I covered Premier Oil (LSE:PMO) on valuethemarkets.com at the beginning of January when it was 76p, and suggested shorting as part of a convertible arbitrage strategy was holding back the company’s valuation. What a difference a month makes! The market showed its appreciation of a trading and operations update with the share price hitting £1.04 on 11th January, but even more recently, it’s news of an early exchange of convertible bonds that’s really got me excited about Premier.
Moving up a gear
The last few quarterly trading updates from Premier have been somewhat lacklustre events with the share price closing below the Open on most occasions, but the January release saw Premier hit prices not seen since August 2015. And rightly so, in my opinion. Production guidance for 2018 is 80-85 kboepd and has been adjusted for asset disposals and allows for the ramp up of the Catcher field. The new producing asset has already proven it’s capable of rates in excess of 60 kbopd as confirmed in an RNS on 24th January, so I wouldn’t be surprised if yearly guidance is surpassed.
Debt reduction to $2.7bn might appear minimal but it’s an important milestone, and the underlying positive cashflow was hampered by one-off refinance costs of $125m and a lower oil price. With Brent above $70, 2018 Capex restrained to just $300m, and Catcher expected to be up to full speed in H1, it’s not difficult to see the potential gear change ahead.
Sophisticated Financing
For much of 2017 Premier oil seemed stuck in first gear and that was largely down to the rather complex refinancing process. While the threat of dilution from the convertible bondholders didn’t cause an immediate drop in the share price like a substantial placing would have, the process of increasing arbitrage shorting slowed the growth of the company’s Market Cap right down.Online discussion was awash with confusion among private investors, and I’m sure, to some holders the circling shorts were a concern. It was a sophisticated solution to get Premier oil out of a sticky situation and although some shareholders might feel disgruntled by the ‘smokes and mirrors’ of the bigger players, the alternatives may well have been far worse. The company was in no position to raise the funds it needed without heavy dilution of existing investors.
Priced-in Dilution
On 11th January Premier invited convertible bondholders to exchange early, and 87.5% took up the offer. There was much online chatter by Private Investors surrounding the announcement, and elation about the move was juxtaposed with fears of a large price drop. Shares in issue increased by over 45% to just over 764m on 19th January and the price barely moved! As you would expect with convertible arbitrage, once the shares were issued, the shorts started to close out positions. In less than one week, declared shorts of over 0.5% have plummeted from 15% to 1.86% according to shorttracker.co.uk.
There’s no doubt in my mind that the finance deal was carefully engineered to minimise the usual shock effect of dilution, but dilution it inevitably was. However, with $205.79m coming from converting bondholders, the added value of the debt reduction to Premier offsets a significant amount of the dilution. The company is looking healthier.
In addition to increased production from Catcher, there’s much to come from Premier this year that could further enhance its valuation. Planning for the appraisal of the ‘world class’ Zama oil discovery is underway and the program is expected to span 2018/2019. In-place estimates for the Zama-1 well are in excess of 1 billion barrels of oil and Premier holds a 25% stake. The Tolmount development sanction is expected in 2018 and progress is being made with financing for the Sea Lion project in the North Falkland basin too.
Premier league
With increased production and lowered costs in a higher oil price environment leading to accelerating debt reduction, the potential for a swift rerate of Premier Oil’s share price is evident. Another springboard might just be around the corner; re-entry into the FTSE 250. It’s more of a technical quirk, but none-the-less a catalyst for a further spurt by Premier. Enter the FTSE 250 and automatically index trackers and further institutional buying is likely to occur. To qualify, a company needs to rise to position 325 or above at the next periodic review, which is in June. That would require a Market Cap of around £845m, and bearing in mind it stands at £715m now, a share price of over 110p would be required. I believe this is easily achievable with a successful ramp-up of Catcher and the oil market remaining balanced.
A quick glance at the Share Price Chart shows a channel that currently tops out at 120p in June. However, if there is a snapback-effect with restricted oil supply in the market from under investment in the sector or political disruption, the company’s debt is going to fall off ever quicker with the rise in oil price.
We will have to wait and see how this recovery plays out, but if there’s one thing I’ve learnt from following the story in Premier Oil these past 2 years, it’s expect the unexpected.
Author: Stuart Langelaan
Disclosure: The author of this piece owns shares in the company written about above
