Valuation Model: MIE's Bondholders to Recover 49.5% Under $60/bbl WTI Base Case If $50.7M Holdouts Taken Out With Priming Debt; Additional 14.6% of Recovery at $65/bbl

Relevant Documents:
Valuation Model and Financials in Excel
FY’18 Report
1H’18 Report
Canlin Sale Announcement

While MIE managed to secure tenders for 84% of its $315.9 million notes outstanding, the company is still facing maturity of $50.7 million tomorrow, April 25, with only $4.1 million of unrestricted cash on the balance sheet as of 2018 end (excluding any cash classified as held-for-sale). As a result, options for the company are limited with last minute debt funded redemption being the most likely scenario.

However, any such lender would likely require security of kinds or priority priming the unsecured exchange notes. Reorg’s projected base case recovery for the notes in that scenario is 49.5% and should the priming not occur, recovery stands at 57%. This compares to a downside case recovery of 5.6% if priming occurs. The downside case also stresses production, costs, associate investments values, and oil prices among others. Should we keep the oil price assumptions in line with the base case and only stress the other factors, adjusted downside case yields 18.1% recovery. The 2019 notes were last indicated on Cbonds at 55/58.

Capital structure of the company prior to the exchange is as follows.
 
Following the exchange, the company has only $50.7 million in notes due April 2019 outstanding with $248.4 million in new 13.75% notes due 2022. A further $26.5 million in new debt was incurred to fund the 10% cash payment and we assume this ranks ahead of the notes.

The company has four other secured loans ranking ahead of the notes.
 

• $60 million outstanding under the $100 million Huarong Macau Loan secured by shares in MIE International Resources and its PSC interests among others. The vehicle controls the 10% in Moliqing PSC and 10% in Daan PSC which were acquired for $55 million.
• $147.2 million Huarong International Loan secured by shares in Gobi Energy, pledge over Gobi Energy’s share of production revenue and receivables, and charge over certain accounts.
• HK$1.255 billion ($160 million) Hammer Capital Loan with HK$382.6 million outstanding as of June 30, 2018 secured by second fixed charge “over certain charged properties.”
• HK$390 million Hammer Capital Loan also secured by second fixed charge “over certain charged properties.”

There was about RMB 60 million ($8.9 million) of debt on balance sheet unexplained by these loans as of 2018 end. We assume, for the purposes of the recovery model, that this ranks ahead of the notes.

The company’s corporate structure is provided below:
 
Valuation

In order to value MIE, we take a sum of the parts approach (assuming the successful sale of Canlin) utilizing DCF for the Daan and Moliqing PSCs and looked at publicly traded majority holder in the Emir asset to determine the value for MIE’s equity stake. We also looked at intercompany receivables, particularly intercompany loan extended to MIE’s associate Palaeontol B.V..

Below is a summary of our valuation, assuming the residual 2019 notes are refinanced with debt that primes the new notes, and the associated recoveries.
 
Daan, Moliqing PSCs

MIE holds two production sharing contracts (PSCs) for producing onshore assets, Daan where it holds 100% and 10% in Moliqing PSC. The Daan PSC is due to expire in 2024, though MIE said in its prospectus there is a possibility of extension up to 2028, and Moliqing PSC expires in 2028. The company does not provide any details or conditions regarding the PSC extension.

The parties to the PSCs are CNPC, PetroChina and MIE. Global Oil Corporation initially entered into the original PSCs for the assets in 1997 and 1998 respectively with CNPC, the China National Petroleum Corporation. “Most of the commercial and operational rights and obligations under the PSCs” were subsequently transferred to PetroChina in 1999 though CNPC remains a party to these contracts.

To value the assets, we projected the company's production, operational costs, segmental and corporate SG&A until 2024 and looked at residual value of the Moliqing PSC in 2024.

We note that the values in the sensitivity table for prices at $70 per barrel are overstated as the company has to pay a progressive ad valorem taxes ranging from 20% to 40% on sales at prices over $65 per barrel which we did not model as our cases assume WTI prices ranging between $55 per barrel to $65 per barrel with additional discount.

