Member Info for PUTUP

Nobull

A DCF is just one person's valuation of a company at one point in time. Your DCF could be different from mine for a multitude of reasons. Moreover, any DCF valuation or other valuation method will change over time. No matter how carefully crafted at the time it is subject to events as they unfold. If you had perfect foresight you might get everything right but more likely than not you will need to adjust as time goes on. So even the very best views on valuation are dynamic.

The market value of a company is determined by the marketplace for the components of its capital. Most often, buybacks are done carefully to not influence this market price (limited portion of daily VWAP). Whether you believe the current price is fair or not is your view and yours only. You might think GKP more fairly valued at £4; me at £3 or wherever. Someone else might think it fairly valued; another overpriced for the risks involved. The marketplace reflect buyers and sellers. Management might have a view also. Whether you are right or not will be determined by how events unfold, including events that were not foreseen at that time.

The point of the DCF exercise was to demonstrate the obvious: that regardless of your DCF the change in its total value is merely the amount of the distribution. (The same as with a dividend.)

Now to the per share level. If everyone participates in the buyback pro rata to their holding, the ownership structure of the company doesn't change. There are less shares o/s post buyback but we all own the same percentages as before and the price doesn't change. The change in value of the company is the amount of the cash that left.

You could even do, as I have done in another jurisdiction, a fixed price buyback at a level above the current price. If everyone participates pro rata, the price doesn't matter. You have the equivalent of a dividend.

However, if you perceive the company's stock to be undervalued you're less likely to participate. You forego the distribution and by doing so you increase your shareholding in the company. You own the same number of shares but there are now less o/s, your ownership interest has increased. If, in contrast, I participate in the buyback beyond my pro rata portion then my shareholding percentage will decline. You get none of the distribution and I get more than my share of it. It is these decisions - not the distribution itself - which will affect how we do in the future. If you are proven right and the stock appreciates you will enjoy having not sold into the distribution versus me who did. If, however, I'm proven right - be it from something I anticipated that you did not or something completely unforeseen by either of us at that time - then relatively speaking I will do better from my decision than you from yours. (It's the same with a dividend. If you choose to reinvest and I don't. If the price goes up you do better than me.)

Yet, again, £50 just left the company. It's the same as if you took your £25 dividend and convinced me to sell some of my shares. The company is no longer owned 50:50 and if buying at £2 proves to have been the right thing to do then you win and I lose - and vice versa. Management are just focusing on generating the £10 a year. You and I decide what the value of the company is. One of us might be right and the other wrong.

Again, if you think the company is undervalued then don’t sell into a buyback and reinvest your dividends. If you’re happy to take some money off the table, pocket the dividends and sell into the buyback.

I used an extreme differential in discount rate to make the point. More likely we might disagree on the future cash flows of the company or what you are prepared to pay for today versus waiting to see how the future unfolds. We’re unlikely to have an identical view on ‘fair value’ at any point in time. (And if by some extraordinary chance we did have identical views we’d likely behave the same, reinvesting dividends or not, selling into a buyback or not.)

Too often management fall into a communication pitfall by stating a view on valuation as a reason for the distribution. Hopefully, they’re stockholders and may have a personal view on value which they’re entitled to express. But it’s their opinion which may be proven right or wrong in the future and they should be clear that each shareholder needs to form their own opinion on value, act accordingly and take responsibility for that action - or inaction - as the case may be. If management say they think the stock is cheap you don’t have to agree with them. Even if on all reasonable grounds they’re right at the time, subsequent events may prove them wrong - or right. You need to make your own call and take ownership of it. Far better, in my view, for management to simply state in their communication that they’re returning £50 to shareholders and to those that want it rather than dishing it pro rata.

Make no mistake: at the moment of the distribution (be it dividend or buyback) the only thing that’s changed is the £50 has been paid out. How it is paid out has absolutely no influence on the ability of the company to generate the £10 per annum.

Have a great weekend!

Nobull. I've done literally thousands of DCFs over the last 35 years. Smart cookies those fellows at Lex.

You are (a) assuming there exists a "correct" fair value and (b) that everyone knows this and agrees with it. That's never the case.

Do a DCF for a company generating a cash flow stream of £10 per annum in perpetuity. Assume it has £100 in cash in the bank, no debt and 100 shares o/s. All to make the mathematics easy. Its shares at trading at £2. Equity value of £200. Management, agnostic to the value of the company, simply wish to return £50 to shareholders. If they dividend the £50, 50p per share, the share value will, ceteris paribus, adjust downwards to reflect the £50 that's left the company. They now trade at £1.50. If they instead buy 25 shares at £2 and cancel them, again, the value of the business has declined £50. Share price doesn't change but the number of shares o/s has declined to 75. 75 x £2 = £150. That's it.

