|Shares Out. (in M):||7||P/E||30||n.m.|
|Market Cap (in $M):||238||P/FCF||4.2||n.m.|
|Net Debt (in $M):||5||EBIT||-41||0|
Norwegian Energy Company (NOR NO), or Noreco, is the remainder of an oil and gas company that has went through multiple restructurings triggered by oil and gas field issues and a high debt load in connection with ongoing developments. The "old" Noreco is now gone, with most assets either sold or relinquished, a new shareholder structure mostly consisting of special situation hedge funds that came in through the debt restructuring and a new management in place appointed by the new shareholders. The remaining assets are an insurance claim, substantial Danish and UK unutilized tax losses, a potential claim for damages and a small stake in the Danish Lulita oil field.
I view Noreco as a highly interesting special situation with multiple upcoming catalysts. My base case assumptions point to 150% upside with very limited downside risk. Additionally, there is no sell-side coverage and investor fatigue is prevalent as many local and international investors were burnt in one of the many restructurings the company went through since 2009.
Having followed the company for a long time I am one of the few who knows the background and current status of the company in-depth and I am convinced this company is highly misunderstood, ignored and massively mispriced on most reasonable scenarios.
To properly understand Noreco one should look at each of the remaining material "assets" in the company, then form a sum of the parts based on likely outcomes to reach a fair intrinsic value range for the company.
Asset #1 - The Siri insurance claim:
In August 2009 cracks were discovered in the structure of the Siri platform installation in Denmark of which Noreco held 50%. The closing of production together with the significant cost related to the repair was financially challenging. Since 2009 Noreco has attempted to engage in a constructive dialogue with its insurers to pay for the loss in accordance with its insurance agreement. The insurers, however, were unwilling to honor the contract, leading to Noreco filing a claim which ended up in a court case that commenced on 12 Sep 2016.
On 15 Dec 2016 the Maritime and Commercial High Court awarded Noreco almost 100% of its claim, including interest and legal fees, clearly indicating the strength of Noreco’s claim.
The full ruling is available in Danish here (351 pages): http://domstol.fe1.tangora.com/media/-300011/files/S-2-14_Dombog_PDF.pdf?rev1
On 17 Feb 2017, The Danish Supreme Court declined to hear the appeal from the insurance companies on the grounds that the Siri Insurance claim case was not viewed as being principle in nature by the court.
On 27 Feb 2017, the Eastern High Court in Copenhagen received an appeal from the insurers, and the court has later accepted to handle the appeal. This will be the final court hearing allowed under Danish law for the insurance consortium as the supreme court has already rejected the case.
Noreco expects the remaining court process to take 1-2 years (likely final ruling mid- to late-2018) but I remain confident that the outcome will not be materially different from the current ruling. A settlement agreement is possible throughout the period. Furthermore, Noreco is due simple interest of 8.05% applied to the $344m award, implying ~$28m per year, as long as the claim remains unpaid.
What to make of this "asset"? Is it as binary as a court case appears at first glance? I contend that it is not.
Reading through the court ruling and following the process after that first ruling shows in my view a clear indication that Noreco holds all the cards and has an extremely strong case, implying a very low probability that the Eastern High Court will overturn the previous ruling.
Firstly, Noreco was awarded pretty close to 100% of the claims they filed against the insurance consortium.
Secondly, they were awarded interest on these claims AND full coverage of legal fees. Such a ruling and the wording of the verdict indicates that the court found the insurance companies clearly in the wrong to such a large extent that they indicated that the case should never have been in the court system in the first place.
Thirdly, after the ruling the Supreme court rejected to review the case, further confirming this thesis.
Finally, my understanding is that the insurance consortium has not submitted any material new evidence to support their case to the Eastern High Court.
So, what does this mean in terms of valuation?
The total award including interest and legal fees amounts to USD 475m. Adjusting for a payment to third parties (Noreco was required to bring in third parties to fund the litigation) and tax Noreco is left with some USD 218m (NOK 240/share). This is directly comparable to the share price of NOK ~255 as net debt is almost 0.
Additionally, the simple interest earned on the award until payment would lift the USD 218m to USD 239m (NOK 262/share) if payment does not occur until Q4 2018.
Impact of court interest on Siri insurance award (USDm & NOK/share):
Asset #2 - Claim for damages:
On 10 Aug 2017 Noreco initiated legal action for damages at the court of Hillerød, Denmark, against the insurers in the Siri insurance claims court case with the claim that the insurers must indemnify the losses suffered by Noreco due to the unjustified rejection of the insurance policy. This includes losses related to refinancing of loans which would not have been as costly had the insurance paid, loss of Siri platform ownership and loss in connection with the required third party litigation funding.
There are clear laws in Denmark that protect insurance holders against insurance companies refusing to pay legitimate claims and the stressed situation in which Noreco found itself due to the lack of payment from insurance companies resulted in several adverse outcomes:
Noreco was “forced to give away” ~$200m to QVT and Awhilhelmsen to be able to pursue the insurance payout
Noreco was forced to sell its stake in the Siri field in 2011, which held an estimated value of $300m at the time (note that this was in a >$100/boe oil price environment).
The lawsuit could thus amount to $200-500m though the final court ruling on such a claim obviously remains uncertain. Noreco expects such a case to cost $2-3m. However, the claim for damages could also be used as leverage against insurance companies to reach a settlement. The insurance consortium consists of many separate insurance companies with whom settlements could be reached individually, potentially against a promise of dropping the claim for damages in return.