Below is the valuation output. On the tables to the left, we estimate sensitivity across cases while the tables to the right portray sensitivity of the base case to the oil price assumptions. $5 change in price per barrel results in additional 14.6 points of recovery for the noteholders.
   
The valuation translates into the following implied EV/EBITDAX multiples which compares to about 4.6x for a much larger company like CNOOC which has $85.5 billion market capitalization, about $21 billion of debt with leverage at less than 1 turn. Furthermore, we include all corporate costs in the Chinese assets DCF. It is very likely that some of these pertain to other parts of the business and as a result, the Chinese assets multiple could potentially be higher as lower corporate costs would yield higher valuation and lower EBITDAX.
 
On the bondholder call, Mei Leon, CFO of MIE said that the value of the Daan asset was estimated to be between $350 million to $400 million by Ryder Scott. The low end is consistent with base case Reorg DCF valuation if we exclude any SG&A incurred. If we include SG&A allocated only to the Chinese segment, excluding the corporate SG&A, base case valuation yields about $300 million.

Ryder Scott’s Daan valuation also sheds light on the purchase price allocation of the $55 million spent on 10% of Daan PSC and 10% of Moliqing PSC. 10% of the low end Ryder Scott Daan valuation translates into price attributable to Moliqing being about $20 million while the high end results in valuation of $15 million. Reorg’s valuation of the Daan asset excluding non-PRC attributed overheads translates into about $30 million attributable for the Daan PSC and $25 million for Moliqing.

The company previously sold Riyadh Energy which held 90% of Moliqing PSC for $45 million with MIE and purchaser entering into the sale agreement on Dec. 1, 2017. The implied price for a 10% block would have been $5 million assuming only the PSC was sold. When initially classified as held for sale, assets of Riyadh were written down by RMB 68 million to RMB 750.8 million as per the 2015 report. They were further written down to RMB 422.9 million thereafter. As a result, Riyadh assets seemed to have been worth about $132 million before the writedowns mentioned and about $65 million thereafter likely driven by falling oil prices, among others.

We attempted to extrapolate the production under the 10% of the Moliqing PSC on the back of the change in the 2018 guidance between the guidance given in the 2017 report and the 2018 interim report. We assume the daily production of the Daan asset remains unchanged with the only change being an increase in ownership from 90% to 100%. The implied annual Moliqing production was about 0.4 kbopd. It is notable that as per the Riyadh Energy (entity which owned 90% of Moliqing PSC) disposal announcement, the net Moliqing 2P reserves were 4.3 mmbbl with net 3P reserves of 7.6 mmbbl as of 2016 end. This would translate into 0.5 mmbbl attributable to 10% share, a figure that could be exhausted within 4 years given our estimated Moliqing production. As a result, it is likely that production attributable to Moliqing is actually lower. This has no impact on the valuation as we use the gross figures guided for the two assets.

The 2018 Daan mid case production guidance based on the 2017 report when only 90% of Daan PSC was owned was 4.4 kbopd or 4.8 kbopd for the full asset.

Assumptions

Realized Oil Price

To project realized oil price, we assumed flat WTI price of $60 per barrel with $3 per barrel discount going forward in the base case which compares to WTI price of $65.75 per barrel on April 22 and 2019 average of $56 per barrel. The ICE December 2020 futures were at $59.6 per barrel while December 2021 futures are at $56.6 per barrel. CME futures are at the same levels.

In the upside case, we assumed price of $62.5 per barrel in 2019 and $65 thereafter with $2 per barrel discount while downside case price assumed was $55 per barrel from 2020 on with $4 per barrel discount.

Production

We projected the 2019 daily production to be 5.5 kbopd in 2019 until 2021 in the base case falling to 4.75 kbopd in 2024. Upside and downside cases are sensitized by 0.2 kbopd. The projection compares to 2018 guidance of 4.9 kbopd to 5.3 kbopd as per the first half report.

