Byron Energy Ltd. Riding the waves at Byron ADD

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1 Vol th Oil & Gas Exp & Prodn Australia Equity research November 30, 2015 ADD Current price: Target price: A$0.19 A$0.59 Previous target: A$ Up/downside: 208.4% Reuters: Bloomberg: Market cap: Average daily turnover: BYE.AX BYE AU US$26.40m A$36.65m US$0.01m A$0.01m Current shares o/s 337.9m Free float: 80.0% Price Close Relative to S&P/ASX 200 (RHS) Dec-14 Mar-15 Jun-15 Sep-15 Source: Bloomberg Price performance 1M 3M 12M Absolute (%) Relative (%) James LAWRENCE T (61) E james.lawrence@morgans.com.au Adrian PRENDERGAST T (61) E adrian.prendergast@morgans.com.au Byron Energy Ltd Riding the waves at Byron BYE s board and management team have collectively over 150 years of operating experience in the Gulf of Mexico. The company is using advancements in seismic processing to identify low risk hydrocarbons up-dip of existing production, generally around salt domes. Funding for the upcoming drilling program is required and the company will either need to raise additional equity or bring in a farm-in partner. Initiate with an Add recommendation and an A$0.59 SOTP valuation. An experienced team utilising advancements in technology BYE s board and management team have collectively over 150 years of operating experience in the Gulf of Mexico. The team has been involved in the drilling of 141 wells at a strike rate of greater than 80% and the company intends to use advances in technology to undertake drilling up-dip of existing hydrocarbon production. Funding is the issue BYE had cash reserves of US$3.7m at the end of 1QCY16 and has signed a contract for the drilling of one well with the option for a second well. We estimate it will cost ~US$12m to drill the two wells on a 100% basis and consequently BYE either needs to raise equity or attract a farm-in partner. The company confirmed at the recent AGM that it is currently in discussions with potential farm-in partners in relation to SMI-6 and SMI- 71 as well as Bivouac Peak. It remains hopeful that an appropriate funding structure can be put in place soon for drilling in 1QCY16. but having attractive high returning assets helps Given the significant infrastructure in the region and the substantial reduction in drilling rig rates, BYE s projects generate healthy returns in the current low oil price environment. Because of this we believe that BYE may be able to bring in a partner to fund the drilling of the two planned wells, thereby removing the need for an equity raising. At the company s recent AGM it was noted that discussions are ongoing with farm-in partners. Initiate coverage with Add recommendation and A$0.59 target price We initiate coverage on BYE with an Add recommendation and A$0.59 target price. Our target price offers investors substantial upside potential from the current share price even after diluting for an equity raising (or farming out SMI-6 and SMI-71) to fund the upcoming exploration program. Key risks to our price target include exploration/farm-out success as well as currency and commodity prices. Financial Summary Jun-14A Jun-15A Jun-16F Jun-17F Jun-18F Revenue (A$m) Operating EBITDA (A$m) (2.21) (2.46) (2.80) (2.87) (2.97) Net Profit (A$m) (2.20) (2.49) (2.88) (2.88) (2.98) Normalised EPS (A$) (0.016) (0.013) (0.009) (0.009) (0.009) Normalised EPS Growth (18.4%) (34.1%) 0.1% 3.4% FD Normalised P/E (x) NA NA NA NA NA DPS (A$) Dividend Yield 0% 0% 0% 0% 0% EV/EBITDA (x) NA NA NA NA NA P/FCFE (x) NA NA NA NA Net Gearing (28.6%) (15.3%) (13.0%) (6.9%) 0.4% P/BV (x) ROE (20.0%) (9.3%) (7.7%) (6.8%) (7.6%) % Change In Normalised EPS Estimates Normalised EPS/consensus EPS (x) SOURCE: MORGANS, COMPANY REPORTS IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN ) AFSL A PARTICIPANT OF ASX GROUP Powered by EFA

