| 2012 | 2013 | ||||||
| Price: | 9.51 | EPS | $0.00 | $0.00 | |||
| Shares Out. (in M): | 50 | P/E | 0.0x | 0.0x | |||
| Market Cap (in $M): | 476 | P/FCF | 0.0x | 0.0x | |||
| Net Debt (in $M): | -21 | EBIT | 0 | 0 | |||
| TEV (in $M): | 455 | TEV/EBIT | 0.0x | 0.0x | |||
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Undervalued spin-off opportunity: Long SilverWillow Energy by way of SilverBirch Energy (TSX: SBE)
Please see the following PDF document for relevant charts, graphs and maps: http://www.scribd.com/doc/80803040/SilverWillow-Analysis
Introduction
SilverBirch Energy is a pre-production oil sands company that is being acquired by Teck Resources. The consideration offered for SilverBirch is $8.50 cash plus one share of a spin-off called SilverWillow Energy. SilverWillow will be spun-off upon completion of the Teck transaction with 3 assets: $25mm in working capital, 1.69 billion barrels of bitumen in-place at their 100% owned Audet oil sands lease and 100% interest in 117,120 acres of oil sands exploration land across the Birch Mountains and Jordan leases.
Overview
UTS Energy begat SilverBirch. And SilverBirch begat SilverWillow.
UTS Energy came to prominence in the mid-2000’s Athabasca oil sands boom. UTS’s main asset was a stake in the undeveloped Fort Hills mining project. During the 2008 financial crisis, WTI crashed to $34.00/bbl from $145.00/bbl, bringing along UTS’s stock price, which tanked from >$5.00 in June 2008 to $0.60 less than four months later. On January 28, 2009, Total E&P announced a low-ball hostile bid of $1.30 for UTS. Shares of UTS consistently traded through the hostile bid which was raised to $1.75 and then eventually dropped. Total E&P came back to the table on July 7, 2010 with a substantially better friendly deal at $3.08 cash plus shares in spin-off SilverBirch. SilverBirch began trading on October 7, 2010 at $5.64 (post 10:1 consolidation). On January 9, 2012, Teck Resources announced a $460mm friendly acquisition of SilverBirch at $8.50 cash plus shares in spin-off SilverWillow.
Teck will acquire SilverBirch by way of plan of arrangement. Holders of 48.4% of shares have locked-up their shares (West Face, TCI, D&O plus Teck’s toehold). The transaction is strategic for Teck, because it is consolidating the Frontier and Equinox oil sands mining projects and the Twin Lakes leases (all of which Teck and SilverBirch hold as 50/50 partners). Due to this relationship, and the fact that SilverBirch was well-shopped, I don’t see a potential for interlopers. The transaction was valued at $0.33/bbl of contingent resource, based on a $460mm deal value, which excludes value of the 50% interests in the Birch Mountains and Jordan leases transferred from UTS to SilverBirch. SilverWillow is set to begin trading upon closing of the Teck transaction, which is expected by April 16 2012. Closing conditions include a positive vote by 66 2/3 of shareholders and approval from the competition bureau. These conditions are rubber stamps at this point.
Valuation
| SilverBirch Price | $9.51 |
| Cash Consideration | $8.50 |
| SilverWillow Implied Price | $1.01 |
| F/D Shares Outstanding | 53.5 |
| Market Cap ($mm) | $54.0 |
| Net Debt ($mm) | ($25.0) |
| Enterprise Value ($mm) | $29.0 |
| In-place Resource at Audet (mmbbl) | 1,690.0 |
| Estimated Recover Factor (Low Case) | 25% |
| Estimated Recoverable Resource (mmbbl) | 422.5 |
| EV / bbl In Place | $0.02 |
| EV / bbl Recoverable | $0.07 |
| Impled Price / Book | 0.6x |
SilverBirch shares are currently trading at $9.51, implying a SilverWillow value of $1.01 and a market cap of $54.0mm. SilverWillow will be seeded with $25mm in working capital, implying an enterprise value of $29.0mm. The Audet in-situ oil sands project will be the company’s focus of activity as it is their most valuable asset. Audet contains 1.69 billion barrels of “discovered bitumen initially in place” as evaluated by well-respected petroleum consulting firm Sproule Associates. The company’s near term plan is to further develop the Audet lease in order to receive a contingent resource assessment by Q4 2012 or Q1 2013. The market values non-producing oil sands companies off of their resource (contingent or prospective) and their reserves, so the establishment of a contingent resource estimate should re-rate the stock upwards in-line with its comps. The Audet lands have had 34 core holes drilled and are in proximity to projects by Suncor, Imperial Oil and Cenovus.
