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Swoop on fully-funded Falcon

This exploration company isn't for the faint-hearted, but much of the upside case has been de-risked
December 3, 2015

With crude stuck below $50 (£33) a barrel for much of the year, 2015 has been terrible for most junior oil and gas explorers. All have had to rethink the economics of their projects and may have been cut off from capital markets. One notable exception is Falcon Oil & Gas (FOG). Thanks to its "farm out, enhance, sell" strategy, it doesn't require further funding nor does it have capital expenditure commitments. Taken alone, these factors don't constitute an investment case, particularly as Falcon is yet to generate any revenue. But we believe the early results from its huge Australian Beetaloo Basin asset, together with supportive drilling partners and likely buyers, mean shareholders could reap a significant gain in the next two years.

IC TIP: Buy
Tip style
Speculative
Risk rating
High
Timescale
Long Term
Bull points
  • Well-developed large shale acreage
  • Drilling costs fully funded
  • Buyers lined up
  • Board track record
Bear points
  • Uncertainty over timing
  • Stalled South African asset

Although it holds licences in South Africa and Hungary, Falcon's main focus is Beetaloo, an unconventional oilfield in Australia's Northern Territory. Ownership is split 30-70 per cent between Falcon and its farm-out partners. The asset comprises three permits across 4.6m acres of potential shale gas, shale oil and tight gas deposits. Between 2009 and 2014, Falcon and its predecessors invested $150m to prove and develop the field. Analysts have compared Beetaloo's geology with the Bakken and Eagle Ford shales in the US. Ahead of an eventual sale, the company is now improving the commerciality of Beetaloo's recoverable resource, which a 2013 competent persons report put at 162 trillion cubic feet of gas and 21.3bn barrels of oil.

Last year that process began when Origin (Au:ORG) and Sasol (Sa:SOL) were brought on to drill nine wells in a Aus$200m (£97m) deal in which Falcon is carried entirely. Following the back-to-back successes of the first two vertical wells, Falcon last month accelerated the drilling of its first horizontal well by a year. Not only have the horizontal results been "very encouraging" so far, but the decision has markedly increased the likelihood of a sale of Beetaloo in 2016 or 2017.

So what's Beetaloo worth? As the quality of the asset is improved with well logs, oil and gas shows and flow tests, analysts at broker GMP have come to a value of $800 an acre. For Falcon, that equates to a net present value of 17.2p a share on a risked basis, and 70.1p un-risked, assuming parity with historical transactions of early-stage shale explorations in the US.

That's a bold comparison, given Beetaloo is pre-production. But big names clearly believe in the geology: perhaps the strongest external validation came in 2012, when France's Total (Fr:FP) and Japan's Inpex (JP:1605) agreed to spend $34bn to develop a major liquefied natural gas infrastructure project 600km north of Beetaloo. Given the colossal impending demand, Falcon chief executive Phil O'Quigley tells us he "won't have a problem" selling the asset. Total, ConocoPhillips (US:COP) and Inpex are all potential bidders and well-known to the Falcon management team.

Selling at the right price can be tricky, so it's reassuring that Falcon's board has been here before. Non-executive chairman John Craven was a co-founder of Cove Energy, a true Aim success story which started from nothing in 2009 and sold to Thailand's national oil company for $1.9bn three years later.

FALCON OIL & GAS (FOG)

ORD PRICE:6.6pMARKET VALUE:£61m
TOUCH:6.5-6.75p12-MONTH HIGH:10.8pLOW: 5.1p
FORWARD DIVIDEND YIELD:nilFORWARD PE RATIO:na
NET ASSET VALUE:4.5¢NET CASH:$9.8m

Year to 31 DecTurnover ($m)Pre-tax profit ($m)Earnings per share (¢)Dividend per share (p)
2012nil-17.7-1.9nil
2013nil-3.6-0.4nil
2014nil-31.8-3.5nil
2015*nil-3.6-0.4nil
2016*nil-4.0-0.4nil
% change----

Normal market size: 15,000

Matched bargain trading

Beta: 0.56

£1=$1.512 *GMP forecasts