Now, let's say you and I agree on the future cash flows of the company as these are certain but have differing views as to the appropriate valuation. We each own half the shares. If the dividend is distributed we get £25 each. If, however, you think the stock is really cheap and I think it's so-so. You may well be inclined to reinvest your dividend by trying to convince me to sell some of my shares to you.

Let's say I think the appropriate discount rate for the company's future cash flows is 10% and so I value the at £100 and so, together with the £100 of cash on the balance sheet, cum distribution, I arrive at my personal valuation of the company at £200 or £2 per share. I think the company is trading at full value.

You, on the other hand, think the appropriate discount rate for such a company (reflecting your own required return on equity) is 5%. You think the future cash flows of the company are worth £200 and so the company ought to be worth £300 pre distribution. You're long because you think it's cheap by 50%.

Again management just want to distribute the excess £50. They buy 25 shares at £2 and cancel them. £50 left the company and the stock still trades at £2 because nothing else changed. You aren't going to sell into the buyback because YOU perceive the company to be cheap. I, on the other hand, might be happy to because I think it's fairly valued. The only way the buyback happens is if someone wants to sell.

We could do a reverse scenario where you're looking to sell and so sell into the buyback whereas I think the stock is cheap and elect not to sell. In ALL circumstances £50 just leaves the company. It's just a question of who gets it. If the stock really is cheap and you don't sell but I do, and the price goes up eventually, you win and I lose. If, on the other hand, I'm bearish and trim my position by selling into the buyback and am proven correct by subsequent events then I win and you lose.

"I am glad you now agree that buybacks destroy value when executed above fair value "

I don't. They neither create nor destroy value. The simply distribute cash. (Do the DCF exercise.)

"but I want to be sure they are done below fair value and that they are done for right motives."

This is the point. We certainly agree re motives and we likely agree that the company screwed up communication previously. But your view on 'fair value' likely differs from mine or Straycat's. For the company as a whole it doesn't matter (do the DCF exercise I suggested) - they just handing out cash for nothing in return. But if YOU believe the stock is trading at below fair value of course you wouldn't sell into the buyback. You'd prefer someone else sold and thereby you increased your ownership stake in the company. If YOU feel that the buyback is being conducted above fair value then of course you should sell (all your stake). What you don't get to do is to come back 3 years later and blame management for buying stock that you now, with hindsight, believe was overvalued then when you yourself didn't take action then.

But I'm sure this dead horse will get back up again. :)

Let me know when you've actually worked through the example I suggested

"If excess cash is on the balance sheet and a company decides to return it through buybacks then the DCF value of the income stream associated with that cash needs to be less than incremental DCF value associated with having fewer shares in issue."

What happens to the DCF value when the cash is removed? Future cash flows only fall to the extent of the return on the cash i.e. next to nothing. The value of the company falls by the value of the cash that is no longer there. Doesn't matter to the DCF how many shares were bought back. The equity value still changes by only the value of the cash returned. Sketch yourself out a simple example and work through it. I think you will find it illuminating.

You were going ok until you got to "if they do any buybacks above the fair value thus calculated." Back to the same ol' fallacy.

The only reason they're not doing buybacks is because key shareholders want to take money off the table and at least recover their initial investment. The stock doesn't have the liquidity to do that via selling shares so it's 'give me the cash.' Carry on.

I have sympathy here. I like stock-based compensation. I like incentivised management. Getting that right is an art not a science. The current LTIP is maxed at 10% so it's not an investor performance killer. There are more important considerations to worry about. But I'd like it to change when it comes up for renewal in a couple of years (if I'm still around by then).

They cancelled because people were screaming at them for holding in treasury. Because they cancelled (and there's been no further buybacks because people screamed at them for doing the previous ones) they now have to issue new shares. Now, again, people scream at them. Damned if they do; damned if they don't. (The buyback wasn't bungled but we've discussed that already.)

"As far as I'm aware, neither the VCP nor the LTIP provide any protection against corporate actions, apart from sale. "

Come on Straycat. You've been around this longer than me. Where's your game gone?

The VCP is over shortly. With respect to the latter you'd be well-advised to consider section 9 (pages 14 and 15) of the RULES OF THE GULF KEYSTONE PETROLEUM LONG-TERM INCENTIVE PLAN
Adopted by Shareholders in general meeting on 17 July 2014
(as amended by resolution of the Remuneration Committee on 5th December 2017 [and pursuant to Shareholder approval on 19 June 2020]):

https://wp-gulfkeystone-2020.s3.eu-west-2.amazonaws.com/media/2020/05/22111249/GKP-LTIP-Rules-mark-up.pdf

Personally I'd be much more in favour of management getting a lot more options but with an at the money strike rather than nil cost. They'd have to be a lot more because the inherent value at the time of grant is much lower but at least then if the stock doesn't perform versus the level at grant they expire worthless. Currently, the LTIP options always have value (outside of bankruptcy). It may be less at exercise than the value at grant but management can more easily shrug that off.

