Member Info for Stevo12

I received a response from Mitch today regarding reverse takeover rules. He stated that the Exchange had confirmed that, although the deal failed the gross asset test, it would not be regarded as a reverse takeover. He also confirmed that the exchange did not consider the Mercurial holding to represent a fundamental change in voting control.

It is normally the Nomad’s responsibility to liaise with the Exchange to clear these matters and not an unexpected result.

The other aspect of this transaction which I struggle to understand is that Tailwind must have somewhere close to the highest operating costs per barrel in the North Sea at $32 per barrel - more than double that of harbour - and combined with admin costs of $4 per barrel and interest costs of a similar amount, results in a cash outflow of close to $40 per barrel .

This excludes royalty and contingent consideration for which there is a $50m liability.

At $80 oil and 75% tax this results in a $10 per barrel net cash, with the benefit of the tax losses being roughly equal to the net debt. Accordingly the purchase price is roughly equal to the total cash flows we can expect from the acquired reserves over the remaining life if oil averages $80 per barrel. Not a great deal

I would add that in the North Sea world there is little need for debt facilities as the government is the new banker funding a minimum or 91.4% of cap expenditure (higher if you can add a few green bells and whistles to the platform). You will only need debt if you buy overpriced producing assets.

North Seas producers are, I am sure, still getting to grips with the new tax regime.

However at a basic level I am struggling to understand why we would pay $700m+ to buy 40m barrels of reserves which will be taxed at 75% (actually slightly higher as you can not offset interest and decommissioning expenditure). Why would you not develop a new discovered field and spend say $1 billion of which cost to Serica would be $50-90m due to investment allowance. Yes it will take 2-3 years to come on stream but why would you not develop rather than buy if you get same reserves for less than 10% of the cost of buying a producing fields. Am I missing something?

I suspect if N Egg had come in we would not have progressed this deal which we have to assume is a reverse takeover in disguise (and not very well disguised)

Also interested to see if they give any guidance on 2023, although I anticipate this will come with year end reporting in Spring and will possibly forecast lower average gas and oil prices than 2022 and unfortunately more EPL.

Interested in investors views on the upcoming Trading update.

One of the key targets was FCF of $2-2.2B and will be interested to see where we sit in this range. It appears that production will be in the higher end of the target range but softening gas and oil prices in Q4 will have had a negative impact. I recall from the presentation that hey need gas at 220p per therm and oil at $90 pbbl. Has anyone tracked average prices over Q4?

I suspect that the share buyback will now continue from today and the deferral in late December was to preserve cash to meet the FCF target. I have no idea on average gas prices as up and down so significantly but oil has been in $75-85 range for last several weeks.

My gut feel is they will be in middle of range around $2.1b - any other views?

Banbury

I would add why are the shareholders are not getting a direct vote on the acquisition (although we are indirectly). The AIM rules are much more relaxed than full listing rules but do require an approval vote for reverse takeovers. There are 4 tests which look at revenue, profitability, balance sheet and consideration and the deal has to pass all 4 test not be categorised as a reverse takeover. We fail the gross asset test when comparing the latest published accounts as Tailwind gross assets exceed those of Serica.

A transaction also classifies as a reverse takeover if it “ result in a fundamental change in its business, board or voting control“. There is an argument that with a single shareholder having more than 25% changes the voting control.

The exchange can give exemptions if the class test produces an anomalous result but given Mitch said in the Q&A that he used the two comparative balance sheets to value the business then it should be a valid test.

We should be asking the board to conform whether they have applied for and been granted an exemption

BANBURY

Were you able to identify where the difference between the $609m of losses in Tailwind Mistal and the total $1.366b of brought forward losses is located? I presume it must sit in another subsidiary. However if this is not recognised by Tailiwind in its group balance sheet, they have doubt over ability to use it.

The deferred tax liability is not a cash liability, but an accounting difference between the book value of assets and their tax written down values to equalise the accounting tax charge in future years. However you are correct that this liability arises due to tax allowances on capital expenditure being higher than accounting amortisation charges. tax losses carried forward are principally due to high year 1 tax allowances for capital expenditure, as well as historical losses made when oil prices were low.

It is going to be interesting to see what disclosures are made in the circular. My fear is that as the circular is not to approve the acquisition but purely the issue of new shares, there my be limited information.

Visitor

Your logic is correct but you would need to remove the cash value of the Serica shares being issued to provide a true comprise of EVs which would result in an EV for Tailwind of approximately £520m. Still an incredibly unbalanced deal compared to Serica’s EV of £315m.

I would say that given production, reserves, decommissioning liabilities, defer red consideration payable e†c, a valuation of 50% of Serica EV would be reasonable- lets say£160m which places a valuati on of £360m on the tax losses. This compares to £240m recognised by Tailwind at end of 2021. Accordingly Tailwind are receiving £120m as a result of the accelerated use of these losses using Serica’s profits. On an undiscounted basis these losses could have a cash value of£500m at 40% tax rate. If used over 3 years this would be discounted to something close to the £360m.

Accordingly it appears that Tailwind shareholder are receiving something close to the full benefit of using the profits of Serica to utilise the historical losses. This is most unusual.

I also attach the link to the definition of net debt from the corporate finance institution:

https://corporatefinanceinstitute.com/resources/valuation/net-debt/

Definition as follows

“Net Debt = Short-Term Debt + Long-Term Debt – Cash and Equivalents

Where:

Short-term debts are financial obligations that are due within 12 months.

Long-term debts are financial obligations that are due beyond a 12-month period. Common examples of long-term debt include bonds, lease obligations, contingent obligations, notes payable, and convertible bonds.

Cash and cash equivalents are the most liquid assets of a company. Common examples of cash and cash equivalents include marketable securities, commercial paper, treasury bills, and bank accounts.”