While I am reluctant to value this "asset" currently it is clear that the amounts in question are material in relation to the current market value. USD 200-500m equals some NOK 220-550/share on top of the value from the Siri insurance claim.
Asset #3 - Unutilized tax losses:
This is the big asset that remains highly misunderstood or ignored by the market today. Noreco holds NOK ~6.1bn of tax losses in Denmark and NOK ~1.5bn in the UK, all of which are not subject to a time limitation of any kind. Applying proper tax rates for each jurisdiction (52% in Denmark and 40% in the UK, though one has to account for varying balances in the “offshore” and “onshore” tax regimes) this tax position equates to NOK ~440/share of deferred tax assets in Denmark and NOK ~80/share in the UK for a total of NOK 520/share if utilized fully. The issue, of course, is how to utilize these tax losses as the company has no real taxable income in any of these jurisdictions currently.
Geek's note - full detail on each tax loss component can be seen here
I see multiple likely routes to realise all or parts of the tax balances which the market really isn't willing to give any value to.
Noreco could opt for a direct sale of tax losses though this is unlikely to be the most value accretive route for shareholders.
Discussions I've had with Riulf Rustad (the chairman) indicates that in such a sale they could "easily" realise 50% of the tax value.
Noreco could acquire producing assets directly.
Noreco could merge with another E&P company which could utilize the tax losses.
Focusing on Denmark where the largest part of the tax losses reside I identify five portfolios which could fit the bill.
Shell, Chevron, Total (acquired Maersk Oil), Hess and Ineos (acquired Dong) are the likely sellers of assets in Denmark. These portfolios have current production of 10 000-60 000 boe/d. Counting companies potentially open to acquire tax losses the number of potential deals rises from 5 to 9 (Ineos/Dong has tax losses themselves so would not have interest in such a deal).
I believe it is likely that a deal structure involving acquiring assets or merging with another company would imply a value creation well in excess of an outright sale. Noreco is working on achieving this by partnering with a financial and/or industrial partner who could provide the equity financing for a potential transaction while Noreco supplies the tax losses. Obvious candidates to partner with are QVT Financial (already involved through insurance case), Kite Lake Capital Management (major shareholder) and Taconic Capital (major shareholder), all of which are already heavily involved in the company and knows the situation well.
The structure of such a deal would look something like this:
Let's do a quick thought experiment to understand what could be achieved through such a transaction:
Assuming a fair value of acquired assets of USD 1bn (roughly matching value of Shell and Maersk portfolios as estimated by third-party consultancy Rystad Energy), debt funding of USD 500m (50%) against producing assets and equity from a partner of USD 500m. Additionally, assume that the nominal deferred tax assets (DTAs) of USD ~400m are utilized over three years at a 10% discount rate.
This would yield an ownership in the JV to Noreco of 40% and a Net Asset Value for the full JV of USD 830m. This implies USD 330m net to Noreco (83% of DTAs).
Tweaking this calculation by assuming that an acquisition is done at 75% of fair value (given dislocated oil markets and unattractive Danish sector) fair value net to Noreco increases to USD 450m (112% of DTAs).
No discounting of DTAs would yield a realization of 100-132% on these same two scenarios.
While this is clearly "playing with numbers" it is increasingly clear to me that the potential to realise a substantial portion of the DTAs is within reality and it compares highly favourably to the market which is giving little to no value to this asset.
Nominal value of deferred tax assets (NOK/share):
Putting it all together:
To me this is one of the clearest mispricings I have seen in a long time, as seen below when we summarize these assets and their potential value.
Sum of the parts:
I believe the outcome of the Siri insurance claim is quite certain, though payment is still some time away. Thus, my base case remains the current award of NOK ~240/share but excludes any further interest since the award date. Adjusting for NOK 5/share of net debt we reach a core value of NOK 235/share (211 in low case and 258 in high case). This is largely in line with the current share price, indicating n 8% downside (-17-+1% low-high). On top of this we have the DTAs and the claim for damages. I assume a tax value realisation of 50-100% with a base case of 75%, which is below my back-of-the-envelope calculation done above. Additionally I value the claim for damages at 0, except in a high scenario where I assume an award of USD 175m. Adding these components to the valuation yields a low case of NOK 470/share (84% upside), a base case of NOK 635/share (149% upside) and a high case of NOK 990/share (288% upside).
Valuation scenarios (NOK/share):
I believe this special situation investment offers a substantially skewed risk/reward profile even if we allow for the fact the the final outcome may well deviate materially from the assumptions I have laid out here. Other special situation investors known to do their homework seems to have reached the same conclusions as I have. For me this stands out as one of very few home-runs I have come across during my time investing and should warrant a careful look by the VIC community.
I have deliberately excluded discussion of a number of "normal" topics in investment analysis as these are immaterial to the case presented. The company is not producing any material revenue nor have they a meaningful cash burn to discuss. The balance sheet is strong with USD ~160m of debt and NOK ~140m cash and also needs very careful adjustment to eliminate certain capped assets and obligations in Norway which are a legacy from the restructuring process but materially skew IFRS numbers.
Asset transaction to utilize DK tax losses (expected in 2017)
Asset transaction to utilize UK tax losses (2017-18)
Final verdict on insurance case (mid- to late-2018)
Moving forward with claim for damages against insurance companies