2 Figure 1: Financial and company summary Byron Energy (BYE) Year to 30 Jun (A $ m) Energy Income statement 2014A 2015A 2016F 2017F 2018F Valuation US$ m A$ m A$ / share Sales SMI-71 (2P reserve NPV) Total revenues SMI-6 (2P reserve NPV) EBITDA EI-76 (risked 3P reserves) Depreciation & amortisation GI-95 (risked 3P reserves) EBIT Bivouac Peak (risked 2C resources) Net interest expense Cash Pre-tax profit Corporate costs Tax expense T o tal Abnormals - pre-tax NPAT Abnormals - post-tax M inorities R eserves P rospective Reported NPAT P 2P 3P Resources (2C ) Oil (mmbbl) C ash flo w statement 2014A 2015A 2016F 2017F 2018F Gas (mmcf) EBITDAX M M B OE Cash flow from operations Capex Disposals Acquisitions Cash flow from investing Incr/(decr) in equity Incr/(decr) in debt Ordinary dividend paid Other financing cash flow Cash flow from financing Inc/(decr) cash Equity FCF Reserve and resource position C o mpany o verview Byron Energy (BYE) is the operator of several blocks in shallow waters of the Gulf of M exico (GoM ) that are prospective for oil and gas. The executive team is experienced with a track record of growing shareholder wealth in the region. Balance sheet 2014A 2015A 2016F 2017F 2018F Cash & deposits Total assets Total liabilities Share capital Other reserves Retained earnings Total equity M inority interest Total shareholders' equity Total liabilities & SE

3 Riding the waves at Byron Key strengths A team looking to replicate past success BYE has an experienced board and management team that have collectively over 150 years operating in the Gulf of Mexico (GoM). The team have been involved in the drilling of 141 wells at a strike rate of greater than 80%. The company is targeting hydrocarbons up-dip of previous wells which still hold recoverable reserves. There are existing processing facilities nearby which BYE could tie into in the event of a successful well. Looking for a farm-in partner We view the potential for a farm-in partner to fund the drilling of the SMI-6 and SMI-71 wells as a key value driver for BYE. The company confirmed at the recent AGM that it is currently in discussions with potential farm-in partners in relation to SMI-6 and SMI-71 as well as Bivouac Peak. This may alleviate the need for BYE to raise equity to fund the drilling and there is also additional potential for some of the prior exploration costs to be repaid to BYE. The company has locked in a rig on a 1+1 contract. Strong cash generators in the current low price environment Our analysis suggests that both SMI-6 and SMI-71 would generate attractive returns in the current oil environment. Production costs (Opex + capex) of ~US$19/boe and ~US$29/boe would result in IRR s of ~65% and ~30% respectively at spot prices (WTI of US$43.00 and gas of US$2.35). Plenty of reserves and resources to get after Collarini, BYE s independent certifier has undertaken a review of the company s oil and gas reserves and resources and these are outlined below. Importantly they exclude the recently acquired Bivouac Peak Leases which BYE believe to contain substantial oil and gas resources. BYE has internally estimated prospective resources of 6.2mmbo and 69.2bcf of gas (17.8mmboe). Importantly given the productivity of a number of the sands located in BYE s permits, and the success achieved utilising new seismic processing techniques, the company is not undertaking what we deem to be high risk exploration activities. Figure 2: BYE s reserve and resource position (net to BYE) Reserves Prospective resources Total 1P 2P 3P Best estimate Oil (mmbbl) Gas (mmcf) MMBOE

4 Bringing experience and technology to the table A highly experienced team BYE has an experienced board and management team that have collectively over 150 years operating in the GoM. Prior to BYE, and since 1992, wells initiated by Doug Battersby, Prent Kallenberger, Bill Sack and Maynard Smith have produced over 26mmbo and 448bcf of gas via 115 producing wells. Importantly for investors in BYE, these successful wells were drilled at an 82% success rate, well above the GoM average of ~50%. Bill Sack has been highly successful in developing leads, and while running Aurora Exploration, he generated 70 prospects of which 55 were drilled at a 80% success rate. In addition to this exploration and operational experience in BYE s key area of focus, the team are also business entrepreneurs and have founded or built up a number of businesses resulting in substantial returns for investors. For more on the Board please refer to Appendix. Figure 3: Management s prior business success Company Date invested Exit date Exit multiple Exit mechanism Petsec (ASX) GOM Focus Sep X Sale of shares on ASX Maynard Smith and Doug Battersby joined PETSEC in 1990 and Prent Kallenberger started in 1992; Petsec 2P reserves increased from zero in 1990 to 255 bcfe (42.5 mmboe) in 1997, 66% gas and 34% oil, with peak production of 100 mmcf/d and 9000 bopd; MS/DB obtained board approval to sell their shares in the second half of Darcy Energy (Private) GOM Focus Jun 00 Dec X Private sale to IB DAIWA Maynard Smith and Doug Battersby formed DARCY in 2000 and raised approximately $US 5 million before Darcy was acquired by IB Daiwa for $US 57.5 million in December Eastern Star Gas (ASX) CSG Focus Nov X Share swap with Santos Santos (ASX: STO) acquired 100% of Eastern Star Gas (ASX: ESG) in November 2011 via a recommended Scheme of Arrangement under which ESG shareholders received Santos shares for every 1 ESG share held. Based on Santos share price at time of the offer of $A13.23, the transaction valued ESG at A$.90 per ESG share of $924 million. Doug Battersby co-founded ESG and was a non-executive director until October Sapex (ASX) Conventional + CSG 2007 Oct X Cash/Share offer by Linc Energy Linc Energy acquired 100% of SAPEX via a recommended Scheme of Arrangement for cash consideration of A$0.72 per share and A$0.50 per option, valuing SAPEX at A$104.1 million. Doug Battersby co-founded SAPEX. Aurora Exploration, LLC (Private) GOM Focus X Private asset sales William Sack Co-founded Aurora Exploration, LLC in 2000, a private entity focused on generating and drilling GOM exploration opportunities, and under his leadership created substantial growth and monetized investments via multiple corporate level assets sales. Seismic processing and Reverse Time Migration (RTM) Seismic processing has evolved significantly from the 1970 s with a number of different iterations, each yielding more accurate seismic images for interpretation. Recently Reverse Time Migration (RTM), the latest development utilised for complex salt plays has been used with great success by companies in the deep waters of the GoM and in Brazil resulting in a number of significant discoveries. Given a reduction in the costs associated with the acquisition and processing, it is being utilised in shallower salt plays where exploration budgets are considerably smaller than their deep water counterparts with great success. RTM is providing BYE a clearer indication of the up-dip potential of existing discovered oil and gas accumulations. Figure 4: RTM seismic providing a clearer image 4

