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Harvest Natural Resources (NYSE:HNR)

Investment Thesis

Investment opportunities are sometimes found in the tucked-away, nether regions of the stock market where few analysts will take notice. But as they say, the fishing is best where the fewest people go. Harvest Natural Resources is one of those stocks that present a unique opportunity. The problem is that it's a company that hasn't made money in five years that's trading below tangible book value, and who's very ability to operate as a going concern is questionable. So why even bother? The reason to consider this stock is that HNR is in the midst of a sale of its share of a partnership in Venezuela and also looking to sell its assets in Gabon to interested parties. HNR has received cash for half of the Venezuela deal. If these transactions close successfully, the company's net asset value alone will be over $8.00 per share, 66% higher than its recent closing price of $4.80. The question that remains will then be: Will management take shareholder-friendly action and return the cash to shareholders?

HNR Company Overview

HNR is an oil and natural gas exploration / development company with assets / interests in the following regions:

  • Venezuela: Through affiliates, HNR owns a 32% interest in Petrodelta. The majority owner is PDVSA, the Venezuelan state-owned oil and natural gas company, which exercises most of the control over Petrodelta's operations. PDVSA however, has been derelict in its duties, providing insufficient monetary support in capital expenditures and falling behind in payments to contractors providing services to Petrodelta. HNR is still waiting on a $9.8 million dividend that was declared in November 2010, and is uncertain on when or whether this or any future dividends will be paid. This is due to Petrodelta's liquidity constraints from PDVSA's lack of monetary support.

(click to enlarge)

HNR's Venezuela Properties

Source: HNR 2012 Annual Report

Although Petrodelta has consistently earned a profit from 2007 to 2013, dividends of profits since 2010 have not been declared, and there's uncertainty over whether any future dividends will be paid. The key point: It's probably a bad idea for HNR to keep doing business in Venezuela! Recently, HNR entered into an agreement to sell its interest in Venezuela for an after-tax amount of $330 million. The first payment has been received and the next payment is expected several months from now.

  • Indonesia: Operational activities in this region are onshore in West Sulawesi and are still in the exploration stage.

HNR's Indonesia Properties

Source: HNR 2012 Annual Report

  • Gabon: Off-shore deep-water drilling exploration is the focus here. The first high-quality 3D seismic images are expected during the second quarter of 2014. In September of 2013, HNR entered into negotiations with Vitol S.A. to sell HNR's 66.67% interest in Gabon for $137 million in cash. Net proceeds were expected to be $121.8 million after transaction costs and taxes; however HNR and Vitol S.A. were unable to reach a deal.

HNR's Gabon Properties

Source: HNR 2012 Annual Report

  • Colombia: HNR signed farm-out agreements with another company. (Farm-outs are when a company assigns its oil or natural gas interest to another party for an up-front payment in addition to a percentage of the revenues) HNR has received notices of default from its partners for failing to comply with certain terms of the farm-out agreement, and has fully impaired the costs associated with that transaction, to the tune of $2.3 million.

Recent Insider Transactions

Date

Insider

Shares

Type

Transaction

Value*

Nov 27, 2013

SPEIRS ROBERT Officer

30,000

Direct

Purchase at $3.15 per share.

94,500

Nov 27, 2013

EDMISTON JAMES A Officer

50,000

Direct

Purchase at $3.15 per share.

157,500

Nov 27, 2013

HAYNES STEPHEN C Officer

10,000

Direct

Purchase at $3.15 per share.

31,500

Nov 27, 2013

MURRAY PATRICK M Director

25,000

Direct

Purchase at $3.15 per share.

78,750

Nov 27, 2013

STINSON JOHN MICHAEL Director

31,000

Direct

Purchase at $3.15 per share.

97,650

Nov 27, 2013

CHESEBRO STEPHEN D Director

100,000

Direct

Purchase at $3.15 per share.

315,000

Source: Yahoo Finance

As we can see, the insiders have been buying since November.

