Hyperdynamics Corp (HDYNQ)

[Picassa]

Hyperdynamics (HDY) -- I started to build my position in this back up late last week. The recent financing was a watershed event for this company IMO. They now have enough money to drill 3 wells back-to-back and also to do a 3D seismic shoot on their deepwater prospects. (I still believe very strongly that they will sell down about another 25% of their interest in their concession, but the fact that they now do not need to do that in order to proceed with their business plan is very significant IMO).

Rodman & Renshaw, the firm that did their recent financing, has become the clear "hammer" on this stock. I found their initiation report on HDY to be most helpful; a copy of that report can be downloaded from http://finance.groups.yahoo.com/group/EnergySectorInvesting/files/ (you need to join the group to be able to download files, its fast free & easy to do so). R&R initiated HDY on 2/11/11 with a "Market Outperform" rating and PT of $8, when the stock had closed the previous day at $4.55, just a tad lower than its current quote.

R&R's explanation of how they derived their valuation (which was performed prior to the NSAI report that has since come out on HDY's deepwater prospects), is as follows (pg. 15):

Coming up with a valuation for HDY at this point is tricky given the number of assumptions that need to be
made…including number of discoveries, size of potential discoveries, and economics of any discoveries. For example, If
the company drills 3 wells, and only records 1 success, but the discovery holds 500+ MMBo gross, HDY could be worth
$3+ billion, or >$20/share. And if we take NSAI’s risked recoverable estimate of 345 MMBo, we’d estimate HDY’s value at
~$2.2 billion, or ~$16/share. And while this significant level of upside is why we like the stock at current levels, there is no
guarantee that HDY will announce a success with its initial test program.

While the stock could definitely reach the above levels if it has a large discovery, as it stands, HDY has only exploration
prospects defined by 2D seismic (although it is currently analyzing its 3D seismic data which should help further de-risk
the prospects). Given this, we are initially going to take a conservative approach to our valuation of HDY and apply a
heftier risk factor than NSAI did. For Fan 1 and Structure 3, we are using a risk factor of 90% (vs. 82% and 79% from
NSAI, respectively). For the tilted fault blocks, we are initially applying a 95% risking factor, versus the NSAI estimate of
89%. This equates to total risked upside potential of ~170 MMBo, or ~110 MMBo net to HDY.

Assigning a per-unit value to this potential is also a bit tricky as it will vary significantly based on the size of the
accumulation, deliverability of the wells, etc. As a result, although our models indicated a higher per-unit value for
Structure 3 than Fan 1 (~$11/Bbl vs. ~$9.75/Bbl), we are going to apply the lower value to the company’s entire risked
upside potential. Obviously, we will refine these assumptions once discoveries are (hopefully) made and we have a better
idea of what a development scenario would look like.
Based on these assumptions, and using a long-term oil price of $85/Bbl, we calculate a risked NAV for HDY of $8/share.

We estimate the risked value of the company’s upside potential to be $1.1 billion, or $8/share. To this, we add ~$1 million
for the value of the company’s non-E&P assets, ~$12 million for proceeds from the exercise of options and warrants, and
~$35 million for its net cash position. This gives us an NAV of ~$1.1 billion, or $8/share.

The recent issuance of a ton of shares @ $5 made the divisor in the valuation calc a lot larger, but IMO the value added by that financing was well more than the dilution created by the increase to the number of shares. They can now both do everything they have wanted to do on their present concession, plus get into some other plays. Being able to get out from under the "one-trick pony" tag that has applied to them is critical IMO.

One thing that was bugging me about this company was, why did they end up deciding to do this equity raise vs. sell down their interest in their concession. The following discussion by R&R (pg. 12) gave me some invaluable insight into this issue:

Drilling Plans and Funding
One of the terms often thrown around when discussing various plays is that they are a ?statistical play?. While this term is
usually used to refer to resource plays, it also applies to exploration. Now, we are not trying to argue that drilling an
exploration well off the coast of Guinea has the same risk profile as drilling a well in the Bakken or the Eagle Ford plays,
simply that exploration does have a statistical component to it. And like in resource plays, a company needs to take
enough shots for the statistics to work out. For example, a good explorationist can typically increase the probability of
success for a blue water exploration well to ~33%, which means there’s a 67% chance the well will be unsuccessful.

However, if a company were to drill three such prospects, the chance that at least one of those wells would be a success
increases to ~70%. For a two-well program, the chance of at least one success would be ~55%.

HDY’s management team understands that multiple shots need to be taken to maximize the chance of success. As a
result, the company is targeting an initial exploration program of 2-3 wells. (An added benefit of a multiple well program is
that HDY will be able to realize some efficiencies as mobilization and demobilization costs will be spread over multiple
wells.) The company plans to bring in a semi-submersible rig to drill the prospects and hopes to spud the first well in
October. In order to meet this timeframe, HDY needs to have the funding in place and rig selected by early April.
The estimated cost of a 2-3 well program is $90-$135 million. At the company’s current 77% interest, that would be ~$70-
$105 million net. As HDY currently has ~$35 million of cash, it would need to raise an additional ~$45-$80 million in order
to fund the program (including the impact of the company’s cash burn rate). HDY has two primary options available to it
for raising the funds…equity or the sale of a partial interest in the license (or a combination of the two).

If HDY chooses to go the sell-down route, it should get a much better price than it received for the earlier 23% interest it
farmed out to Dana in January 2010 for ~$19.6 million (<$1 million per percentage point). The company was in
negotiations with a large independent for a second farm-out, with a price-tag estimated at $3-$4 million per percentage
point. Although this deal was terminated for undisclosed reasons, we would not be surprised to see the company get a
number at least as big if it chose to go the sell-down route again. Based on this, we think HDY could raise ample capital
by selling down ~15 percentage points.

Now, while most investors typically don’t want to see additional dilution, equity may actually be less dilutive than a farmout,
depending on where the company can price the deal. Based on HDY’s current stock price, it’s trading at ~$7.5 million
per percentage point.
As we mentioned, HDY plans to kick-off its drilling program in October. It has not yet selected the initial prospects it plans
to drill as it is currently interpreting the data from its 3D seismic shoot in order to refine its locations. The wells should take
roughly 60 days to drill, putting results from its first exploration test most likely late this year or early next year.

So that was the situation -- HDY could either sell down its interest in their concession at $3-4M a point, or issue stock at $8M a point. Looking at it that way it makes the decision to raise equity a no-brainer IMO.

I'm seriously considering buying more stock both this week and after 4/21 (which is the date that a lot of shares and warrants come out of lockup), but would like to entertain discussion about this company to see if I might be missing something about this stock. If you believe this stock is overvalued, pray tell why? For extra credit, keep your response civil please.

http://siliconinvestor.advfn.com/readmsg.aspx?msgid=27282736