The resulting projected production between 2019 and 2024 is 11.5 mmbbl compared to 16.7 mmbbl 2P reserve of Chinese oil fields in 2018 or 12.5 mmbbl in 2017.

Sales are assumed to be 100% of production

Direct Costs, Distribution Costs, Non Income Taxes

We referred to historical costs per barrel for these costs and sensitized them by 5% across the upside and downside case. This implied gross profit per barrel has historically been about $2 per barrel higher than the reported cash netback.

Segmental G&A, Employee Benefits

We inflate the absolute value of these by 1.5% in the base case between 2019 and 2021 and 2% thereafter. The growth across cases is sensitized by 1 point.

Capex

When projecting capex for the Chinese assets, we refer to the guidance provided in annual reports which ranged between $5 million for 2016 and $20 million for 2018 (as per 1H’18 report).

We assumed capex of $13.75 million annually for the base case with sensitivity of $1.25 million per case.

Corporate G&A, Employee Benefits

Since the group has been disposing of significant portions of the businesses, we project the G&A overheads to decline by 25% in 2019 and 20% in 2020 in the base case. The decline is by 25% and 10% for the corporate employee benefits. Thereafter, we inflate them in line with the segmental SG&A. We assume that 25% of the corporate employee expenses are non cash, in the form of share based payments - roughly in line with historical levels.

Moliqing Residual Value

The DCF model stops in 2024 when the Daan PSC expires. Since Moliqing has 4 years left on the PSC, we assumed residual value of $5 million in 2024 discounted to today.

Emir Oil

MIE holds a 40% stake in Paleontol which owns Emir Oil, a project focused on production and exploration in Kazakhstan. Reach Energy Berhad, holds the residual 60% stake in the asset and is also the operator. The Malaysian oil and gas company purchased its stake in Emir Oil from MIE in November of 2016 for total consideration of $175.9 million. It is currently the sole asset of the Malaysian oil and gas company.

As of 2018, the field had 67.5 mmbbl in 2P oil reserves, 7.8 mmbbl in 2P LPG reserves, and 78.8 bscf 2P gas reserves with detailed breakdown prepared by Gaffney, Cline & Associates as follows.
 

Oil production in 2018 stood at 0.98 mmbbl (2.693 kbopd) while gas production was 1.55 bcf and estimated future production profile was as per below.
 


As per reserve report produced by Gaffney, Cline, and Associates, the current well stock comprises 54 development wells that have been active in the field over the historical period. Production from the existing wells has been declining “over the last several years” with increases being primarily due to new wells coming onstream. The approved drilling schedule contemplates 48 wells to be drilled between 2019 and 2025 as follows.
 

As a result, the company has significant capex spend ahead between 2019 and 2023. Capex of MYR 829 million is included in the minimum work programme over the life of the production contract expiring in 2036 as per 2018 fourth quarter report. In the release today, AGM report, the company guided capex of $44.8 million, or roughly MYR 184.9 million, in 2019 split between $31.3 million on development activities and $13.5 million on exploration wells.

Historical financial performance of the asset was as follows. It is notable that the company has yet to produce significant cash flows which would be driven by its increased daily production.
   
Reach Energy currently has a market capitalization of $91.1 million with its 60% owned Palaeontol B.V. having about $145.2 million in net shareholder loans provided by MIE which owns the residual 40% in Palaeontol B.V.. If MIE’s stake were to trade in line with Reach Energy’s market capitalization, enterprise value of the asset stands at MYR 1.179 billion or $284.7 million pointing to significant anticipated EBITDAX increases to warrant this.
 
The shareholder loan is provided by MIE Holdings and as per MIE’s exchange memorandum, it is unsecured with maturities between 2019 to 2036. Reach’s 2018 annual report provides further details on this facility. It amounted to $145.2 million as of the reporting period end and had the following maturity schedule.
 

Given that Reach’s sole asset is its 60% holding in Emir Oil, its market capitalization should reflect the value of 60% of its equity in Paleontol B.V.. If we adjust this to reflect the 40% stake of MIE, MIE’s equity share of Paleontol B.V. should be worth about $60.7 million. However, we apply a range of discounts to reflect non-controlling stake and potential distressed sale. Based on the 60% stake sale price of $175.9 million, the 40% stake would be worth about $117.3 million.