For this analysis, I have estimated a recovery factor of 25%, which is conservative. SAGD (“Steam Assisted Gravity Drainage”) projects have fairly variable recovery rates. For reference, I have included a few third party SAGD recovery estimates:
| Precedent Oil Sands Transactions - Pre-Production In-Situ Projects | ||||
| Date | Value ($mm) | Recoverable Resource (mmbbl) | $/bbl | |
| Grizzly acquisition of Petrobank's May River asset | 31-Jan-12 | $225 | 715 | $0.31 |
| PetroChina acquisition of AOSC MacKay asset | 3-Jan-12 | $680 | 687 | $0.99 |
| Athabasca acquisition of AOS / CLL Halfway Creek asset | 27-Sep-11 | $54 | 156 | $0.35 |
| PTT Exploration & Production acq of 40% of Statoil's Kai Kos Dehseh SAGD project | 22-Nov-10 | $2,327 | 1,080 | $2.15 |
| Southern Pacific acquisition of North Peace Red Earth asset | 27-Sep-10 | $14 | 105 | $0.13 |
| CNRL acquisition of Enerplus Kirby asset | 21-Sep-10 | $405 | 520 | $0.78 |
| Athabasca acquisition of Excelsior | 13-Sep-10 | $119 | 183 | $0.65 |
| Storm acquisition of Surmont lease | 10-Jun-10 | $54 | 112 | $0.48 |
| BP Canada acquisition of 75% interest in Terre de Grace project from Value Creation | 15-Mar-10 | $900 | 2,015 | $0.45 |
| Devon Energy acquisition of 50% interest in Kirby leases from BP Canada | 11-Mar-10 | $650 | 750 | $0.87 |
| PetroChina acquisition of 60% interest in JV assets from Athabasca | 1-Sep-09 | $1,900 | 3,019 | $0.63 |
| Occidental acquisition of 15% working interest in Joslyn | 23-Jun-08 | $500 | 370 | $1.35 |
| Ivanhoe acquisition of Talisman leases | 28-May-08 | $105 | 294 | $0.36 |
| Husky Energy and BP's exchange 50% interest in Sunrise Oil Sands/Toledo Refinery | 1-Jan-08 | $1,318 | 1,600 | $0.82 |
| MEG Energy acquisition of Paramount's Surmont leases | 31-May-07 | $302 | 409 | $0.74 |
| Petrobank acquisition of 16% working interest in Whitesands | 11-Jul-07 | $120 | 644 | $0.19 |
| Statoil acquisition of North American Oil Sands | 27-Apr-07 | $2,200 | 2,200 | $1.00 |
| Enerplus acquisition of Kirby leases | 11-Apr-07 | $183 | 220 | $0.83 |
| ConocoPhilips upstream/downstream JV with EnCana | 5-Oct-06 | $3,100 | 3,250 | $0.95 |
| KNOC acquisition of Newmont's Blackgold project | 24-Jul-06 | $303 | 250 | $1.21 |
| Total acquisition of Deer Creek | 2-Aug-05 | $1,674 | 1,880 | $0.89 |
| Average | $0.77 | |||
| Median | $0.78 | |||
| Minimum | $0.13 | |||
| Maximum | $2.15 | |||
| Average of Select Transactions | $0.61 | |||
| SilverWillow | $29 | 423 | $0.07 | |
| SilverWillow Discount to Average of Select Transactions | -89% | |||
Pre-production oil sands companies are valued based on their recoverable resource estimate (their barrels in the ground). This market is relatively liquid as there have been numerous oil sands transactions over the past five years. I estimate a recoverable resource for SilverWillow of 423 million barrels, based on a conservative 25% recovery rate on 1.69 billion barrels in place. On average, pre-production in-situ projects have been acquired at $0.77/bbl. Smaller early stage projects have been acquired for $0.61/bbl on average. SilverWillow is currently trading at $0.07/bbl, which represents an 89% discount to its most direct comparables and a 48% discount to the lowest transaction value of $0.13/bbl (this was a very small and poor quality asset).
Sum of Parts Analysis
| Sum of Parts | Low | High |
| Working Capital ($mm) | $25.0 | $25.0 |
| Working Capital (per share) | $0.47 | $0.47 |
| In-place Resource at Audet (mmbbl) | 1,690.0 | 1,690.0 |
| Recovery | 25% | 35% |
| Estimated Recoverable Resource (mmbbl) | 422.5 | 591.5 |
| Resource Value ($/bbl) | $0.15 | $0.35 |
| Resource Value ($mm) | $63.4 | $207.0 |
| Resource Value (per share) | $1.19 | $3.87 |
| Birch Mountains / Jordan (Acres) | 117,120 | 117,120 |
| Land Value ($/acre) | $100.00 | $200.00 |
| Land Value ($mm) | $11.7 | $23.4 |
| Land Value (per share) | $0.22 | $0.44 |
| F/D Shares Outstanding | 53.48 | 53.48 |
| Sum of Parts NAV ($mm) | $100.1 | $255.4 |
| SilverWillow Value | $1.87 | $4.78 |
| SilverWillow Implied Price | $1.01 | $1.01 |
| Upside | 85.3% | 372.9% |
| Book Value | $1.80 |
The largest driver of value in the company is the bitumen resource at Audet. I have utilized a conservative value range of $0.15 - $0.35 per recoverable barrel, as compared to precedent transactions at $0.61/bbl. The most recent comparable oil sands deal was Grizzly’s acquisition of Petrobank’s May River asset for $0.31/bbl. SilverBirch, SilverWillow’s parent, is being acquired at ~$0.33/bbl.