5 BYE is utilising RTM processing to help better understand the potential for oil and gas accumulations up-dip of existing oil and gas accumulations, but below the edge of the salt domes. BYE utilised RTM for the SMI-6 well and the difference between the output of late 1990 s seismic and the 2011 RTM is illustrated below. The RTM clearly shows up the salt dome which was not visible on the old seismic image. Figure 5: Late 1990 s PreStack Time Migration seismic Figure 6: 2011 RTM seismic The SMI-6 well was drilled in June 2014 and while there were a number of issues associated with the well (due to the drill rig used) the well mapped very closely to that of the seismic image. This success of correlating the processed RTM seismic image to the subsurface helps support BYE s strategy and de-risk future wells/targets. A Gulf of Mexico specialist The company has assembled an attractive suite of blocks in the Gulf of Mexico (GoM) and operates solely in this area. BYE is attracted to the GoM because it has been a prolific producer of oil and gas and consequently has significant infrastructure. There have been significant proved and unproved reserves of both oil and gas and exploration success generally offers a short development cycle and rapid payback. Importantly, there is a well-established and stable administration and companies only have to deal with one landowner (the Bureau of Ocean Energy Management). BYE s acreage has numerous play types across with some focussed on oil, while others have a gas bias. Importantly all are believed to be highly favourable for hydrocarbon generation, accumulation and commercial development given their proximity to existing infrastructure in the region. The key features of BYE s blocks include: previous discoveries and production within most of the blocks; shallow water depths (from 10 60m); variety of structures including salt domes, rollover closures, fault structures and anticlines; stratigraphic traps such as channel sands and bar sands; targets up-dip from known production; and good quality reservoirs. 5

6 Figure 7: BYE is focused in shallow waters of the Gulf of Mexico South Marsh Island (SMI) SMI-6 (100% WI and 81.25% NRI) SMI-6 is located offshore Louisiana in the shallow waters of the GoM. The water depth of the block is approximately 20m and SMI-6 covers a salt dome which has previously produced 18.6mmbbo and 37.1bcf of gas from this block. Figure 8: SMI-6 location over salt dome Figure 9: Salt dome overhang and target sands BYE has previously drilled a well (SMI-6 #1) in the block which encountered significant mechanical issues (and resulted in two side-tracks) and never reached the primary target zones (G,H and I sands). The well did however intersect two hydrocarbon bearing sands (F30 and F40) and was subsequently cased and suspended. 6

