Spartan Delta unlocks value, still cheap

The spin offs look OK at first blush

Today’s announcement that Spartan Delta (SDE) had sold off Montney oil assets for CAD$1.7 billion and will pay a special dividend of $9.50 per SDE share came as a bit of a welcome surprise to most energy investors. But many sold into the news thinking the value creation by this management team had run its course. That judgment is likely wrong, and possibly very wrong.

The assets sold to Crescent Point (CPG) comprise largely the Velvet assets Spartan Delta acquired barely two years ago for about CAD$750 million. They are good assets and in my opinion Crescent Point will do well with them.

I originally purchased my Spartan Delta holding when I traced the assets of the former Bellatrix Exploration into Spartan Delta who purchased those assets out of the bankruptcy of Bellatrix, paying a nominal price for extremely profitable natural gas assets in the Deep Basin. Bellatrix failed from over use of debt and the collapse of natural gas prices putting it in an insolvent state.

At the current price of CAD$14.60 a share an investor gets the $9.50 dividend, another special dividend of CAD$0.10 a share, and one share of spin off Logan Energy, a new company that will host about 4,500 Boe/day production from acreage in three areas of Montney (Simonette, Pouce Coupe, and Flat Rock) with 193,000 acres of land. The Logan shares are valued at CAD$0.35 by National Bank Financial and will be distributed share for share to Spartan Delta shareholders as a dividend in kind, together with a short term warrant to buy additonal shares at CAD$0.35 per share until July of this year. The Logan assets are interesting and present a strong case for growth and a stream of dividends. It is far too early to try and value the assets and I am confident National Bank’s valuation was sensible, and puts a value of about CAD$60 million on Logan before any exercise of the warrants. Back of the envelope arithmetic suggests that 4,500 Boe/day of liquids with an assumed netback in the CAD$30 range provides about CAD$50 million of cash flow (before SG&A likely less than CAD$10 million) and at a hypothetical multiple of three times would value Logan at more than double the National Bank valuation, assuming a share count of 171 million. That assumed CAD$30 netback is a wild ass guess and not all that reliable but within the bounds of sensibility post the coming recession. It is not hard to see why a valuation of CAD$60 million is sensible today and the prospect of a higher value emerging in a year two quite likely. That is the state of Canada’s energy industry.

Spartan Delta retains the former Bellatrix assets which they expect to produce about 40,000 Boe/day of natural gas and related liquids and two thirds of the gas is hedged for 2023 at CAD$4.45 a gigajoule. Dusting off my old model of Bellatrix (I took a bath on that holding when the company failed) and making a few adjustments I see that retained business as capable of generating somewhere around CAD$200 to CAD$250million per year of cash flow and expect the market to value the residual Spartan Delta at around CAD$6.00 a share at today’s commodity prices, substantially more if oil prices rise materially.

Adding it all up, I see buying Spartan Delta at $14.60 providing:

$9.60 immediate dividend
$0.35 Logan spin off shares
$0.05 Logan spin off warrant
$6.00 Residual SDE comprising one time Bellatrix assets
$16.00 total value

Lots of risk and lots of opportunity. The 10% discount to my rough valuation is within the error term of the rough estimates and may not be a discount at all. Nonetheless, I see value growth likely so I added 10,000 shares to my 55,000 share holding. I think the management of Spartan Delta (who took a lot of criticism from investors wanting to see more money “returned to shareholders” at the time) is first class and like their record of creating value. I see today’s announcement as another example.