What does HCI’s Impact oil deal really mean?

Shareholders in Hosken Consolidated Investments (HCI) are no closer to the cash payout they seemed to be banking on, and HCI is no nearer to cutting its weighty R2.7bn debt.

That’s because an expected windfall from the sale of a chunk of its oil and gas exploration interests has been displaced by a longer-term participatory arrangement and only a partial sell-down of these assets.

Last week, HCI’s 49%-owned associate Impact Oil & Gas announced a farm-out transaction for its interests in blocks 2912 and 2913B off Namibia with energy giant TotalEnergies. These blocks are better known as the Venus discovery, and have widely been regarded as some of the most significant oil finds in recent decades.

Impact held a 20% stake in the blocks, but has offered up a 10.5% stake to TotalEnergies, keeping a holding of about 9%.

The deal, effective from the start of this month, includes a full carry loan on Impact’s retained interest for all joint venture costs until the first sales of oil roll in. Which could be anything from five to seven years away.

Impact will also be reimbursed in cash for its share of past costs, estimated at $99m (about R1.86bn).

Initial expectations, which were also articulated in HCI’s annual report, were that the proceeds from a sale of its Namibian oil interests would at least extinguish debt. This may still happen, though in a slightly more convoluted manner.

“These oil blocks might obviously not be very valuable right now. But if you believe in the upside, it’s enough support for us to remain long-term shareholders in this thing — even if there are more developments, which I’m certain there will be,” HCI CEO Johnny Copelyn tells the FM.

Market watcher Piet Viljoen, executive director of Merchant West Investments, has already described the farm-out deal as “very smart”.

But others seemed genuinely disappointed. Perhaps the idea of gratification delayed — or diluted — didn’t sit well with speculators. After all, market chatter last year suggested a healthy bidding process for the Namibian blocks. Even recently there were rumours of a counterbid for the blocks for $1bn.

So, what on paper might appear to be fairly slick arrangements to secure HCI’s future stake in the oilfield without incurring further crippling costs put the share price on the skids.

At the time of writing, HCI’s shares had lost about 9% since details of the deal were disclosed. By contrast, the share price of Canada-listed Africa Oil Corp (AOC), another significant investor in Impact, kicked up about 12%.

ClucasGray portfolio manager Brendon Hubbard says the 20% divergence on the share prices — in reaction to exactly the same deal — is bizarre. “There are complexities. Everyone is scrambling to put some numbers together.”

Hubbard says an estimation of the 10.5% stake given away by Impact — based on money already spent and including the $99m reimbursement — gives an inferred value of about $570m.

He points out that Impact and AOC have indicated that the capex to place two floating production storage and offloading platforms above Venus to pump 400,000 barrels per day will be as high as $16bn.

“Impact will own 9.5% of the block with HCI owning [almost] 50% of Impact, therefore HCI’s exposure is 4.75%,” says Hubbard. Impact and AOC have indicated that the repayment of the interest-free loan to TotalEnergies will take three to four years. Hubbard says if a four-year arrangement is assumed, this implies a $200m repayment profile per year for HCI’s investment.

“But the agreement gives Impact a free carry on the exploration costs of [new well] Mangetti, which is now being drilled, and the Damara lead and Damara south potential deposits, which form part of the block,” says Hubbard.

Late last year TotalEnergies estimated at least 1-billion to 2-billion barrels of oil from block 2912, lower than early estimates of tens of billions of barrels by some excitable industry pundits.

These are large tracts and difficult to quantify with any authority at this stage. Block 2913B is located off southern Namibia and covers about 8,215km² in water depths up to 3,000m. Nearby block 2912 covers about 7,884km² in water depths of between 3,000m and 3,900m.

What is easier to discern is that the arrangement with TotalEnergies gives Impact a carry loan for all of its remaining development, appraisal and exploration costs on the blocks until the first oil starts flowing. The carry loan is then repayable to TotalEnergies from Impact’s aftertax cash flow, and net of all joint venture costs (including capex from production on the blocks) after the oil starts flowing.

