‘Follow the Mice” to International Plays: Banker

James Mahony – October 17, 2014

When it comes to untested plays around the world, international juniors often open the door for major producers, a Calgary-based investment banker told colleagues in Calgary this week.

“Follow the mice to find the elephants,” said Sonny Mottahed, summing up the approach som majors have taken as they wait for juniors to tackle riskier plays in uncharted, usually onshore regions of the world. “Junior companies lead the pack into new jurisdictions, and they’re often followed by majors.”

Mottahed was speaking at the Calgary Global Exploration Forum’s annual conference in Calgary this week. “At the highest level, [the work] starts off with prospectivity and delivers on exploration success,” he said, acknowledging the past three years have been “fairly challenging” for many international E&P companies.

Thursday’s speakers also discussed how new jurisdictions go about attracting producers. For Mottahed, whose firm Black Spruce Merchant Capital Corp. has backed juniors in the international space, it takes prospectivity, energy reform, new licensing rounds, and “good geopolitics.” In recent years, having unconventional resource potential has also helped, he said.

Juniors entering foreign territory typically pursue one of two strategies, proving up as much resource as they can, then monetizing the play before first production, something he called a “good formula” that’s been proven. Another path is to take steps to improve the value of current discoveries, yet leave enough “meat on the bone” to attract the buy who can deploy the amount of capital needed to get “full value.”

As with domestic juniors, internationals have their preferred venues, and current hotspots include the onshore United Kingdom, France and Germany. In addition, Mexico, Peru, and Myanmar have drawn international E&P players. East Africa has also been a hotspot, with companies exploring in Kenya, Tanzania and Mozambique in recent years.

In some countries, international juniors have boosted national production, as occurred in Colomiba, where they pushed average daily volumes to about 190,000 boe per day. Yet, the reason some international jurisdictions are in favour, while others fall out, is more complex. Mottahed said fiscal and regulatory changes can be the root of a change in attitude – for or against – the host country.

Nothing a familiar pattern, he cited the Kurdistan region of Iraq, where acreage was acquired by sever juniors early in the game. In many cases, those companies later sold their interests to much larger players, including majors that had initially stayed away.

A similar pattern unfolded in Poland, where such juniors as BNK Petroleum Inc., San Leon Energy plc and 3Legs Resources plc initially led the country’s shale gas rush. Today, those players have been displaced by Chevron Corporation, ConocoPhillips, Italy’s ENI S.p.A., France’s Total S.A. and other global heavy-hitters, who are able to invest the substantial capital needed to develop reserves.

Yet, while the potential reward in the international arena is often high, the space is also perceived as risky by many lenders and underwriters. Another speaker at Thursday’s CGEF conference agreed the last few years have been a challenge, as public equity issues by international E&P companies have fallen, whether measured by deal value or the number of deals closed.

“For good companies with good ideas and assets, there’s always an ability to get [capital], just maybe not at the price you wanted,” said Rob King, managing director for RBC Capital Markets. He called the recovery in international E&P companies “gradual”, noting the stocks of some companies have traded at or near their historical lows.

On that score, King has seen a disconnect between the public market valuations of internationals and their business performance. He cited an example: Calgary-based Gran Tierra Energy Inc., which operates in South America. The company’s stock has traded at roughly 2.5 times cash flow, he said. While issuing stock in public markets has been a mainstay for many juniors, international players have had to work harder recently to raise money, and are also sourcing debt capital and private equity. Ross Robertson, an executive with New York-based Durham Capital Corporation, said his firm taps secured, junior and senior debt capital from institutions, often pension funds, insurance companies and university endowment funds.

When it comes to clients, Durham looks for international companies that are “liquidity-strained by temporary circumstances.” The firm practises reserves-based lending. “At the end of the day, it boils down to the collateral value of the [borrower's] assets,” he said. “If they were sold, what kind of price would they raise?” He acknowledged his firm’s clients pay a higher price, in the form of a higher interest rate and higher fees, in return for greater flexibility.

Another speaker, representing two ‘pure-play’ exploration juniors that operate in Indonesia and Africa, posed a question to panel members discussing the financing climate for international juniors. “What sort of characteristics need to come back into the market to make it frothy for exploration companies?” he asked.

“This is a risk-return business,” said Pentti Karkkainen, a founder and senior strategy advisor with Calgary-based KERN Partners Ltd., a private equity firm that focuses on the energy sector.

“To the extent that [investors] can achieve returns by taking less risk, they’re going to do that. …I think [Rob King's] charts show that, given [company] valuations and where people can otherwise invest a dollar, they can get very attractive returns on a risk-weighted basis by doing things other than taking risks associated with exploration. So, why would you do that?”

After Thursday’s panel discussion, Karkkainen said private equity firms like his are always looking for good assets in the companies they back, but “top-decile” management teams are still key.

“It still starts with management, and our appreciation of their capability to truly build something of standing and consequence, to somehow differentiate themselves. There is no formula that says ‘this is the way it’s gonna be.’ It’s based on a view, a feeling, and the experiences and skill sets of management to be able to do something.”

With a longer time-horizon than some firms, KERN backs a company on the understanding that they will be working together for a while. “You can source a deal, but then you have to live it for maybe seven, eight or nine years,” he said. “Becoming truly a partner with the management teams really makes a difference.”

Before starting KERN, Karkkainen worked as an analyst in the investment community. “Back in my analyst days, I used to say the loneliest job in town is the CEO’s. It’s still a very lonely job, because who does that individual talk to when things aren’t going quite right? You want to develop that kind of relationship with a management team and work things through when they’re tough.”

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Follow the Mice to International Plays