The equity value of $60.7 million points to value of about $200 million between the shareholder loan and MIE’s 40% equity stake. While we did not fundamentally value the Emir Oil asset itself in depth, we note that the share price of Reach Energy has been falling over the past two years and we apply sensitivity to the implied value of MIE’s equity in Paleontol.
 

In the base case, we assumed a 50% discount to the implied equity value of $60.7 million reflecting a distressed sale and the non-controlling nature of the stake and 25% discount to the shareholder loan to take into account lack of visibility on its recoverability. Ability to collect on the amount due was also noted by the management in the notes exchange memorandum. As seen on the repayment schedule above, some of the amounts due are as far as 2036 while others have no fixed repayment period.

In the upside case, we take a 25% discount to the equity value and allow for 100% recovery on the shareholder loan while in the downside case, we discount the equity by 75% and apply a 50% discount on the shareholder loan.

The reason we are allowing for some equity value from the asset despite discounting the shareholder loans which should technically sit higher up in the capital structure is to reflect the much higher likelihood of monetizing the equity in the short term while recovering value from longer term loans may prove much more difficult.
 

Receivables

MIE’s 2018 report available does not provide a breakdown of the RMB 972.2 million in prepayment, deposits, and other receivables. However, as per Reach Energy’s report, the company had about RMB 975.8 million outstanding in intercompany loans from MIE. It is unclear how much if any is there outstanding under the consideration receivable as of 2018 .

For the purpose of the valuation, we only ascribe valuation to the receivable from Palaeontol B.V. as per the schedule in the Emir Oil section. We also note that close to half of the receivables have been written off through loss allowance as per the historical accounts below.
 

Canlin Sale

The company is in the process of selling its Canadian asset for $250 million to Far East Energy. MIE’s CEO and Chairman Zhang Ruilin owns 9.99% of Far East Energy while his spouse Zhao Jiangbo owns 80% of the company and brother-in-law Zhao Jiangwei is in possession of the residual stake.

The sale of Maple Marathon was initially conditional on all conditions precedent being fulfilled or waived on or before Jan. 31, 2019. However, this has been extended Sept. 30. As per the release dated Sept. 24, 2018, the $250 million consideration comprises $150 million in cash and $100 million retained by Far East Energy for the repayment of the third party loan.

The conditions precedent on the deal were as follows.
 

• Approval of the share purchase agreement,
• Compliance and satisfaction of all applicable requirements,
• Obtaining all applicable consents, waivers, agreements or execution or relevant deeds or any other form of documents in respect of the outstanding third party loan extended by China Huarong Macau,
• The approval of the change of control by at least two thirds of the directors of Canlin pursuant to the shareholders’ agreement of Canlin,
• And the receipt of competition act approval.

Reserves

MIE had 338.7 mmboe in 2P reserves as per Ryder Scott report of which Canlin and Journey made up 286.6 mmboe. Further 35.4 mmboe was in the Emir Oil asset. MIE’s “China Oilfields” 2P reserves increased 4.219 mmbbl to 16.708 mmbbl despite the 2018 production of about 1.9 mmbbl.

Of the 1.9 mmbbl, about 1.6 mmbbl would come from the full year of production of the 90% share in the Daan asset as per 2018 guidance in the 2017 report. This implies that net 2P reserves from 90% of Daan as of 2018 end would be about 10.9 mmbbl or 12.1 mmbbl for the whole asset following acquisition of the residual 10%. As a result, there has been an increase in 2P reserves in China by about 4.6 mmbbl though the drivers are not elaborated in the report.

In MIE’s Riyadh Energy disposal release, Moliqing PSC had about 4.3 mmbbl net 2P reserves as of 2016 when the company owned 90% of the PSC. As a result, the acquired 10% in the PSC would not be able to bridge the significant increase without any new discoveries.