Petrobank cleaning the slate

Petrobank (TSX: PBG) announced today that they were selling their primary property asset, the May River project for $225 million. After paying off their $60 million bank debt, this will leave their corporate with approximately $165 million to figure out what to do in the meantime. Their other primary asset includes their 59% ownership stake in Petrobakken (TSX: PBN) which readers of this site will also know has its own issues, although it has solved its imminent financial problems by floating a $900M, 8.625% coupon bond issue with an 8 year maturity date.

Readers might suspect that I’d rather want to put my money in that bond than the equity.

This is about a clean a slate that Petrobank will have before it decides how to invest the proceeds in other projects. The May River project was not as successful as management anticipated and they likely hit the best bid they could solicit. The low-rate interest environment does create a lot of froth, and they were probably wise to take the money while they could.

Petrobakken trying to find the cash

On December 13, 2011, Petrobakken (TSX: PBN) released more information with respect to their 2012 plans and numbers.

The two salient snippets are as follows:

We are also pleased to announce our initial capital plan for 2012, which allow us to build on our 2011 operational success. We anticipate capital development expenditures of approximately $700 million, primarily focused on horizontal drilling and completions, predominantly in the Bakken and Cardium light oil plays. We expect that this drilling-focused activity will generate a 2012 exit production rate of between 50,000 and 54,000 boepd. Our estimated year-over-year average production growth will exceed 15%, on an absolute and per-share basis. We expect this initial 2012 program to be executed entirely from funds from operations, with surplus cash flow available to fund dividends and debt repayment.

For 2012 we estimate that our corporate base decline rate will be in the range of 30-35%. In 2010, our base production declined approximately 40%, while the 2011 base decline rate is now forecast at approximately 35%. We have been encouraged by the results of our recently completed wells, and we are also beginning to see the benefit of the continued maturation of our producing assets with a significant proportion of our production now coming from older, shallower decline, horizontal wells.

As part of our ongoing balance sheet management, and to reward continuing support from existing shareholders, we are pleased to announce the implementation of a DRIP. The DRIP provides eligible holders of common shares resident in Canada the opportunity to reinvest their monthly cash dividends in PetroBakken shares at a 5% discount to the then current market prices. Petrobank (59% shareholder of the Company) has indicated an intention to participate in the DRIP with respect to 50% of their PetroBakken shares, which will amount to $53 million in additional liquidity to the Company on an annual basis. Subject to the receipt of approval of the Toronto Stock Exchange, the DRIP will be implemented for the January 2012 dividend, which is payable in mid-February 2012. Additional information regarding the DRIP can be found below.

The company is planning on spending $700M in capex in 2012, which is a decrease from projected 2011 capex numbers of $900M. The capital budget for 2012 will be slightly below their operating cash flow for the year, assuming current oil prices remain steady (a 12-month extrapolation of 2011 figures for the first nine months is $650M, noting that WTIC prices were lower then than they are now).

It still leaves one wondering when the company is actually going to generate significant amounts of cash in excess of capital expenditures – when you add the $180M of dividends projected in 2012 (minus the ~$53M that Petrobank will re-invest for Petrobakken equity), it does not leave much for them to pay off their February 2013 debenture, which holders have a one-day put option to redeem (and given the small coupon and the credit profile of the company, they most certainly will unless if there is a sweetener given to them in the interim).

The DRIP decision in itself is rather interesting – it effectively starves half the cash flow that Petrobank will receive from Petrobakken in exchange for further equity. Since Petrobank owns 59% of Petrobakken, it will result in Petrobank foregoing $53M/year in dividends in exchange for further equity. Assuming a $13/share price for Petrobakken, this will mean Petrobakken will issue 4.3M shares to Petrobank over 2012 – a cost of capital of 7.8% for Petrobakken, assuming the dividend is not cut. This is expensive capital for the company.

The company has hedged a significant amount of oil (20,000 boepd, about 40% of its expected production) with existing high prices which I think is a smart decision. Still, they are extremely leveraged and their only salvation is continued high oil prices. If there is any significant contraction in the price of oil, they will be in clear financial difficulty, especially when it comes to negotiating with the $750M debenture that is effectively due in February of 2013.

Petrobank / Petrobakken – How to play Petrobank

I noticed that one of the most bullish people on Petrobank (TSX: PBG) / Petrobakken (TSX: PBN) that I know of on the internet has stated they have “Caved to a moment of weakness” and increased the concentration of their PBG holdings to 40% of their equity portfolio. This is as close as you can get in finance to an “all-in” bet without actually going all-in.

I wrote about portfolio concentration in a previous post, and if your portfolio size is a sufficiently small fraction of your annual income, then making concentrated bets is not only acceptable, but ideal.

PBG owns 59% of PBN, so PBG is joined at the hip with PBN’s performance. Indeed, looking at the consolidated financial statements of PBG is quite challenging since one has to mentally sort out what PBN is doing away from the main figures and this takes a bit of work. They do some segmenting in the management discussion and analysis, but the relevant component is that PBG’s business unit does not make any revenues and spent about $54M in Q1 for capital expenditures. Also, when subtracting the market capitalization of PBG’s ownership in PBN, PBG’s price is around $40M. If you believe PBG’s operations have any value at all, it would make PBG the better bet between the two companies.

A very relevant issue for PBG is that they depend on PBN’s dividend stream to provide approximately $100M/year of cash. PBN’s dividend level is at a point where I would expect it to be dropped at some point in the future. PBG also has a mostly untapped $200M line of credit at its disposal and it has the option to selling more of its PBN stake, although I am sure management would not want to press down PBN further from current levels.

A believer in PBG’s operations (but not PBN) would likely be better served by going long PBG and shorting PBN. Calculating the ratio is an exercise in arithmetic: an investor purchasing 100 shares of PBG can offset the PBN ownership by shorting 104 shares of PBN.