I decided to spend some time playing with AOI's numbers to see how the company is being valued by the market.
I focused on Prospective Oil Resources and Chance of Success because, with all due respect to Chris Brown at Canaccord, who just changed his valuation method from NAV based on potential oil resources to be found to a discounted cash flow estimate method, I am of the opinion that figuring out Net Asset Values based on Prospective Oil Resources and Chance of Success is the appropriate way to value exploration companies.
This is how most, if not all of the other analysts covering AOI current do their valuation estimates for the company, except for Canaccord. I also note that this is how the most recent M&A transactions in East Africa have been completed - Tullow buying Hardman Resources; Tullow buying Heritage's Uganda assets; and Cove Energy being bought by PTT. They were all based on the buyer's assessment of prospective resources.
(Off topic question - did Christopher Brown change his valuation method to discounted cash flow estimates for ALL of the exploration companies he covers at Canaccord? It would be interesting to find out if he did, or if he just singled out AOI!)
Anyway, back to the analysis - I focused on four key dates in the past 12 months:
March 26, 2012 - first announcement of Ngamia-1 oil discovery.
May 7, 2012 - announcement of second major oil interval at Ngamia-1.
August 22, 2012 - announcement of updated independent resource estimate in Kenya and Ethiopia.
November 26, 2012 - announcement of oil discovery at Twiga-1.
I also focused on Unrisked Net Best Estimate of Prospective Oil Resources for Kenya and Ethiopia only. I have excluded anything having to do with Puntland in my analysis.
I then divided AOI's basic market capitalization by $4.23/barrel. This $4.23/barrel is the number that the Heritage/Tullow precedent transaction was valued at and can be found in AOI's most recent presentation. The result of: (market capitalization / US$4.23) gives the implied number of barrels of oil the market is assuming AOI will find.
I then divided this number by the Unrisked Net Best Estimate of Prospective Oil Resources for Kenya and Ethiopia. This gives the Chance of Success percentage and tells you what overall Chance of Success the market is giving AOI.
So the Chance of Success formula is: (AOI market capitalization /$4.23) / Unrisked Net Best Estimate of Prospective Oil Resources for Kenya and Ethiopia. I have calculated this number on a day by day basis from today back to March 26, 2012.
It is important to remember that the Unrisked Net Best Estimate of Prospective Oil Resources for Kenya and Ethiopia was 3.74 billion barrels at any time BEFORE August 22, 2012. On August 22, 2012, an updated estimate was released that increased the estimate to 9.29 billion barrels (this number can also be found in AOI's most recent presentation).
From March 26, 2012 (discovery date for Ngamia-1) to May 4th, 2012, AOI's valuation shoed the company was trading at an average Chance of Success of 6.1%.
From May 7, 2012 (announcement of second major oil interval at Ngamia-1) to August 22,2012 (announcement of updated independent resource estimate in Kenya and Ethiopia), AOI was trading at an average Chance of Success of 11.7%. The highest Chance of Success valuation during this period that AOI hit was 15.6% on May 28, 2012.
From August 23, 2012 to November 23, 2012 (last day before Twiga-1 results were released), AOI was trading at an average Chance of Success of 5.6%.
From November 26, 2012 (announcement of Twiga-1 results) to today, AOI has traded at an average Chance of Success of 4.6%. So upon the Twiga-1 news, even though it was a discovery, the market reduced AOI's Chance of Success valuation by a full percentage point. Does not seem reasonable to me.
Given that Ngamia-1 and Twiga-1 results were successful discoveries, it seems to me that an appropriate Chance of Success AS OF RIGHT NOW should probably be in the 7-9% range instead of 4.6%. With further discoveries, the Chance of Success percentage would probably spike as high, if not higher, as the 15.6% figure it hit back on May 28, 2012.
Based on AOI's current number of basic shares outstanding of 252,166,000 (on AOI's website), I worked it out that each 1% move in the Chance of Success percentage works out to about C$1.55/share.