Selected Balance Sheet Data (for the quarter ended September 30, 2013) (thousands)

Total Current Assets: $7,581

Other Assets: $6,258

Long-Term Receivable - Equity Affiliate: $14,947

Total Current Liabilities: $17,262

Long-Term Debt: $76,793

Embedded Derivative-Debt: $3,487

Warrant Derivative Liability: $4,757

Other Long-Term Liabilities: $640

Total Equity: $528,345

Stock Data

Price per Share: $4.80

Tangible Book Value: Total Equity - Other Assets - Long-Term Receivable = $528.345-$6.258-$14.947 = $507.14 (To be conservative, we subtract the other assets and the long-term receivable and assume they will never be recovered)

Tangible Book Value per Share = $507.14 / 45 million shares out = $11.27"

"Price / Tangible Book Value = $4.80 / $11.27 = 0.43"

Recent Key Events / Catalysts

  • In a press release, HNR announced on Dec 16, 2013 that it entered into an agreement with Pluspetrol to sell all the company's interests in Venezuela in two transactions totaling $400 million in cash. The net proceeds after taxes are expected to be $122 million and $208 million. The transaction for the first amount has already been closed. The closing of the second transaction is still subject to approval from the government of Venezuela, and if granted should happen around mid-year.
  • Proceeds from the transaction will be used to pay down HNR's long-term debt and the rest used for working capital.
  • In a press release dated November 19, 2013, HNR announced that it was unable to reach an agreement with Vitol S.A. for the sale of the company's interests in offshore Gabon.
  • In a press release dated January 15, 2014, HNR announced that it completed redemption of all $79,750,000 of its outstanding 11% senior notes due 2014 plus accrued interest.

Valuation

How can you value a company that doesn't make any money? Well, a sum-of-the-parts asset valuation is one way.

If the Venezuela transaction closes as expected, HNR will have net cash of (Balance sheet data as of 9-30-13):

$122m + $208m + Current Assets - Current Liabilities - Long-Term Debt - Embedded Derivative Debt - Warrant Derivative Liability - Other Long-Term Liabilities = $122 + $208 + $7.581 - $17.262 - $76.793 - $3.487 - $4.757 - $0.640 = $234.64m

Monthly expenses: $2m* 6 months till Venezuela deal close=$12m

Net cash per share by June 2014~ (234.64m-$12m) / 45m shares outstanding = $4.95

Their net cash will exceed their stock price by $4.95/$4.8 - 1 = 3%

If we add the valuation of their oil and gas properties according to their carrying value on the most recent balance sheet, we get the following: $106.366m, or $106.366m / 45m shares outstanding = $2.36 per share. Then a sum-of-the-parts valuation gives us a fair value of ($4.95+$2.36) = $7.31 per share, which is about 50% higher than the current stock price of $4.80.

Risks

  • Although we have potential sum-of-the-parts valuation of $7.31 per share, in order for that value to be realized by shareholders, HNR needs to return that money back to shareholders. If they continue with their exploration and development activities and continue to lose money, shareholder value will be destroyed.
  • The Venezuela transaction may not be approved by the Venezuelan government, thereby further hindering HNR to unlock the value of its assets and return capital to shareholders.
  • The value of HNR's oil and gas properties as listed on their balance sheet may be overstated or they may not be able to find a buyer, particularly for their assets / interests in Gabon. (The recent deal with Vitol S.A. fell apart.)

Conclusion

Overall, I think HNR is a unique investment opportunity with the above catalysts / recent developments. The fact that it's trading below tangible book value minimizes downside risk. Although there are no sure things in life, the management seems confident that the Venezuela transaction will close, and it seems that they're committed in unlocking the value of their assets for shareholders. With HNR's debt extinguished and with a strong, liquid balance sheet, I think this is a low-risk value investment with the embedded option for a large payoff should their remaining oil and gas properties prove valuable.

Source: Harvest Natural Resources: Upcoming Catalysts Provide An Opportunity For A 50% Return