Impact will pool its share of the barrels with TotalEnergies for more regular offtakes and a more stable cash flow profile, and will benefit from the energy giant’s marketing and sales capabilities.

Impact CEO Siraj Ahmed says the arrangements represent a pivotal transaction that paves the way for the group to transition from an exploration company to a hydrocarbon-producing business.

From HCI’s perspective, the arrangement might be viewed with a little more circumspection. HCI sits with R2.7bn debt, which Copelyn has deemed too high, especially in terms of pursuing opportunities in platinum mining, the national lottery and natural gas.

The oil and gas exploration interests are also “outsized” compared with HCI’s other interests in gaming, hotels, property, passenger transport, broadcasting and industrial businesses. The group invested $65m (about R1.2bn) in Impact alone last year. The total tilt by HCI into oil and gas exploration sits at about $220m (roughly R3.7bn), which is more than HCI’s bottom-line earnings for financial 2023.

And there remain plenty of potential long-term risks for oil aside from movements in the crude price. These include political risks in terms of a new possible tax on oil developments in Namibia — which is not unheard of in countries that suddenly start gushing oil. Then there’s the competition from green energy, not to mention the possibility of a glut from new oil discoveries around the world.

HCI’s hefty debt also means it’s somewhat restricted in unlocking value for shareholders, with them effectively being unable to unbundle or buy out any of its JSE-listed investments or even consider share buybacks.

But, while this predicament looks likely to keep a lid on its share price, the farm-out deal might well be the first step in HCI slashing its borrowings.

Fortunately for HCI, its 82%-held subsidiary Frontier Transport last week declared a special dividend of 137.8c a share. On a net basis, that means R260m back in the bank.

HCI could consider another oil deal to cut gearing further if mutterings at last week’s AOC investor presentation are to be believed. AOC holds a 31% stake in Impact. CEO Roger Tucker noted a “newly formed” relationship with HCI with a view to pursuing short-term activity in potentially trying to increase its position in Impact.

“Nothing is guaranteed at the moment. We will need some cash for that. But we are actively looking at it as a potential option now that we have this deal over the line. I have to be a little diffuse on this … the deal has just gone through. But we are actively looking at other ways of deploying capital into this asset.”

Tucker, significantly, also said the “rump” of Impact, which includes extensive exploration concessions in South African waters, did not fit with AOC in future. 

Presuming there is pressure on Impact to separate its Namibian and South African interests, could there be an option for HCI to sell down its holding in Impact’s significant minority stakes in the Namibian blocks to AOC?

Hubbard believes HCI might swap unlisted Impact shares for AOC (listed on the Toronto Stock Exchange) which places a value well north of the R1.75bn reflected on the HCI balance sheet.

A back-of-the-matchbox calculation suggests that HCI, factoring in normal operational cash flows from its casinos and other mainstay investments, could reduce its debt dramatically if a $30m dividend from Impact is due and if anything between $50m and $80m can be realised on selling down its Namibian oil interests.

Copelyn himself believes an investment company like HCI, with numerous assets, could operate more comfortably with debt levels of between R1bn and R1.2bn, and says: “Perhaps there is a maximum debt level of R2.5bn. We’d get uncomfortable over R3bn.”

Of course, it will be interesting to watch HCI if it keeps a stake via Impact in the currently dormant South African oil and gas exploration interests. One project off the Eastern Cape coast has already been blown out the water by environmentalists, which will surely stifle enthusiasm for any thrusts in the near future.

But with energy concerns top of mind in South Africa, perceptions about offshore developments might well change over time. HCI knows the value of being a patient investor. Perhaps by the time a friendlier exploration dispensation rolls around, HCI is cash flush and ready to delve in with renewed vigour?

Source: Financial Mail – Marc Hasenfuss

* The writer is part of an investment club with HCI in its portfolio