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BIG PICTURE - Dragon Oil’s proposed Petroceltic takeover makes strategic sense

Dragon Oil has been on the acquisition trail for a number of years and City experts see the strategic sense in the proposed deal.


Shares in Petroceltic International (LON:PCI) jumped over 22%  as it revealed it is in ‘detailed’ discussions over a £500mln bid from Dragon Oil (LON:DGO).

In a short stock exchange announcement, it said the offer had been pitched at 230p a share or a 29% premium to Friday’s closing price.

The proposed price appears acceptable to Petroceltic’s board, which said it would recommend an offer at the indicated price.

Dragon Oil has been on the acquisition trail for a number of years and City experts see the strategic sense in the proposed deal, beyond the immediate production boost, which would add 25,000 bopd to take Dragon’s daily output past 100,000 barrels. 

Operationally, Petroceltic’s main challenges in the coming years will be the financing and managing of the Ain Tsila gas development project in Algeria. 

Dragon offers the financial wherewithal to bring the project into the production phase pretty easily, according to Gerry Hennigan, analyst at Dublin-based Goodbody.

The proposed 230p takeover price lands in between analyst's total and core valuation for Petroceltic of 252p and 222p respectively.

Hennigan suspects Dragon is primarily interested in the core elements of the Petroceltic business – Algeria as well as production in Egypt and Bulgaria – and as such he describes the offer price as being “there or there about”.

Elsewhere, one dissenting City voice came from Peel Hunt, which said that 230p per share was too low as it gives no value to Petroceltic’s exploration upside. And as such analyst Werner Riding said Dragon would be getting a good deal.  

Riding says he would not be surprised to see a competing offer from another party if Dragon’s 230p offer became ‘firm’. 

If indeed a firm 230p offer is made by Dragon, Petroceltic’s board intends to give the proposal its recommendation.

Petroceltic’s board includes two representatives of Worldview Capital Management, its largest shareholder with 22%. 

Worldview was cast in the role of ‘activist’ earlier this year when it opposed a $100mln funding and an alternative revised deal was subsequently negotiated and passed. 

Analysts expect Worldview to be agreeable to a sale to Dragon. 

Indeed, Westhouse Securities analyst Mark Henderson said along with other major shareholders it is likely to have been involved in engineering the deal.

SP Angel, meanwhile, believes Dragon Oil’s backers will also be agreeable. 

The broker told clients “it is inconceivable” that Dragon had not “tested in theory” the point of view of the Emirates National Oil Company, its 54% owner. 

SP Angel points out that Dragon maintains open dialogue with its main backer, so there shouldn’t be a problem securing the necessary approval on that side.

Dragon currently produces in the order of 76,000 bopd from its operations in the Turkmen waters of the Caspian Sea, and via its ongoing development drilling it is aiming for 100,000 bopd from those assets alone next year.

It is this cash-generating engine that will both pay for the PCI deal and support the Ain Tsila development.

Dragon generated some US$547mln of revenue in the first half of 2014, and its interim cash balance totalled US$1.8bn. 

During the same six month period, Petroceltic generated US$96mln of revenue and ended the first half with US$105mln of cash – it also revealed it was due just shy of US$80mln from the Egyptian authorities for past sales.

In this regard the timing of the proposed merger is somewhat opportune as today BG revealed it had received a payment of US$350mln from the Egyptian government for oil and gas sales. 

It has been seen as positive for the whole sector as it is the latest signal that the authorities are expediting due payments.

It is also notable that Dragon has in recent months set its own footprints in Egypt and Algeria -securing exploration acreage in both territories.

One curious sidebar to the deal is the implications for Petroceltic’s exploration interests in the Kurdistan region of Iraq, which may end up being divested because of the merger.

The issue arises as Dragon has interests in southern Iraq, where it made a new discovery early last month with the Faihaa-1 exploration well, near Basra, flowing at a rate of 2,000 barrels per day.

Companies in the past have not held interests on both sides of the regional boarder as a result of the long standing dispute over oil contracts and oil policies in Kurdistan, which Baghdad deems illegal. 

A new Iraq leadership though means the country’s future oil policy is not currently clear. And as the current military conflict continues the whole project remains the subject of some degree of uncertainty.

Hennigan, at Goodbody, said that as Dragon Oil is primarily interested Petroceltic’s tangible core business, it would not be too concerned if it had to offload the Kurdistan assets.

He also points out that Petroceltic has yet to have exploration success in Kurdistan and as such it would only become a real dilemma for Dragon if a discovery was made. 

Petroceltic’s drilling operations are due to restart for the Shireen exploration well this month, following a precautionary suspension due to fighting in the region.

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