The New Zealand Oil & Gas (NZOG) saga took another depressing turn this week when Andrew Hudson, chief executive of the Takeovers Panel, rejected approaches from NZOG shareholders with the comment: "the panel reached the view that the majority of complaints appear to relate to matters of opinion where different views might honestly and reasonably be held".
Hudson's statement was in response to "several complaints from various shareholders of NZOG in relation to the proposed acquisition of minority interests in NZOG by O.G. Oil Gas (OGOG) under a scheme of arrangement".
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Hudson's media release appeared to contradict two basic Takeovers Panel objectives.
These are: "Our mandate is to strengthen investor confidence in New Zealand's capital markets" and the panel "will always ensure shareholders, no matter what their size or influence, have equal, informed opportunities to participate in major share transactions".
It is hard to believe that Hudson's media release has strengthened "investor confidence in New Zealand's capital markets".
In addition, if there are different views regarding NZOG's valuation, why didn't the panel, or the NZOG independent directors, release these views to ensure that shareholders "have equal, informed opportunities" to vote on the NZOG scheme of arrangement?
A key issue regarding the proposed takeover is the value of NZOG's Australian Ironbark exploration activities and the market's response to the drilling of this prospect late next year.
The two Ironbark permits are in an extensive gas region off the coast of northwest Australia. These are permits WA-359-P and WA-409-P, with the former being the most important as it will be drilled at the end of 2020.
The first point to note is that the valuation of oil exploration companies, which is extremely complex and difficult, is usually undertaken by corporate advisers with extensive expertise in this area. Northington Partners, the independent adviser for the NZOG/OGOG transaction, seems to have limited expertise in this area.
Earlier this year Cue Energy, which is listed on the ASX and is 50.04 per cent owned by NZOG, sold a 15 per cent stake in the Ironbark WA-359-P prospect to NZOG.
Following the transaction BP, which is the permit's operator, has a 42.5 per cent interest, Cue 21.5 per cent, ASX-listed Beach Energy 21 per cent and NZOG 15 per cent.
However, NZOG has a total direct and indirect interest of 25.75 per cent by way of its majority stake in Cue and five of the seven Cue directors — Alastair McGregor, Andrew Jefferies, Rebecca DeLaet, Rod Ritchie and Samuel Kellner — are also NZOG directors.
The accompanying table summarises the assessed value of the WA-359-P permit in two independent reports. These are the SRK Consulting report for Cue's meeting of shareholders to approve the sale of 15 per cent of WA-359-P to NZOG and the latest Northington report.
Northington picked up SRK's WA-359-P valuation, which had an extremely wide range between $0.6m and $84.5m for the 15 per cent interest, but in Northington's final NZOG valuation it determined that WA-359-P was worth between only $4.4m and $20.0m.
Several points can be made in relation to these valuations including:
• The SRK report for Cue shareholders noted that the preferred value of $56.3m was calculated by SRK Consulting using a conservative approach "due to the varying levels of technical and geological uncertainty"
• The Northington report noted that NZOG had effectively paid $4.5m for its 15 per cent interest in WA-359-P "being the value of the past costs reimbursed to Cue and a free carry of the costs of drilling a well equivalent to 2.85 per cent of the total well cost for WA-359-P"
• NZOG's share of WA-359-P's drilling costs will be an additional $24m
• Northington Partners has given no value to WA-409-P, the other Ironbark permit, even though SRK assessed it has a preferred value of $8.6m as far as NZOG is concerned
• The original OGOG offer for NZOG of 62c a share, which was strongly recommended by the target company's independent directors, was based on an assessed value of only $4.4m for WA-359-P.
Opponents of the takeover argue that NZOG's assets have been seriously undervalued, particularly the Ironbark prospects.
This criticism has been enhanced by comments made by Dr Rosalind Archer, the independent chair of the NZOG committee assessing the OGOG offer.
Archer wrote: "The market appears to have attributed little or no value to Ironbark prior to the announcement of this Scheme (the OGOG offer).
"In fact, the market capitalisation of the company fell by almost exactly our expected share of the well costs, which suggests the market is pricing in the drilling costs and the low chances of success."
This is a very strange interpretation of how sharemarkets work.
Investors, particularly in oil exploration companies, usually have a short-term focus and don't buy into these companies until just before drilling begins, certainly not 15 to 18 months before commencement as Archer is suggesting.
Take for example the drilling of the onshore Kohatukai-1 well, south of New Plymouth last year, which was 25 per cent owned by NZOG. Drilling began on September 24, 2018 with NZOG's share price and trading volume immediately picking up. The company's share price rose from 57c to 65c and trading volume was much higher than usual in October and November until NZOG announced on November 11 that the well had been plugged and abandoned.
WA-359-P, which is a far larger prospect than Kohatukai-1, will be drilled at the end of 2020 and could attract Australian investor interest.
NZOG shareholders must choose between voting in favour of the 74c per share offer now or waiting to see whether the company's share price will react positively to the WA-359-P drilling programme late next year.
But the most frustrating aspect of this scheme of arrangement, whatever the outcome, is that several shareholders have written detailed letters criticising the valuation to NZOG's independent directors or the Takeovers Panel but neither of these have been willing to publish their specific responses to the critiques.
At least one of these submissions has been written by a long-term industry expert, who appears to have far more industry knowledge than Northington.
Independent directors should bend over backwards to act in the best interests of shareholders but NZOG's independent directors seem to be determined to accept the lowest valuation rather than putting up a strong argument for a higher valuation.
This column recognises that oil exploration companies are difficult to value, and can have a wide valuation range, as reflected by SRK's total WA-359-P valuation range of A$3.8m ($4.08m) to A$538.0m (with a preferred value of A$357.0m).
However, there are clear signs that most of NZOG's other assets have also been conservatively valued by Northington. These include:
• Cue's sharemarket value is worth more than the Northington assessment
• The Kupe production assets also appear to be conservatively valued
• No value has been given to NZOG's 50 per cent interest in the Clipper permit off the Canterbury coast even though there has been a substantial investment in this permit
• Corporate overheads appear to have been based on a reasonable amount of future development and exploration, yet the valuation doesn't seem to give much value to these prospects. Why was Andrew Jefferies paid $849,000 last year when NZOG, based on Northington's assessment, appears to be little more than a relatively passive investment company?
As far as this columnist is concerned, the performance of NZOG's independent directors ranks as one of the worst over the past 20 years or more and there have been several dreadful precedents over this period.
Meanwhile, these directors certainly can't claim that they have "strengthened investor confidence in New Zealand's capital markets".
Shareholders will determine the eventual outcome of this scheme at a meeting in Wellington on November 14.
- Brian Gaynor is a director of Milford Asset Management.