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Kevin Graham
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I am a professional engineer & MBA graduate from Canada. I am a passionate value investor and have a strong interest in finance, economics and the markets in general. I would describe myself as an investment sloth. I believe I understand the Graham-Buffett value method and take it seriously. My... More
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  • Petrobank Energy: An Terrible Risk / Reward Opportunity 4 comments
    Oct 23, 2010 10:46 PM | about stocks: PBEGF, LSTMF, PMGLF
    After reading the article below on Petrobank (OTCPK:PBEGF), I decided that I better dig in and take a look at this opportunity. It was presented as, “Heads I win huge, tails I win pretty big."

    Naturally, I don’t buy on other’s opinions but I will use them as a starting point for my own analysis. I am going to give my detailed analysis of Petrobank (TSE – PBG) right off the start because I don't care for research opinions of analysts. I like to keep my investment ideas simple, but after digging a little deeper I discovered the company is fairly valued or overvalued and has some very lucritive stock options.

    Please note that all figures are taken from the respective companies annual reports, annual information form, and quarterly reports. The debt and share data is the most recent and the reserves reports are from 2009 yearend review.

    The Subsidiaries Are Trading at a Steep Premium to Intrinsic Value

    1) Lets start with Petrobakken (TSE - PBN). First, the PBN's reserves have a net present value, discounted at 10%, before tax value (NPV10-BT) of $2.46 billion for proved reserves (1P) and a NPV10-BT value of $3.65 billion for proved plus probable reserves (2P). I tend to be conservative and use proven reserves but for this analysis it won't matter much so we'll use the more optimistic value of $3.7 billion, which includes reserves that are not yet on production. The company has a convoluted debt structure of bank debt, net working capital deficiency and convertible debentures. The convertible debentures are convertible into common shares at prescribed prices so for the sake of analysis I will add them to the fully diluted shares and only consider the debt to be the sum of the bank debt and working capital deficiency. For PBN the total debt is $698 million. The fully diluted shares outstanding if you include all options and convertible debentures is 207.7 million shares. Petrobank owns 58% of PBN.

    The Net Asset Value (NYSE:NAV) of the reserves, discounted at 10%, debt adjusted per share is as follows:

    NAV10-BT 1P = ($2460 million – 698 million) / 207.7 million shares = $8.48/share

    NAV10-BT 2P = ($3650 million – 698 million) / 207.7 million shares = $14.21/share

    The PBN shares closed today at $22.84, a sizeable premium to the reserves. This is a 61% premium to the 2P reserve value.

    I know some will point out that they have some other assets, such as land which is not included in this analysis, but those assets are usually insignificant and don’t provide any cash from operations.

    2) Secondly, Petrominerales (TSE – PMG). The NPV10-BT is $1.46 billion for 1P reserves and NPV10-BT is $2.08 billion for 2P reserves. Again they have a convoluted debt structure similar to PBN (I will comment on the stock options below). PMG has no debt and net working capital of $67 million. PMG however has significant convertible debentures and they will be converted into equity (as per the company's formula) again for the sake of analysis. Fully diluted shares outstanding total 125.9 million. Petrobank owns 66% of PMG.

    Similarily, the Net Asset Value per share computes to be:

    NAV10-BT 1P = ($1460 million + $67 million) / 125.9 million = $12.12/share

    NAV10-BT 2P = ($2080 million + $67 million) / 125.9 million = $17.05/share

    The PMG shares closed today at $25.45 again a sizeable premium to the reserve value. This is a 49% premium to the 2P reserve value.

    3) Heavy oil assets. Here, they don’t have any proven producing reserves in the report, but simply NPV10-BT of $367 million for 2P reserves. I believe some of these are coming online as of this year. These assets are held at the parent company level and PBG has no debt. The fully diluted shares outstanding is 110.2 million.

    The Net Asset Value can be computed to be:

    NAV10 2P = ($367 million + 0) / 110.2 million = $3.33/share (These are wholly owned by PBG)

    4) THAI technology. This is interesting because Baytex and Shell Canada just sold their respective shares in the project to Petrobank. Since they are partners they know exactly how well the THAI process is performing. Why did they just sell? I would guess the results aren’t coming on as expected and both partners wanted out. It was interesting that Baytex didn’t even discuss in there last report. Ascribing a value is very difficult so I will give it a value of zero.

    Total Company Value

    So if we take the sum of the parts for the probable basis (2P), the total equals $3.49 billion or 31.76/share of PBG. PBG currently closed today at $40.46/share. On a proven basis (1P) and including heavy oil assets, the total is $2.39 billion or $21.73/share.

    Clearly you can disagree with the engineering value of the reserves but that is as close to reality you can get. It takes into consideration the production profile, royalties, operating cost, abandonment costs, etc and discounts it back to today at 10%. It’s the best shot at the cash flow the wells will produce.