Romaron

It is of course up to you to evaluate the companies financial information to inform your own investment decision. However to dismiss Enquest’s finance lease liabilities as “heavy payments were at the front end and are getting cheaper’ ignores that Enquest has still got $550m of capital repayments to make. The capital repayments on leases in 2019,2020 and 2021 were $132m, $123m and $136m. - no reduction and In addition there was approx $50m of interest on the finance leases paid. Finance leases are structured as fixed annual payments and do not generally vary over life of lease, although the component of interest and capital changes over the life of the lease.

We all make our own investment decisions based on our understanding of the business and our risk tolerance and I think most of us believe there is real upside to the share price of oil prices hold. However if you are unable to debate alternate views then that is your choice.

By the way my professional experience is that I am a recently retired partner of a Big 4 having been an audit partner for 15 years and a corporate finance partner for the last 10 years. I have an MBA in business finance and qualified as a chartered accountant in 1989. So yes I did learn basic financial literacy from a book and a professor and have been applying it in practice for the last 35 years.

Serica’s tax bill excluding EPL looks to be in the £150-200m range for 2022. So Tailwind losses could be used over say 3 years if gas remains at current rates, but I think it unlikely that gas prices match the average 2022 prices in 2023.

Londoner

Re deferred consideration. The amount ultimately payable will principally depend on future oil prices and production volumes. The internal discount rate applied also has an impact. I am struggling a little to understand why the amount payable over next 12 months is quite low at $52m as disclosed in interims. 5,000 bpd entitlement at $60 profit would yield entitlement of $110m. I don’t know whether there is an adjustment for tax or some other form of adjustment.

Londoner

Understand. So you believe two identical companies that use different financing methods - one uses bank debt and the other takes out a finance lease to fund the same asset at the same price with identical interest rates have different EV’s.

Martinen and romaron

Further to recent discussion regarding Enterprise Value. My estimation of EV is $2b (market cap+Bonds+RBL-cash+finance lease+ defer consideration). This translates to approximately $10 pbbl of 2p reserves and an EV to Ebitda multiple of 2. This EBitda multiple is low compared to other sectors but difficult to determine the impact of EPL. Serica is paying $18 pbbl for Tailwind which seems very high in post EPL world.

While we can debate the definition of debt for EV purposes – although any decent finically text book will clarify. Let’s look at the way the industry values O&G companies which starts with a $ valuation per barrel of 2p reserves. The value per barrel is driven by cost of production, expected future 0&G prices and the tax regime among other things. This gross value, which is effectively enterprise value, is then adjusted for any financial obligations to be taken on with the business (if you are acquiring the legal entity). This would include debt, cash, finance leases, deferred consideration, royalties payable, decommissioning liabilities etc to arrive at a purchase price for the legal entity (equivalent to our market cap). There would be a further adjustment for the benefit of tax losses which would transfer with the legal entity.

The purposes of EV is to be able to compare business by adjusting for different funding structures and debt levels. If I give an example of two identical companies, company A takes out a $500m RBL loan to fund a new oil rig and company B funds the oil rig via a $500m finance lease. Both companies will have the same Enterprise Value and, if interest rates are comparable, the same market Cap. To suggest Company A’s EV would be $500m higher (worth more per barrel of 2p reserves) is obviously incorrect

Enquest has a very high EV to market cap ratio (4-5) which represents high level of financial liabilities compared to market Cap. While this is high risk, it is the reason I am invested in Enquest as every $1 reduction in financial liabilities should translate to a $1 increase in market cap. If oil prices hold above $80 for next 2-3 years then Enquest will be repaying over $600m pa of financial liabilities (debt, finance leases and deferred consideration) which translates to a 25p per share price increase per year for next 3 years.

It is always helpful to have a constructive discussion on these boards and gather knowledge from others views and insights.

Christmas wishes to all and hopefully a more rewarding 2023.

Comment from FT

‘To boot, the maths over proven reserves looks flawed. Adjust for cash, tax and a likely production drop since Serica's last count of 62 million barrels and the investor reckons Serica's are valued at about $8 a barrel. Contrast Tailwind's
41.8 million, which are also likely to have shrunk. Serica seems to be valuing them at $18 a barrel or more. How does that make sense? This deal is less slick than it looks."

Pretty much lines up with views on this Board.

Londoner and savemore

Debt for determining EV purposes is all interest bearing financial liabilities and is defined as bank, bond, fixed coupon preference shares, capital value of lease liabilities, minority interests and unfunded defined benefit pension net deficits.

The intent of EV is to determine a businesses operating asset value less operating liabilities and to compare to EBITDA to derive multiple. EV excludes all financing related liabilities and assets such as Finance lease which are not charged to operating costs but are are charged to interest.

Deferred consideration is also deemed a debt lIke instrument as the operating assets and cash flows of the acquired business which has. It yet been fully paid for.

Londoner

Enterprise value is not just adjusted for debt but also financial liabilities. A company can choose to borrow money to buy a Rig or it can lease it. They are both financial liabilities that have to be funded out of future cash flows. On acquiring a business you could borrow from a bank to fund purchase price or you can have seller agree to spending the purchase price over future years.

The fundamental question is would you value two businesses that are identical except for one has to pay $500m in the future for its equipment and another $500m for businesses it had purchased but not yet paid for. This is why enterprise value also adjusts for financial liabilities as well as debt to provide comparable valuations that are not dependent on the means of funding a business.

Also Serica are paying closer to $20 per barrel.

Romaron

You are correct that a $10 per barrel reserve valuation would result in a valuation of over $2b but this is the enterprise value and not market cap. You need to deduct financial liabilities from enterprise value to provide an indicator of market cap.

Our financial liabilities are be debt, finance leases and unpaid consideration for prior acquisitions.