEO Stephen Mitchell with Ian Gorman, Molopo’s former COO.  Gorman resigned in November 2011 as the board decided to build a North America based management team.

Permian

As of March 31, 2012 Molopo had over 26,000 net acres in Crockett County, Texas.  This includes 25,000 net acres in the Fiesta project and 1,400 net acres in the Barnhart project.  Other operators targeting the Wolfcamp near Fiesta include Approach Resources (AREX), EOG Resources (EOG), El Paso, BHP Billiton (BHP) and Conoco (COP).  Molopo believes that it has captured unrisked recoverable resources of at least 70MMboe, assuming only one prospective interval across its acreage.  Thus far, Molopo has only tested one Wolfcamp zone – the A Bench.  Other prospective zones include the B Bench, the C Bench, the D Bench and the Cline/Cisco.  Most operators have been focused on the B Bench but have had commercial success in all zones.  Secondary conventional targets include Ellenberger and Canyon sands. 

Molopo has one rig under a one-year contract that will drill back-to-back wells in the Permian basin.  After drilling the first Barnhart well, the rig moved to the Fiesta project where it will drill four to five long lateral horizontal wells during the remainder of 2012.  Well costs are estimated to be $9 million, including drilling completion and hook up.  We and management view this estimate to be very conservative given recent declines in completion costs and well costs quoted by other operators in the area.  In full development, well costs should approach $6 million.  The total 2012 budget for the Permian is $75 million. 

We assign a liquidation value to the Permian of $80 million based on approximately $3,000 per acre.  Acreage in the area has sold for as much as $6,000 per acre.  This assigns no value to the three wells that are on production, or the fourth in the process of completion.  Molopo expects to exit the year at a daily production rate of 2,300 boe, the vast majority of which would come from the Permian.  Based on a conservative market multiple on daily production of $50k per flowing barrel, this production would be worth approximately $115 million.   

Fiesta Project

Molopo has 100% working interest in a contiguous 25,000 acre block.  The original acreage was acquired at an average cost of $300 per acre.  Molopo recently bought out its 22% non-op partner for $9 million ($1,660/acre).  The selling partner retained an after payout reversionary interest of 20%.  The work commitments, based on 7 leases with different ranches, required a $2.5 million spend in the first 18 months and contained a primary term of three to four years.  Molopo has spent $6 million on seismic acquisition.

To date, Molopo has drilled three “science” wells in Fiesta with encouraging yet not convincingly economic results.  The primary purpose of the first three wells was to confirm that the Wolfcamp would produce oil in this area.  Since being placed on rod pump in early May, the three wells in aggregate have produced between 300 and 550 barrels of equivalent oil production per day.  Data obtained from electric logs, core samples and initial production confirm that the area is indeed in the oil window.  There had been much skepticism that the Wolfcamp in Fiesta would be thermally mature enough to produce oil.  The data, on an absolute basis and as compared to those of other operators, show superior porosity, permeability, thermal maturity, oil saturation, and total organic content.

Subsequent wells will focus on proving commerciality using drilling and completion techniques proven successful by offset operators in the area.  Management is confident that they can achieve a 2.5-5x uplift over the initial wells, or initial production rates of approximately 600 boepd.  Per well recoverable reserves are estimated to be 450Mboe with a pre-tax IRR of 30%.   

Barnhart Project

Molopo has a 100% working interest in a 1,400 acre block offsetting EOG’s University Lavan project in northern Crockett County.  EOG’s wells there have had average initial production rates of 910 barrels boepd (77% liquids).  Molopo is currently completing its first well in Barnhart.  Given EOG’s success in the area, we view this well as essentially a proved undeveloped location, with a very high chance of success.  While success in the Barnhart well does not necessarily de-risk the Fiesta project, it will demonstrate the Molopo team’s ability to drill, complete, and operate horizontal oil wells.  It will also be a welcomed source of cash flow.  Molopo acquired this acreage in December 2011 and has no requirement to drill until late 2013. 

Western Canada

Molopo has approximately 45,000 net acres in Saskatchewan that is prospective for Bakken and Midale oil.  The company acquired the vast majority of these lands in September 2009 at a cost of $14 million.  Most of the acreage is exploratory, but the company does have approximately 250 boepd of net non-operated production from some Legacy Oil + Gas (LEG CN) operated Bakken wells.  After some disappointing exploration results this year, Molopo appears to be considering a sale of its Saskatchewan assets.  We believe that fair value for these assets is approximately $25 million.  The company spent approximately $25 million in Western Canada in 2011, and plans to spend approximately $21 million here in 2012.

Molopo sold its other Western Canadian asset – the Spearfish – to Legacy in February 2011 for C$188 million (C$93 million in cash and 6.1mm Legacy shares).  This sales price was approximately A$0.75 per Molopo share.  Molopo sold its LEG shares in January 2012 at an average price of C$11.60 for proceeds of $C71.7 million. 

Our liquidation value estimate for Western Canada is $25 million - $10 million for the production and $15 million for the exploration acreage.  The acreage could be worth much more, but without further capital spent, we think $10 million is very conservative at less than $250 per acre.

Queensland

Molopo owns five coalbed methane project areas in the Bowen Basin of Queensland, Australia.  This property has been a divestment candidate for more than a year now.  It is moving into the development phase and requires substantial capital investment, which the company is not in a position to fund.  Molopo has invested approximately $65 million in Queensland to date.  We originally expected that any proceeds from a sale would cover the cumulative costs; however, recent management body language indicates that the company would sell for somewhat less.  We believe a sale of Queensland is imminent, as the company has said publicly that it is in final negotiations with the buyer, has agreed on a price and is finalizing the purchase and sale agreement. 

South Africa

Molopo owns two biogenic gas prospects in South Africa.  Proved and probable reserves are 9.2 Bcf and 23.0 Bcf, respectively.  The company will shortly be awarded its production license from the government.  Recently, Molopo has stated publicly that it will likely sell South Africa in 2012.  We believe that the fair value of this asset is $10 million.  We had previously assigned no value to this asset, but based on management’s guidance to a potential sale, the cost to date seems like an appropriate value.

Quebec

Molopo holds 1.4 million acres in the Quebec Lowlands that is prospective for shale gas development.  Several other operators have had encouraging initial results, which confirm substantial gas resource in place.  However, a government ban on hydraulic fracturing is in place through 2014.  Molopo will hold its licenses at no cost until the government decides how to proceed.  We value Quebec at zero.  The optionality here is obviously tremendous as the asset could ultimately prove to be a TCF resource.  The government ban could also be viewed as a blessing in disguise as it allow Molopo to maintain its position without having to put capital into drilling while gas prices are uneconomic.

Liquidation Valuation

Please note that the above liquidation valuation assumes an effective date of March 31, 2012.  Molopo’s cash balance will be reduced by approximately $7 million per month as Permian wells are drilled.  However, assuming drilling success, each well should be accretive to NAV by at least $5 million or $0.02 per share.   

1.      Sale of Queensland – If at any reasonable price, the shares are currently trading at a pro-forma negative enterprise value

2.      Permian drilling results – First Barnhart well currently flowing back.  We should have a 30 day rate by the end of August

3.      Listing in North America, likely in Toronto