7 The lease has an expiry date of 27 December 2015 and BYE will seek to extend this by drilling a second well (SMI-6 #2) or by submitting a development plan for the existing sands. BYE has also investigated production options which include using nearby production platform facilities if drilling is successful. BYE intends to drill a well on the prospect in FY16 (subject to funding or a the signing of a farm-in partner) and has a rig already signed up for this on a 1+1 contract. We forecast the cost of a dry well to be ~US$8m. Figure 10: SMI-6 reserve and resource position (net to BYE) Reserves SMI-70/71 (100% WI and 81.25% NRI) Prospective resources SMI-6 1P 2P 3P Best estimate Oil (mmbbl) Gas (mmcf) MMBOE The SMI-70/71 blocks are located in water of depths up to 40m offshore Louisiana and cover a portion of a large salt dome. Since 1963 production from the sands above 7,500ft have delivered 75mmbbo. Figure 11: SMI-70/71 location over salt dome Figure 12: Potential of the SM71 #1 up-dip well The company is targeting hydrocarbons up-dip of previous wells which still hold recoverable reserves. There are existing processing facilities nearby which BYE could tie into in the event of a successful well. BYE intends to drill a well on the prospect in FY16 (subject to funding or a the signing of a farm-in partner) and we forecast the cost of a dry hole to be ~US$4.0m. Figure 13: SMI-71 reserve and resource position (net to BYE) Reserves Eugene Island Blocks EI-63/76 (100% WI and 81.25% NRI) Prospective resources SMI-71 1P 2P 3P Best estimate Oil (mmbbl) Gas (mmcf) MMBOE EI-63/76 cover the western portion of a salt dome that has produced 6.5mmbbo and 361bcf of gas since There is infrastructure in place that could be utilised in the event of drilling success and production could be brought on in a speedy manner. 7

8 Figure 14: EI 63/76 location over salt dome Figure 15: RTM interpretation has identified up-dip potential BYE completed the interpretation of RTM seismic data during 4QCY15 and identified a number of leads and prospects which will result in further follow-up work. Figure 16: EI-76 reserve and resource position (net to BYE) Reserves EI-18 (100% WI and 78.75% NRI) Prospective resources EI-76 1P 2P 3P Best estimate Oil (mmbbl) Gas (mmcf) MMBOE BYE picked up the EI-18 block in March 2015 when it was the highest bidder in the Gulf of Mexico Lease Sale 235. It is located in approximately 3m of water and will be subjected to enhanced seismic reprocessing techniques in the future. Grand Isle Blocks GI-63/72/73 (100% WI and 81.25% NRI) During 4Q15, BYE licensed 3D RTM seismic data on the GI-63/72/73 blocks. The company has commenced interpreting the material and this is expected to continue throughout the remainder of 1HFY16. GI-95 (100% WI and 79.75% NRI) GI-95 is located in water deeper than the company s other Grand Isle blocks and is heavily gas prone. Given current Henry Hub gas prices and the attractiveness of BYE s SMI projects, we do not anticipate any near-term exploration to occur on this block. Figure 17: GI-95 reserve and resource position (net to BYE) Reserves Prospective resources GI-95 1P 2P 3P Best estimate Oil (mmbbl) Gas (mmcf) MMBOE

9 Bivouac Peak Leases In early November, BYE acquired an onshore/marshland lease from private landowners over approximately 2,400 contiguous acres (9.7 square kilometres) along the southern Louisiana Gulf Coast. The Bivouac Peak Prospect is located in the highly productive transitional zone and was acquired under the Aurora Exploration Option Agreement and was identified by Bill Sack. BYE has acquired a 90% working interest in the leases with a net revenue interest of 67.05%. Exploration costs are consistent with other BYE projects and a dry hole cost is estimated at ~US$9.5m. In the event of success, BYE believes it would cost an additional US$8.5m to bring the production online six months after the initial well completion. Figure 18: Conceptual cross section of BYE s projects in various water depths BYE has already identified significant upside to its internally assessed prospective resource numbers and the additional evaluation and reprocessing of 3D seismic data is ongoing. No independent reserves/resources have been ascribed to the project but BYE intends to have these leases included in the next review by their certifier, Collarini. Figure 19: Bivouac Peak resource position (net to BYE) Reserves Prospective resources Bivouac Peak 1P 2P 3P Best estimate* Oil (mmbbl) Gas (mmcf) MMBOE * Resources are BYE s internal assessment Valuation We value BYE using a risked sum of the parts (SOTP) methodology comprising a NPV of the SMI-6 and SMI-71 blocks and a risked NPV/boe metric for the company s other projects. For SMI-6 and SMI-71 we have modelled out the production of the company s 2P reserves position. Further upside exists for both these projects if the company converts some of the additional reserves or resources into the 2P category. BYE is currently cash constrained and requires additional funding (via equity or a farm-in partner) to enable the drilling of the SMI-6 and SMI-71 blocks. We have assumed the company undertakes a US$15.0m equity raising at A$0.15 to fund the exploration but note that a farmout of the acreage is more accretive. These options are discussed in the company financials and funding scenarios. 9

