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Friday, December 12, 2014

Oil & Gas - SPAC - Too good to be TRUE?

Highlights

  • Margin of safety is widening …Three existing oil and gas undergraduate SPACs (Reach Energy, Cliq and Sona) are trading at ~13-16% discount to intrinsic cash value (Refer Fig 1). We understand that SPACs have requirement to place at least ~90% (Reach Energy has the highest of 94.75%) of fund raised into trust account. This theoretically will serve as t he base value of the SPACs as investors can choose to votes against QAs and get back the cash value from trust account plus net interest earned. Hence, buying into these 3 SPACs now will provide base potential return of 15-19%
  • Too good to be TRUE? We think the widening gap between share price and intrinsic cash value are due to i) plunged in oil price, ii) high participation from retail investors with limited institutional shareholders (range from 2% to 11%) and iii) lack of instant arbitrage opportunity given the value can only be realised upon successful acquisition of QA or approaching end of 3 years’ time frame.
  • Higher risk free returns than FD… or investors with longer term horizon, in the worst case scenario, holding to maturity will provides attractive return of 17-29% (after taken into account interest earn of 3.2% pa, 10% tax on interest and other expenses). This will translate to ~11-13% risk free return pa. which is significantly higher than average FD rate of 3.2% pa.
  • Downside protection while enjoying upside “option”…Successful completion of QA could provide better upside. Based on the intrinsic cash value, we believe the market has mispriced the security due to misunderstanding of the SPAC structure. Hibiscus traded at a low of 52 sen and is currently trading at RM0.98 after successful completion of qualifying asset. Historically, Hibiscus (the only graduated SPAC) was traded at discount to intrinsic value but the discount was zeroised upon announcing QA and trading on premium towards completion of deal. This underpinned our belief that intrinsic cash value will serve as base return with upside “option” from value accretive qualifying asset.
  • Current weak oil price environment provides better bargain power for undergraduate SPAC…SPACs are cash companies looking for oilfield assets and should potentially be able to negotiate for better pricing especially in the declining oil price environment.

Risks

  • Identification of qualifying asset takes > 3 year; Further market mispricing; Plunged in oil price.

Valuation

  • Share prices should be underpinned by cash backing per share. The current discount provides unique opportunity to lock in long term (<3 years) returns.
Source: Hong Leong Investment Bank Research - 10 Dec 2014

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