    Now the value of the company will vary depending on the discount rate you choose and oil price. I would guess the company is being valued at a discount rate of 7.5% and $80 oil and $5-6 AECO gas price and the current proven and probable reserves (2P).

    Myself, as a value investor, I prefer to buy with a margin of safety. This investment clearly doesn’t offer and room for error on the reserves or the price of the commodities. Clearly a lot of arm waving is required to believe that these shares provide a margin of safety. Analyst reports are not worth the value of the paper they are printed on. Commit them to the fire.

    I will add that this analysis is for a specific point in time (Dec 31, 2009). I have not analyzed the company’s return on invested capital for the last several years. That will tell us how well management has done drilling new wells and if they are earning positive returns on capital. PBG’s return on equity was 20% in 2008 and 4% in 2009. Returns on total capital are obviously less than that given the leverage these companies use. If someone would like to calculate please go ahead but I don't see any value in light of what else I dug up in the financial reports on stock options.

    Stock Options – Where can I get some?

    The main reason I wouldn’t touch any of these companies with a ten-foot pole is the deferred common shares and the incentive shares. Both of these are basically stock options and I quote:

    In the second quarter of 2010, shareholders approved an incentive plan for directors, officers, service providers and employees. The plan allows the holder to receive one common share upon the vesting and payment of $0.05 per share exercise price. The terms of the incentive shares granted are determined by the Company’s Board of Directors but typically, incentive shares vest after four years from the date of grant and expire between five and 10 years after the date of grant.

    Now if that isn’t lucrative, please let me what is. Essentially they are options priced at $0.05/share and expire 10 years after the grant date.

    Can someone explain how these options align the interest of the shareholders to management and employees? Why $0.05 per share and not $0.01 per share? Why leave the nickel on the table? What shareholder would agree to these terms? Oh that’s right, Petrobank is the majority shareholder in both PBN & PMG, go figure.


    Reread the last paragraph, be careful investing in ideas found on investing websites before doing your own analysis. This investment is not an obvious deep value investment and significant losses could occur, especially if oil prices fall.  That said, the company may have significant drilling opportunities or other soft assets.  I will leave the valuation of those assets to the speculators because I wouldn't know where to start. 

    I leave you with a quote from Warren Buffett.

    “The market, like the Lord, helps those who help themselves. The market unlike the Lord, does not help those who know not what they do.”

    My blog is

    Disclosure: no position in any of the stocks mentioned.

    Disclosure: no position in any of the stocks mentioned.
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Comments (4)
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  • Anthony Grossi
    , contributor
    Comments (204) | Send Message
    So I know you wrote this quite a while ago when the price was $40. Has the drop in price down to about $9 changed your mind about PetroBank? I will be avoiding this stock just b/c of management, like the options issue you pointed out, but the sector itself I find very cheap now that the market has taken its toll.
    I've been using the following metrics for valuation and would appreciate your criticism/insight since you also track this space.
    total MMBOE per $100 investment
    you'd be surprised how many of these companies have debt above 50% of their proven reserve values. Doesn't leave much room for shareholders to share in the profits. I've basically been looking at this as a pure asset play and only recently have been starting to look at company operations and management. Thanks for any info you choose to share.
    I'm pretty keen on PEYUF, which you've also written about.
    ticker PEY
    EP/PV10 = (133 X 20) + 474 / 2105 = 1.48
    total MMBOE per $100 = (256.7/133) X (100/20) = 7.7 MMBOE
    debt/PV10 = 474/2105 = 0.23
    by virtue of comparison, PEY has low debt but also lower MMBOE per $100 investment than many of its peers.
    thanks for your time
    26 Sep 2011, 12:31 AM Reply Like
  • Kevin Graham
    , contributor
    Comments (59) | Send Message
    Author’s reply » Hi Anthony,


    I haven't changed my mind at all on PBN, in fact if oil falls further this company is bankrupt. They are leveraged to the hilt, poor operating results, and poor assets. It's hard to change that.


    If you go to my blog you can read all about my year end review of PBN and other exchanges with Devin Shire.


    29 Sep 2011, 02:19 PM Reply Like
  • herkfsu
    , contributor
    Comments (205) | Send Message
    Kevin, looking at PBNs latest Q2 report, it shows


    "At the date of this MD&A there are 9,421,165 stock options, 2,684,601 incentive shares, and 89,644 deferred common shares outstanding. "


    I don't see the this as a huge problem. Can you point out where I may be in error. Thanks.
    1 Oct 2011, 05:48 PM Reply Like
  • herkfsu
    , contributor
    Comments (205) | Send Message
    I also see this


    "Share-based compensation expense was $3.7 million for the three months ended June 30, 2011 (2010 - $10.5 million) and $9.1 million for the six months ended June 30, 2011 (2010 - $17.8 million). "


    Is 3.7 million a lot? They have cash flows of 190 million.
    1 Oct 2011, 05:48 PM Reply Like
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