10 A$/share Oil & Gas Exp & Prodn Australia Equity research November 30, 2015 Figure 20: SOTP valuation for BYE SMI-71 (2P reserve NPV) 0.32 SMI-6 (2P reserve NPV) 0.03 EI-76 (risked 3P reserves) 0.07 GI-95 (risked 3P reserves) 0.12 Bivouac Peak (risked 2C resources) 0.02 Cash FY16f Corporate costs 0.59 SOTP Valuation Last price 0.19 Company financials and funding scenarios BYE held cash of US$3.7m at the end of 1Q16 and has forecast a spend of US$0.53m for the current quarter. The company currently has loans of ~US$1.6m due for repayment on 1 July In order to fund the drilling of the SMI-6 and SMI-71 prospects BYE will require additional funding. This may either be achieved by way of equity or via farming in a partner to fund the drilling. We estimate the company will require ~US$12.0m to drill a well at both SMI-6 and SMI-71. Our FY16 cash balance is forecast to be US$2.5m at year end which would result in BYE needing to raise US$10.5m at a minimum to fund this exploration. This would leave little contingency for the company but would result in both SMI-6 and SMI-71 being drilled. The company would likely require further funding post this. Alternatively BYE could undertake a larger equity raising of US$15m which will provide sufficient cash to drill the two prospects and provide additional working capital. Another option available is bringing in a partner to fund the two wells. BYE could achieve this due to the company s high equity interests (100% WI) and attractive prospects in both SMI-6 and SMI-71. We view the farm-out as the better option for the company as it would guarantee the drilling of two wells and also provide less dilution than a US$15m raising. At the company s recent AGM it was noted that discussions are ongoing with farm-in partners. Our scenario below does not assume any back costs are paid to BYE for exploration work already undertaken. We have run a number of raising/farm-in scenarios which look at the respective impacts on our valuation. The farm-in scenario only assumes a partner comes in for 50% the SMI-6 and SMI-70/71 blocks and carries BYE for the exploration wells. 10

11 Valuation per share Oil & Gas Exp & Prodn Australia Equity research November 30, 2015 Figure 21: BYE valuations under various raising/farm-in scenarios US$10.5m equity raising US$15.0m equity raising 50% farm-down for drilling Key risks There are a number of risks involved with an investment in BYE or the oil and gas sector more generally. Some of these include: Oil and gas exploration and development risk. BYE s future success depends on the success of its exploration drilling program and its ability to commercialise any discoveries. Financing risk. BYE has low cash reserves and will be dependent on additional capital raising and farm-outs to joint venture partners in order to meet exploration commitments and potentially development its assets. Key personnel risk. BYE is a small company and relies on the technical and commercial skillset of this team. Loss of any key members of this group could set back the company s plans but this is somewhat mitigated given the large shareholdings of these personnel. 11

12 Figure 22: Board Appendix Board The Board have a mix of specialist oil and gas industry and commercial experience and have generated significant shareholder wealth over the years. Non Exec Chairman Managing Director Director & COO Executive Director Nonexecutive Director Nonexecutive Director Mr. Doug Battersby (MSc Petroleum Geology and Geochemistry) Mr Maynard Smith (BSc Geophysics) Mr Prent Kallenberger (BSc Geology, MSc Geophysics) William Sack (BSc. Earth Sci./Physics, MSc. Geology, MBA) Mr. Charles Sands (BSc) Mr. Paul Young Petroleum geologist w ith over forty five years technical and managerial oil and gas experience. Cofounded Eastern Star Gas, SAPEX and Darcy Energy. Formerly Technical Director at Petsec Energy. Geophysicist w ith over forty years technical and managerial experience predominantly in Gulf of Mexico. Co-founded Darcy Energy and Byron. Chief Operating Officer w ith Petsec Energy ( ). Geoscientist w ith over thirty years experience in oil and gas. Generated prospects leading to the drilling of over 125 w ells in the Gulf of Mexico and California. 12 years w ith Petsec Energy (Geophysical Manager and Vice President of Exploration ). Explorationist w ith 26 years experience in the Gulf of Mexico region in both technical and executive roles. Co-founder/Managing Partner of Aurora Exploration, LLC a private entity focused on GOM exploration, former Sr. VP Exploration w ith Bayou Bend Petroleum (a Lundin group TSX listed company) and previously served in various roles including VP Exploration & Joint Ventures w ith Petsec Energy. Former director of Darcy Energy. Thirty years of broad based business and management experience in the USA. President of A. Santini Storage Company of New Jersey Inc. Co-founder and executive director of corporate advisory business Baron Partners. Has been in merchant banking in Australia for more than 26 years. Director of Ambition Group, Australian Rural Capital. Former Chairman Peter Lehmann Wines and former director of Sapex. 12

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