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Challenges in Malaysia’s SPAC land

Updated: Saturday June 14, 2014 MYT 11:54:03 AM

Challenges in SPAC land

BY STARBIZWEEK TEAM

HOW much control should Special Purpose Acquisition Companies (SPACs) exert over the assets they acquire? This is a question that is increasingly becoming a moot point with listed SPACs.
Here’s one indication of this: According to sources, Reach Energy Bhd, the oil and gas SPAC seeking a listing on Bursa Malaysia, has tweaked one the clauses in its prospectus relating to control over the assets it hopes to buy. It has now stipulated that it will seek to secure majority control over the assets it buys into. 
Apparently this was done to ensure there was no confusion in this area going forward.
SPAC guidelines from the start, had a very strict view on this matter. The rules initially required SPACs to secure both majority ownership and management control over the assets they buy. Subsequently, the rules were loosened after taking into consideration the dynamics of certain industries such as the minerals and resources industry that includes oil and gas.
Here, especially in large production or exploration fields, the norm is for a few parties to have stakes without anyone having more than 50% as a means to diversify the huge capital requirements and spread business risks.
Hence the SPAC guideline rules then allowed for instances where SPACs may acquire non-majority stakes. But the condition of this was that the SPAC still needed to demonstate that it exerted “management control” over the operations of the asset.
For already-listed CLIQ Energy Bhd, the SPAC has had to consider going back to the drawing board of one of its planned acquisitions to ensure it had sufficient control over asset it was looking to buy, sources say.

Then there’s the recently-proposed acquisition by Sona Petroleum Bhd – it said it planned to fork out US$280mil (RM903.64mil) for a 40% stake in an operating asset of London-listed Salamander Energy Plc.
Details on this deal aren’t available yet as the company is yet to ink its sale and purchase agreement with Salamander, only having announced a heads of agreement.
Indeed Sona’s planned acquisition is one of the bigger stories hogging the talk space among retail investors these days.
Instead of seeing investor interest grow after it announced the planned deal, the stock has retreated by 12%.
It isn’t yet clear why the stock had been sold down.
But one factor could be this: on the day of Sona’s announcement, a major bank issued a note to its private banking clients to “take profit” on the grounds that Sona was poised to be an oil and gas exploration and production player and hence the risk-rewards were different.
The note said that the 72% return for Sona’s IPO investors was “phenomenal” and it was time to take some money off the table.
“Going forward, Sona will be transformed into a typical E&P company that is subject to exploration risks and oil price fluctuations.”

That note, however, failed to examine in detail the quality of the asset being acquired.
In fact indications are that the asset Sona is buying into is value accretive to its shareholders.
Sona officials say they will elaborate on finer details of the deal after they ink the sales and purchase agreement.
A key issue is that Sona will have to indicate that despite having only a 40% stake in the operating asset, it does have management control over it.
All about management control
But why the fixation with management control? If the SPAC is acquiring a stake in a very good asset at a very good price, then aren’t the SPAC shareholders going to gain?
The answer lies deep in the philosophy of SPACS.
The rules were created to allow experienced professionals to raise funds from the capital market in order to buy into assets from which they can value add.
If SPACS were going to buy passive stakes in great assets, then they would be more likened to a close-end fund such as iCapital.biz Bhd, which invests into listed companies.
But SPACS are expected to operate the assets they buy in order to be in the drivers’ seat of those assets.
“The promoters of SPACs need to display economic activity and not just financial and strategic moves. They must be seen to be rolling up their sleeves up and getting involved in the management of the assets they acquire to create value for their (SPAC) shareholders,” explains an investment banker.
The qualifying acquisitions of SPACS have therefore to go through both qualitative and quantitative tests – the former addressing issues such as management control and the later, to ascertain the earnings and potential of the said asset.

This philosophy also has an accounting element to it. In order to equity account and consolidate cash flows and earnings, one has to display it controls the management of the owned asset.
The next question to ask is what exactly entails management control?
The test has to be one of substance over form, notes a corporate lawyer familiar with the SPAC guidelines.
“This “control” issue can take many permutations. In the end, the SPAC has to show that in substance, it has full control over the asset,” he says.
One industry player puts it this way: “You have to be the guy who calls the shots for schedules as in when to drill or when to issue a capital call. If another party is deciding that, then you may face dilution (in the asset ownership) if you can’t come up with the money for a sudden cash call,” he says.
“Of course some claim that blocking rights are as good as having control. But its not the same.”
Drawing from the experience of Hibiscus Petroleum Bhd, the only listed SPAC to have concluded its qualifying acquisition, where it acquired a 35% stake in a Middle East based exploration firm, Lime Petroleum. Hibiscus became the project manager of the asset and earned a project management fee for that role. It is also understood that it paid a premium for its 35% stake as that acquisition came with management control over the concessions.

