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China North East Petroleum Expands

|Includes: CEO, China North East Petroleum Holdings Ltd. (CNEP), PTR, SNP

In August 31st, I published an article on Seekingalpha under the title “China North East Petroleum is poised to Grow”, in the article I was expecting a strategic expansion move to take place at China North East Petroleum (NYSEAmex: NEP) within weeks, on October 1st this prediction became a reality.


On October st, China North East Petroleum announced that it acquired 100% of the equity of Song Yuan Tiancheng Drilling Engineering Co. Ltd. ("Tiancheng") for $13 million dollars in cash, from the press release:

Tiancheng generated revenue of approximately $14.7 million, net profit of $5.2 million and was cash flow positive from operations. Tiancheng has generated consistently solid financial results, including operating margins in the mid-40% range, net margins in the mid-30% range and steady operating cash flow."

Tiancheng has seven  rigs in operation. With approximately 320 employees, it has the capacity to drill 220 wells on an annual basis. Tiancheng is the largest of three PetroChina- licensed private drilling operators based on the total number of drilling rigs. The company counts PetroChina and two private oil producers as its main customers.

Based on the announced financial metrics, China North seems to have negotiated an excellent purchase price, paying under 1 times multiple of revenues and just under 3 net profits multiple, thus making the deal immediately accretive by adding 16c in EPS based on a 31 million fully diluted share count.

This acquisition by China North while extremely profitable, and is likely to add significantly to revenues and EPS in the next few quarters, the acquisition actually offers a series of key strategic benefits:

-         PTR Ties: This deal will solidify China North relationship with PetroChina (NYSE: PTR) by making China North both a production partner and an oil fields service provider, thus greatly expanding future collaboration opportunities.

-         Private Relationships: This deal will offer China North a direct relationship with a number of current and future private oil producers working with Tiancheng, this relationship will assist China North in its strategy of ultimately consolidating some of the private oil producers under its umbrella.

-         Diversification: This acquisition will diversify China North revenue stream, by making the company less dependant on the sharp short term fluctuations in oil prices, yet this diversification is being achieved without scarifying net profit margins.

-         New leases: NEP management has indicated that owning a driller would better position the company to obtain new oil field leases from PTR, this acquisition fulfills this requirement, which in combination with the company plentiful liquidity and strong relationship with PTR puts them at a heavily favored position to obtain new production leases.

-         Accelerated Drilling: By owning 7 rigs, NEP today can deploy some assets to its own fields, thus significantly accelerating drilling on its oil assets, while decreasing drilling costs; unlike a pure oil field service provider NEP can maximize its rigs utilization by deploying excess capacity to its own fields, or concentrating on its own fields in periods of high oil prices.

NEP management is fully aware of the above advantages, as highlighted in their acquisition press release:

"We are extremely pleased with this acquisition, which transforms China North East Petroleum into a more diversified oil exploration and production company," commented Mr. Hongjun Wang, President of China North East Petroleum. "We believe that the vertical expansion of our business into oilfield services will increase our competitive advantage and provide us with an opportunity to capture additional business from China's state-owned oil companies, who continue to invest heavily in the drilling and services sector. This agreement allows us to better develop lease opportunities with China's SOE's at terms that are more favorable for our company. Further, possessing in- house drilling rigs can accelerate our drilling schedule and lower operating costs..

As have been highlighted in prior writings (Tremendous Value Found in China North East Petroleum and China North East Petroleum Catapults to the Next level) China North management continue to work diligently to position China North as one of the largest private oil producers and players in the nascent Chinese private oil industry, management has been systematic in its efforts to achieve that goal, with the Tiancheng acquisition another milestone has been crossed, and it is very likely that within the next two quarters China North will proceed with its next strategic step of acquiring further oil reserves or securing a new lease from PetroChina.

As of today China North East Petroleum continue to be a company that is under followed and largely obscure from the investing public, however under that shadow the building blocks of a giant are being assembled.

Nawar Alsaadi

Individual Investor
The author is long NEP