(I haven't checked but I would fully expect the LTIP and VCP plans to protect holders of options against the effect of dividends (and buybacks, splits etc etc). All else being equal a dividend causes a lower stock price. A lower stock price would lower the value of a nil-cost option unless they're protected.)

"So who gets the divdends on these shares on 13th May if they are issued but not allotted to anyone and if they rank pari passu? I am heartily sick at hearing this news."

When they are issued the recipient is entitled to all the benefits ascribed to them. They are never issued but not allotted.

This should be of no surprise at all. The terms of the company's VCP and LTIP are all there plain to see. Don't complain about the block listing. It merely implements the terms of the VCP and LTIP. The time to complain about these is long gone. Thankfully this will be the last issuance under the VCP. As I said earlier, only a fool wouldn't use the fully diluted share count which included the dilution from the VCP already. (See notes 9 and 15 to the full year results.) The new award of nil-cost options under the LTIP increases the dilutive effect of options. Adjust the numbers accordingly.

Exactly as I expected. Back to sleep.

"I think the arrears will be paid off by the first three payments"

Fully recovered in Feb sales invoice (circa $8.1m)

R Factor isn't particularly significant until Q2.

(Opu thinks he knows all the questions management are discussing with all their investors, analysts and potential investors. Management think otherwise.)

"Then the amount of unrecovered costs (CRP) becomes $172 m only. "

GKP share

ATB

"and denies any significant field development capex. "

No it doesn't

I should add, Straycat - just for clarity - that of course the PSC and FDP are entwined. The PSC governs the splits of spoils from investment and also, via the cost recovery mechanism, who bares its financial burden. But what I was objecting to was the statement that one can be traded for the other. Again, one is agreed and recently supported by Barzani, the other is under negotiation. If asked to revise the PSC - it has been revisited once already - I'd expect GKP to ensure any changes are neutral to the company (as with the CBC and WI). If the KRG pressures something worse for GKP then we're all in trouble.

"Do you really think that JH is sat in front of the MNR, apologising for the fact that he is rewarding his shareholders for ANOTHER massive dividend?
No.He's flexing his shareholder muscle."

No. I don't think GKP dividends even feature in the conversation with the MNR. You seem to think they're linked and, worse, they convey some sense of power to GKP in the negotiations. I don't think they are at all. I also don't think the MNR focus at all on GKP dividends. How much did the KRG take home last year versus that paid to GKP shareholders? I think the MNR rightly focus on field investment versus reaping cash today, alongside their non-monetary goals such as environmental and social. And I absolutely wouldn't characterizing paying out excess capital as "flexing ... shareholder muscle."

FH1 made the comment that if the KRG was concerned about the tradeoff of losing near term cash flow in order to invest in the field they could simply renegotiate the PSC. I replied that they've said they will honour these agreements (as they should). He still thinks the comments from Barzani were in relation to some other agreements. You stepped into the middle of that 'conversation.'

Anyway, let's (you and I) move on. Unfortunately there wasn't that much to excite in the FY results. The dividend should be of no surprise to anyone. Expect another substantial interim later in the year as the CRP is further recovered and paid out (with a commensurate fall in the value of what's left). Recent performance metrics still disappointed. Operating cost expectations have been revised significantly higher. We're still not even close to 55k. And clearly the cost of moving beyond it has gone up significantly and no doubt this features highly in the discussions with the MNR - much more so than GKP's dividend announcement.

I want to see real progress re SH14/15 as well as fixing SH-12.

FH1: " If KRG are baulking at capital cost then can renegotiate a new PSC. "

Try to keep up Straycat :)

FH1: " If KRG are baulking at capital cost then can renegotiate a new PSC. "

ME: "Only if threatened with a wholesale ripping up of agreed contractural obligations, something the KRG just recently said they wouldn't do, would GKP agree to something less favourable than they have now. Investing on the basis of getting a better PSC would be foolish."

So, the FDP is being negotiated within the given and agreed construct of the PSC. The PSC determines who gets the spoils of sales and also how the burden of investment is shared. Given the PSC, and current levels of production and field sales, it is the KRG who bares the bulk of the burden. If the KRG said something like "we are are only going to agree to the FDP if we change the PSC in our favour" you can expect things to come to a complete standstill. We only reap a very small share of the gains from investment. This is and always will be a KRG sandpit. GKP and MOL are just doing the execution in return for a thin slither of the pie.

No I'm up large. And the stock continues to creep closer to my targets. But there wasn't anything startling in the FY results. Quite the contrary.

And no they're not different. The "Iraq challenge" you refer to challenges the right of the KRG to enter into PSC and other contracts in relation to its natural resources.