One typical feature in joint operating agreements in the oil and gas space is that parties may have blocking rights, whereby they are able to block decisions made by the operator.
Then there are clauses which require major decisions to be made unanimously, meaning that all consortium shareholders have to agree.
“However, none of this maybe as good as taking over the key management and financial position of the operator,” opines the lawyer.
That though may be easier said than done. For starters, why would the other consortium members allow the new entrant, who does not have majority ownership, take over the running of say a producing oil and gas asset?
Furthermore, the SPAC managers will have to display sufficient track record in being able to garner the confidence of the other consortium members to hand over the reins of the operations to them.
That again, goes back to the SPAC philosophy – the managers have to have that amount of standing in the business segments they operate in, convincing all that their management control over the asset would bring about more value than by them merely being a passive shareholder.
Still, the control issue indicates the serious challenge SPACs face: if they were to pursue buying majority ownership in the asset, then they would probably end up paying a significant premium.
That in turn makes finding acquisitions that deliver attractive returns all the more challenging.

 

Updated: Saturday June 14, 2014 MYT 7:02:41 AM

Sona’s value accretive deal

QUALITATIVE issues aside, Sona Petroleum Bhd’s planned acquisition of London-listed Salamander Energy Plc’s Thai assets has its merits.

For starters, the part producing, part exploration assets will be earnings accretive for Sona.

According to Salamander, the operations at their producing Thai oil field (called Bualuang) had an average production of between 7,000 and 8,000 barrels of oil per day (bopd) between 2008 and 2012, but following additional investments, production increased 71% to 12,300 bopd in 2013.

Based on Sona’s 40% equity, it will be entitled to almost 5,000 bopd, based on 2013 volumes.

Production is expected to rise to 14,000 bopd in 2014, raising Sona’s entitlement to 5,600 bopd and thereby giving it positive cash flows.

Significantly, one report indicates that Sona is paying slightly less than whatSapuraKencana Petroleum Bhd paid for the oil and gas assets of Newfield International Holdings last year, when valued on a price per barrel of oil.

According to JP Morgan, Sona is paying US$23.30 per barrel for this deal based on the 2P (proven and probable) reserves.

Sona’s acquisition is for 100% oil.

“The deal equates to an enterprise value (EV)/2P of US$23.30 per barrel of oil (pboe) and EV/2P + 2C of US$12/boe, versus PTT Exploration and Production Pcl’s acquisition of Hess Corp’s Thai assets at US$12 pboe (87% gas), and EV/2P of US$15pboe for Espanola de Petroleos SA’s acquisition of Coastal Energy Co,” says JP Morgan. (2C refers to the best estimate of contingent resources)

“Although the acquisition multiple of US$23.30 pboe is on the higher side compared to Coastal and Hess deals, it is on a lower side compared to Newfield’s acquisition,” says JP Morgan.

Another endorsement of the Sona deal can be found in the fact that international bank BNP Paribas SA has agreed to extend Sona a loan of US$140mil for the deal.

“BNP Paribas is known to be conservative when it comes to oil deals. The fact that they are financing the deal is a show of confidence in the viability of the asset,” says an oil and gas executive.

Nonetheless over the week, Sona’s share price continued to react negatively to Sona’s announcement.

Since the quality assurance (QA) announcement last Thursday, Sona’s mother share and warrants have declined by 12% (7 sen) and 12.5% (4 sen) respectively to close at 52.5 sen and 28 sen.

On June 5, Sona announced an agreement to acquire a 40% stake in Salamander’s operated Thai interests for US$280mil in cash. The deal is subject to both regulatory and shareholder approvals of both Salamander and Sona.

Under the terms of the deal, Sona will pay US$250mil for a 40% stake in the B8/38 concession, which includes the producing Bualuang oil field. The B8/38 field, which is shallow in nature with depths of 60m, has been producing since 2008.

Sona will also pay US$30mil (RM96mil) for a 40% stake in the G4/50 exploration concession.

Included in this is the carrying costs to Salamander, where it will be funding the drilling of two exploration wells.

Sona will make an additional payment of up to US$15mil (RM49mil) in the event of a commercial discovery on G4/50.

JP Morgan says that according to Salamander Energy, the Bualuang field in B8/38 contains 30 millions of barrels (mmboe) of 2P oil and 27.8mmboe of 2C (best estimate of contingent reserves) resources with a production average of 12,300 barrels in 2013. Production is expected to reach 14,000 barrels (5,600 barrels for Sona based on its 40% stake) in 2014.

JP Morgan adds that assuming there are 12,000 barrels of gross production in 2015, Sona can generate revenue of over US$150mil (RM480mil).

“Sona can also benefit from approximately 40 million barrels of oil (net to Sona) of prospective resources at G4/50,” says JP Morgan.

The Bualuang production licence is scheduled to expire in 2026. However, the operator has the option to extend the production licence for a further 10 years if it can prove sufficient reserves for production to continue.

 

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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