by Jeffrey Alton & Bill Feingold
Cobalt International (CIE) recently completed a $1.15 billion convertible bond issue, its second convertible in the past 18 months. Here’s our summary of the company and its convertibles.
Modest Proven Success…….
Cobalt International Energy, Inc (CIE) is a development stage oil and gas production company with interests in the Gulf of Mexico and in Western Africa off the Gabon and Angola coasts.
The company has 7.9 million barrels of proven reserves on its books from the Heidelberg Project in the Gulf of Mexico. Anadarko is the operator and CIE has a 9.375% ownership. First production is estimated in 2016 and production is estimated to be about 80,000 barrels of oil per day.
Gives Way to a Potentially Bright Future……
The real excitement for CIE lies in two more recent discoveries in West Africa. These include the recently announced Orca Discovery and the Camela Project.
CIE has a 40% ownership in the Orca Discovery and has estimated total reserves of 400 to 700 million barrels of oil. The field is twice the size of Manhattan. The company has not announced an estimated first production date, but an additional appraisal well is planned in 2015. CIE is the operator for the field.
CIE also has a 40% ownership in the Cameia Project and has estimated total reserves approaching 300 million barrels of oil. Production is estimated to begin in 2017 with the potential of 100,000 barrels per day if other discoveries in the hub prove fruitful.
That’s not Cheap……
CIE currently has not realized any revenue to date, and has $1.4 billion of unrestricted cash. Operating expenditures in the first quarter was $178 million and total planned expenditures for 2014 are $750 to $850 million. To date, Cobalt International has spent north of $1.5 billion in exploration and development in addition to purchasing equipment costing about $1.6 billion that it carries on its books.
40% ownership and operator status in large oil fields under development expands CIE’s financial flexibility beyond the capital markets. As the company develops priorities in its exploration activities, CIE has the potential to farm-out interest in its current projects and exploration to third parties to raise cash and limit expenditures.
But Valuation Currently Seems in Line with a Comparison…………
A valuation comparison point is Kosmos Energy, Ltd (KOS). Kosmos, which owns about 24% of the large Jubilee Field off the coast of Ghana, has a market cap of just north of $4 billion. Jubilee has experienced some production problems, but is currently producing about 100,000 barrels per day. Estimates for Jubilee range from 800 million to 1 billion barrels in potential reserves, making Kosmos share of potential reserves about 240 million barrels of oil. CIE has a current market cap of about 7 billion, with a potential share of reserves up to about 400 million barrels of oil based on information released by the company. Both companies are actively pursuing additional development projects. Based on potential barrels in the ground against market cap, the companies are valued similarly.
Drilling wells is typically an optimistic catalyst for oil and gas stocks as excitement surrounds potential discoveries. Cobalt is planning to spud one appraisal well in the Shenandoah discovery and three discovery wells in the second half of 2014. Of course a successful discovery will move the stock as the Orca discovery was early this year. However, we would be patient in entering a position in the stock until we see a 5% to 10% discount to the current price as the Orca announcement is digested and the market realizes that additional work must be completed on the well to prove its commercial viability. As spud dates for the new wells draw closer for CIE later in the year, we believe that catalysts will then be in place for the stock.
About the Convertibles…
Cobalt now has two convertibles with substantially different profiles. The older bond, which pays a 2.625% coupon and matures in December 2019, should be viewed as a yield-oriented play with some equity upside. This bond now trades around 93 cents on the dollar for a yield to maturity of about 4%—substantially less than one would expect or accept from a non-convertible Cobalt bond of similar tenor. The question becomes whether the equity component has enough juice to justify accepting this lowish (for the credit) yield.
While it’s not impossible to make a case for the bond along these lines, it is fairly difficult. The conversion price, slightly above 35, is more than twice the stock’s current level. It’s a guessing game what the true credit rating of a revenue-free company should be, but it’s hard to imagine these bonds would be much above 75 cents on the dollar in the absence of the conversion feature. This is a semi-geek way of saying they look fairly expensive, even after taking it a bit on the chin after the announcement of the new deal. They’d look a lot more attractive in the mid-to-high 80’s, which is where they’d probably be trading in a convertible market less starved for paper.
The new bond looks a lot more like a convertible, and a lot more appealing, to the naked eye. It now yields a bit under 3%, with a conversion premium about 38%. (Comparing these with the nominal deal terms, 3.125% coupon and 25% premium, you can see that the bonds have been well received, although the deal terms also accounted for the substantial amount of stock to be sold by hedge funds).
If you are looking for substantial equity exposure but with some current income and seniority in the capital structure, the new bond is clearly superior. It figures to participate in about 60% of the stock’s upside, versus maybe half that much for the older convertible. Theoretically, the old bond looks several percent cheaper than the old one. This can be debated—some may feel the shorter-dated old bond should be modeled with more generous credit assumptions. Either way, the new bond comes out ahead.
The old bond only looks better for investors who insist upon bonds with maturities inside, say, seven years, as well as those who cannot buy bonds above par. Given the speculative nature of the company and the reasonably comparable yields, the new bond looks superior. This is not, after all, a widows-and-orphans credit to begin with. The old bond has likely been overvalued because of a lack of paper in the market—its holders are probably reluctant to mark their bonds down for further losses, even if they recognize the new bond has a better risk/reward profile. In reality, most of the owners of the old bonds likely bought the new ones as well.