I have used a range of $100 - $200 per acre to value the company’s exploration lands. This is in line with recent oil sands lease sales. However, given that the best leases were taken up in the great oil sands land grab of the mid-2000’s, recent sales are more likely to be of poor quality and therefore SilverWillow’s exploration lands may be worth significantly more. In mid 2005, oil sands leases averaged over $700 per acre. Over the past few years land sales have been around $100 per acre. On February 3 2012, bankrupt Oilsands Quest announced the sale of their small, unexplored Eagles nest property for $4.4mm, implying $193 per acre. This property is immediately west of Birch Mountains.
In summary, the company has $0.47 per share in cash, $1.19 - $3.87 per share in resource value and $0.22 - $0.44 per share in land value. This equates to a total value per SilverWillow share of $1.87 - $4.78 per share, reflecting upside to current of 85% - 373%. The company states its book value at $1.80 per share, in-line with my low range intrinsic value estimate.
SilverBirch Spin-Off Outperformance
On July 7 2010, Total E&P announced that it was acquiring UTS Energy. The consideration was $3.08 per share in addition to shares in spin-off SilverBirch. SilverBirch was seeded with $50mm in working capital and initially held 891mmbbl of contingent bitumen resource. Post announcement of the acquisition by Total, SilverBirch shares dramatically outperformed, finishing up the year 97.8%, compared to 19.6% for the Oil Sands Total Return Index. The resource was initially valued by the market at $0.14/bbl upon announcement. This valuation grew to $0.25/bbl upon spin-off and $0.33/bbl by year end.
Currently, the market values SilverWillow’s resource at an estimated $0.07/bbl, which is a substantial discount to SilverBirch’s historical valuation.
Shareholders
| Shareholders | Shares | % Basic | % F/D |
| Kevin Douglas | 9,630,200 | 19.3% | 18.0% |
| West Face Capital | 9,468,426 | 18.9% | 17.7% |
| The Children's Investment Fund | 9,373,739 | 18.7% | 17.5% |
| Teck Resources | 4,700,567 | 9.4% | 8.8% |
| Directors and Officers | 520,192 | 1.0% | 7.5% |
| Total Holdings Disclosed | 33,693,124 | 67.4% | |
| Float | 16,312,907 | 32.6% |
Wealthy investor Kevin Douglas initially disclosed his stake in July 2011, and continued to acquire shares up until Jan 18 2012 (after the Teck / SilverBirch acquisition announcement). West Face acquired their stake after Total’s initial hostile bid for UTS. TCI acquired their stake after Total’s friendly deal with UTS. Insiders only own ~520,000 shares (1% of the company), but have 3,373,000 options struck at $6.42 (7.5% of the company). SilverWillow will be well-supported by large, successful investors, in addition to a management team with a meaningful stake in the company. Both West Face and TCI have Board representation (however SilverWillow has not disclosed whether any Board changes will be made upon spin-off)
Strategy
SilverWillow will never make any money. They are not in the business of producing oil. They are in the business of creating value by developing oil sands assets and selling them to large oil companies. This strategy was successfully executed at both UTS and SilverBirch. SilverWillow will be led by Howard Lutley, the former President and CEO of SilverBirch and former VP Mining of UTS. This company will get sold at some point in the next one to three years.
Risks
As a pre-production oil sands development company with no cash flows, SilverWillow’s stock price will be correlated with risk assets in general, more specifically the price of oil. One could hedge this risk by shorting a basket of oil sands companies or by shorting an underperforming heavy oil developer such as Ivanhoe Energy (TSX: IE).
The Audet lands are still in early stages and are not yet delineated enough for a contingent resource estimate. Of particular concern is the integrity of the cap rock, which is essential in order to have a successful SAGD project. There is no certainty that this project will become commercially viable. However, SilverBirch’s management team has had two past successes and they know this asset best. I do not believe they would go forward with Audet as their crown jewel and company-maker without high conviction in its viability as an in-situ oil sands project.
Catalysts
Conclusion
SilverWillow is a substantially undervalued spin-off. Its parent SilverBirch was also a spin-off and made investors a lot of money with a 164% return (84% annualized) from July 2010 to present. This is history repeating itself.
I recommend getting long SilverBirch (TSX: SBE) to partake in the SilverWillow spin-off. I have a target price for SilverBirch of $10.40 - $13.30 (currently trading at $9.51), implying a target price of $1.90 - $4.80 for SilverWillow (currently trading at $1.01).
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