Valeura’s Magic Trick

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Disclosure: The following represents my opinions only. I am long VLE.TO and TNZ.TO (Image credit to Harry Shelton on Unsplash)

As I watched Valeura Energy (VLE.TO, last at $1.58) soar 125% yesterday on the news of its >20,000 bopd acquisition in Thailand, something really crystallized for me. The concept of larger companies divesting of oil assets for ESG or portfolio rationalization reasons is well-established, but finding quality teams, capable of optimizing, running, and eventually decommissioning those assets is a different animal altogether. Any quality asset seller will want to sell to a quality buyer in order to minimize the risk of, in the future, being accused of laying off assets just to get them off the sheets. It’s the seller’s responsibility to ensure that the buyers are qualified and capable, both financially and organizationally, to carry on the business to the same or better standards. As a result, sometimes divestitures may be less about the headline sales price and more about simply finding good homes for non-core holdings.

When I first read VLE’s news, I have to admit that disbelief was my first reaction. I understood that there must have been some decommissioning liability that came with the asset, but it was clear there was going to be a lot of torque to the equity. As it turns out, the decommissioning liability in VLE’s deal is about US$214 million, but that’s where things start getting interesting. VLE believes that the fields and facilities that they plan to purchase have the potential for optimization/extension which would push those decommissioning liabilities further out in time, giving VLE more time to invest its cash flows to generate returns for shareholders. For example, say that you take on a field with a decommissioning obligation that is scheduled for 2026. In that case, the seller has this liability on their balance sheet that reads like a bond that matures in 2026. You come along and say, “Hey, that bond isn’t due in 2026… if I optimize this and/or drill these wells to extend the field life, the bond doesn’t come due until 2030, or 2032, or…” — you get the point. All of a sudden you get years of additional cash flow by investing a little more in order to extend the field life, while leveraging a capital asset that’s already in place.

None of this is of interest to the sellers — as they are in “divest mode” — nor does it concern them. What concerns the sellers is finding good homes for their assets, while the buyers focus on extending the field lives. The best part is that the buyers are effectively getting very low cost debt financing, from the sellers, by paying a lower headline purchase price, plus assuming the decommissioning liability. There’s no need for any debt (other than operating/bridge debt) within this kind of deal structure and it gives a massive amount of torque to the underlying equity of the buyer, as any additional asset value creation, on a big production base in this case, accrues to the buyer’s shareholders. Hence the big pop in VLE. I expect that management will have more to say about the plan over the coming weeks and months (this hasn’t been “marketed” to institutions yet), but the deal is expected to close in Q1 2023 and it will vault VLE into a completely new size category. Congratulations to Sean Guest and his team — and cue the golf clap. Quite a deal. I’ve read two analyst reports with targets of $4.50 and $8.25, so take your pick. I’ll use them as goalposts for now.

Okay, so what have I learned from this?

  1. I’ve learned that qualified teams are hard to come by as sellers look to divest of non-core assets,
  2. I’ve learned that quality asset sellers value quality asset buyers, and that the sellers are willing to engineer deals on very favourable terms in order to ensure that their assets go into capable hands,
  3. I’ve learned that decommissioning liabilities are a snapshot in time that don’t necessarily reflect what “could be” done — they represent a status quo situation, which may or may not be representative of the future,
  4. I’ve learned that decommissioning liabilities are like bonds which may have a flexible maturity date,
  5. … and lastly, I’ve learned that the value accretion that comes from deals structured like this can be significant, as the optimization/drilling value creation (upside) all goes to the equity holders.

My big takeaway action? Hold onto my Tenaz Energy (TNZ.TO, last at $1.46) with both hands and just stay the course. One day TNZ will find an asset… I’m just not sure when that day will come. Based on what I’ve just seen with VLE though, when that day does come for the TNZ team, I’m feeling like it will have been worth the wait. I’ve written about TNZ quite a bit in the past, so I won’t rehash it here, but quality management is hard to come by and TNZ has it in spades. It’s also worth pointing out that TNZ only has about 28 million shares outstanding, so the leverage to shareholders could be significant if they too are able to pull a rabbit out the hat.

Time will tell.