Deeply troubled global independent oil and gas producer Talisman Energy Inc. (TSX: TLM)(NYSE: TLM) continues to disappoint investors despite many analyst believing the company has solid potential upside.
It was only late last year when iconic activist investor Carl Icahn seized a 6% stake in the global oil explorer and producer, which since then has grown to 7.5% of the company’s float. This indicates Icahn believes there is considerable value to be unlocked, with some analysts previously stating the company may be worth as much as $17 per share if it can divest itself of poorly performing assets.
But after another round of disappointing quarterly results coupled with further negative news, I no longer share Icahn’s views or those of fellow Fools who believe there is considerable value waiting to be unlocked.
1. Production remains heavily weighted toward natural gas
A key problem faced by Talisman is that its hydrocarbon production remains heavily weighted toward lower-margin natural gas. For the second quarter 2014, natural gas made up 61% of the company’s total production mix and typically the margins on natural gas are significantly lower, with prices expected to soften further.
This weighting is also significantly higher than many of Talisman’s peers, including troubled Penn West Petroleum Ltd. (TSX: PWT)(NYSE: PWE), which suffers from the same burden yet with natural gas only making up 35% of its total production.
Despite Talisman focusing on boosting oil and liquids production, I don’t see how they can be boosted to the point where they become the dominant part of the production mix. That leaves Talisman exposed to the vagaries of softer and volatile natural gas prices, which will continue to impact its bottom line.
2. Asset quality remains low
Despite divesting itself of $ billion in non-core assets over the last year, Talisman finds itself burdened with a range of low quality assets, with the biggest stinkers being its mature North Sea oil assets.
The poor quality of those assets, which Talisman has been trying to offload for some time, becomes apparent when their oil and liquids netback or operating margin of $14 per barrel is considered. This is considerably lower than the oil and liquids netbacks generated by Talisman’s other operations, which range from $41.67 to $51.24 per barrel. Yet those assets are responsible for 21% of Talisman’s total liquids production, thereby having a significant impact on the company’s profitability.
But the bad news doesn’t stop there for investors. Those North Sea assets are taxed at between 62% and 78% depending whether they fall in U.K. or Norwegian jurisdiction. These applicable tax rates are significantly higher than other jurisdictions in which Talisman operates and continue to have a significant impact on its profitability.
Talisman has already disposed of 49% of its U.K. assets to Sinopec Shanghai Petroleum Co. (NYSE: SHI) for almost $1.7 billion in 2012. But it is unlikely the company will be able to find buyers for the remainder of those assets given the mature nature of the assets, declining production, high tax rates, and regulatory hurdles.
3. Operating margins remain horribly low
These issues around production mix and asset quality continue to impact Talisman’s margins, with the company’s netback of $27.18 being one of the lowest in the patch. Even Penn West Petroleum generates a higher netback of $36.67 per barrel than Talisman, primarily because of lower operating costs and a higher production weighting to oil and liquids.
Given Talisman’s size, with an enterprise value of $15 billion coupled with many of its assets being of poor quality it is hard to see how any company would be interested in acquiring it as a whole, let alone paying a takeover premium. Already Spanish integrated oil major Repsol SA has dropped any interest in acquiring the company as a whole, but has flagged interest in acquiring those Talisman assets it believes would be accretive.
However, those assets, including North American, Asian, and Colombia assets, are among some of the company’s most profitable and their sale would impact Talisman’s bottom line while leaving it stuck with unprofitable assets.
Clearly Talisman is shaping up as a lame duck and a value trap for investors, with its poor quality assets continuing to weigh heavily upon its performance and act as an albatross around the neck of its better performing operations. For all of these reasons, I can’t see any value in the company at this time and in my opinion, the only way existing shareholders could realize any value is for the company to be broken up.
