True, the potential farm-out or disposal of a material portion of the company's interest in its Bolivar shale oil properties, located within the Middle Magdalena Valley in Colombia, South America, has taken longer than planned. However, the company is still in negotiations and I still believe a deal will happen, and one that will spark an overdue share price re-rating.
Reasons to be optimistic
In a trading update at the end of April, managing director Steve Voss commented: "We are very pleased with the amount of guidance and technical insights we have gained thus far in the Bolivar farm-out process from companies experienced in shale oil projects. We hope to complete this process in the second or third quarter of 2013." Global Energy is working together with investment bank Jefferies International to find a farm-out partner.
In a note to clients less than two weeks ago, brokerage Northland Capital commented: "Given the process is largely out of Global's control, it is not a great surprise to see a delay in light of the similar experience of many other companies seeking farm-outs. The process of due diligence and hammering out terms can take time and, of course, the ultimate timing is subject to third-parties. Given the presence of high-quality operators (in the area), we continue to be optimistic that a farm-out will ultimately be achieved and expect this to prove a valuation milestone."
Directors have significant interests
It's worth remembering that Mr Voss has a significant interest in making sure a farm-out deal happens, and at a good price. In fact, between mid-November and the end of December last year, he made no fewer than eight separate share transactions and, in the process, spent £202,000 increasing his holding from 125,568 shares to over 323,000 shares. That's the equivalent of 0.9 per cent of the company's share capital. Mr Voss started buying at 90.7p a share and spent over £100,000 in three trades in late November topping up his holding at 105p and 106p a share.
He was not alone because around the same time chairman Mikel Faulkner spent over £52,500 buying shares at 105p to take his holding to 350,000 shares, or almost 1 per cent of the issued share capital, and non-executive David Quint spent £13,750 buying 12,500 shares at 110p. So with Global Energy's shares currently priced on a bid-offer spread of 75p to 78p, all three directors are heavily under water on these director deals. Or, to put it another way, for 78p a share you are getting assets worth around 144p at current exchange rates and a chunk of these assets are likely to be worth a lot more than book value in the event of a farm-out deal on the Magdalena properties.
Increased interests in shale oil
It's worth noting that interest has increased in the past few years in shale oil throughout the oil industry and specifically in the northern Middle Magdalena Valley Basin. As I have pointed out previously, the adjacent or nearby activity by major oil companies, including ExxonMobil (NYSE: XOM) and Royal Dutch Shell (LSE: RDSA), indicate the Bolivar properties are within the premier area of the Middle Magdalena Shale Oil play.
It therefore makes sense for Global Energy to take its time to get the best possible price for these valuable assets, and find the right strategic partner with the technical expertise and financial resources to accelerate the pace of development of Global Energy's reserve-rich property in the Middle Magdalena field. The company can afford to be patient; at the end of last year, net borrowings of $11.6m equated to a modest 14 per cent of net assets of $80m (£52m), so there are no funding concerns.
A better year ahead
Clearly, some investors have bailed out after what was an extensive kitchen sinking of last year's accounts. But what they have overlooked is that the issues which caused hefty write-offs and profit shortfall last year are very unlikely to be repeated.
Namely, gross oil production declined last year due to downtime of the Tilodiran well. The lack of equipment availability to replace faulty pumps cost around four months of that well's production.
In the Llanos Basin there was a delay in completing Rio Verde 2 to a water disposal well until October (due to delayed receipt of approval). This meant that little benefit from the development was seen in last year's results. Given the size of the cost savings at Tilodiran (around $400,000 a month, or the equivalent of $4 per barrel of water on transportation costs), it is only reasonable to assume Global Energy's profitability will improve markedly in 2013 now that Rio Verde 2 is operational.
Pre-tax profits were also hit by unfavourable currency movements and net profits were impacted by a major tax change by Colombia which distorted the earnings figures. This relates to equity tax and changes that disqualify certain tax losses from previous years and led to a tax charge of $3.7m. However, the tax rate is now expected to normalise in the future.
As a result analysts at Northland Capital expect Global Energy to produce revenues of around $45.8m this year, up from $44m in 2012, but importantly the company will not encounter the issues which dragged down profits in 2012. In fact, full-year pre-tax profits are expected to rise from $2.7m to $6.2m to produce underlying EPS of 11.4¢, or 7.4p. This means the shares are being priced on only 10 times earnings estimates and are rated on less than half Northland's risked-reserves based price target of 184p.
Catalysts for share price re-rating
Investors also seem to have overlooked the fact that we are set for a much improved trading performance when Global Energy reports half-year results in late September. That's because the company reported adjusted pre-tax profits of only $1.2m on revenues of $20m in the first half last year due to the downtime of the Tilodiran 2 well (126 days) during the six-month period. With that issue resolved, expect production to rise sharply. And with the company benefiting from the aforementioned $400,000 monthly cost savings at Tilodiran, then profits could easily more than double in the first half of this year, albeit form a low base.
Global Energy's shares have also fallen to a major support level around 70p and the 14-day RSI is on the floor. So, even though they are well below my buy advice of 103p ('Insiders major buy signal', 17 Dec 2012), I am comfortable reiterating my buy recommendation ahead of a likely farm-out agreement on the Magdalena properties, and much improved half-year results in the third quarter.
Good news on either front could spark a very sharp re-rating indeed. A recovery back to my 103p buy-in price is a realistic prospect.
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