Cairn Energy (CNE) is a company that I have followed for many years, almost for as long as its ongoing saga relating to compensation from the Indian government but it is starting to look more likely that will actually finally be settled. This all dates back to 2007 when Cairn restructured and floated its Indian subsidiary whilst retaining 10% of the shares, which it was restricted from selling. Subsequently, Cairn India merged with Vedanta, and Cairn Energy received a 5% equity stake in Vedanta but in April 2017 the Indian Income Tax Department forced the sale of that and seized the £455 million proceeds from it, citing outstanding tax due from the deal in 2007 – although the tax law that it was trying to apply was only actually introduced in 2012! After several years of legal battles, an international tribunal in The Hague unanimously ruled last December in favour of Cairn, under the UK-India Bilateral Treaty, and awarded the company $1.2 billion in damages as well as interest and costs, which became payable at that time. Subsequently the Indian government appealed against the decision in March and that appeal is yet to be heard, but the consensus seems to be that the original ruling is unlikely to be overturned, although when it comes to court decisions you can never bank on anything.
Since the ruling, Cairn has been looking into other ways to recover the money due under the arbitration award, after the refusal by India to pay up, or at the very least to make enough of a nuisance of itself that the government changes its mind and honours the award. The company had already filed a lawsuit in the US demanding that the federal court there forces Air India - controlled by the Indian government - to pay $1.26 billion, and the airline has until the middle of this month to challenge that or risk having its assets seized. This is all part of a strategy by Cairn to recover the money via India’s overseas assets, of which it has already identified around $70 billion worth that could potentially be offset against the $1.72 billion owed (the award plus interests and penalties). Things further escalated last week when a French court ordered the seizure of property in Paris, owned by the Indian government and valued at around €20 million, and Cairn is looking to force the sale and receive the proceeds from that. I suspect that this is all part of a ploy to force India into settling the dispute - possibly even with some sort of offer to honour the original award but maybe with reduced interest and penalty payments - rather than a strategy by Cairn to actually recoup the full amount in this way. Basically, showing India that it has the courts on its side and can potentially cause it a lot of problems – if Air India planes were to be seized for instance. India may try to ride this out until its appeal is heard, but given that it took part in the arbitration process for four years it seems unlikely that the award will be overturned just because India doesn’t like the outcome. So, I now see a better chance than ever before that Cairn will finally see this money and the whole saga will come to an end soon.
Given that Cairn is currently valued at around £754 million, with a share price of 151p, receiving the compensation claim in full - or even doing a deal with India for a good proportion of it - would be highly significant for the company, and offers plenty of potential upside. Quite possibly it would result in a special dividend, similar to the one announced in December for 32p per share, and totalling around $250 million, from the sale of its assets in Senegal for $525 million (with a further $100 million possible dependent on production and prevailing oil prices). Since exiting India the company had been focused on the North Sea, where it has had success with its interests in the Catcher and Kracken fields, but in March it announced a change of direction, with the sale of both stakes and the purchase of producing fields in Egypt. The sale of both raised $460 million and was back-dated to January 1 2020, and given the uncapped contingent consideration that was part of that agreement up until 2025 - $75 million at $60 Brent, $125 million at $65/barrel - there should be significant amounts of cash to come from that in the future. At the same time, Cairn announced that it had entered into a joint venture with Cheiron to purchase the Shell Egypt onshore Western Desert portfolio of assets, for $646 million in total ($323 million net to Cairn), but also with additional considerations (costing Cairn up to $140 million), and this also has an effective economic date of January 1 2020. Those assets gave Cairn 113mmboe of 2P reserves and net production of 33,000-38,000boepd for 2021, with roughly two-thirds of that being gas. There is also significant further upside via the development of around 49mmboe of 2C resources, net to Cairn, and as at the end of 2020. The production sharing mechanism for these Egyptian assets is complicated and varies from block to block, including cost recovery mechanisms, as well as depending on production levels and prices, but it is at least in line with what you typically see in Egypt.
It remains to be seen how well this change of focus works out for Cairn, but looking at the projections for production over the coming years, and the Capex required for these licence areas and to potentially exploit the 2C resources, there is enough to interest me from that alone and believe that the market is currently undervaluing Cairn. The current share price and seeming weakness compared to many of its peers could also potentially be due to Aegon Asset Management continuing to sell off its stake, as on June 1 there was a TR1 announcing that it had dropped from 3.89% to 2.93%, and so may well be reducing to zero (there is no requirement for any further disclosures now that it is below 3%). Given the producing assets that the company has, as well as upside potential from its exploration licences in various countries – including in Mexico (15% WI) where an exploration drill at Sayulita-1 and an appraisal of last years discovery at Saasken are planned, and operator ENI recently announced that it had received final approval for this drill to go ahead, targeting potentially 650 million barrels of oil in place. Elsewhere, in Suriname, it has 100% of Block 61 and will be carrying out 3D seismics later this year with a view to drilling in the future, given the other discoveries in the surrounding area and that previous seismics have identified multiple targets of interest on this licence area. On the basis of all of this - the production and potential exploration success, plus the likelihood of a successful defence of the arbitration award (if it even gets that far without India offering to do a deal) and finally recovering the money owed to the company - I have recently been buying shares, as I believe that it is too cheap at the current share price. There is of course some risk of the India award being reversed, and that would have a seriously detrimental impact on the share price (I have a guaranteed stop loss in place to limit my losses in that scenario), but I see that outcome as highly unlikely.
Filed under: Cairn Energy, Tern, McBride, SIG, Barratt Developments, Kromek, TomWinnifrith.com
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