Ajek-1 Unsuccessful; Downgrading to HOLD
Recommendation: HOLD
Risk: HIGH
12-Month Target Price: C$11.00
Prior: C$12.00
12-Month Total Return: 16.6%

Niko Resources (NKO-T) has issued an operations update announcing that its Ajek-1 exploration well on the Kofiau block (58% operated working interest once a farm-out to Hess is completed) offshore Indonesia encountered subcommercial oil and gas only.

NEGATIVE. The fact that the well was drilled in 25 days (32% faster than planned) is encouraging for assumptions regarding future drilling costs. The discovery of both reservoir and hydrocarbon charge also suggests that further exploration of the Kofiau block is warranted. However, that does not, in our opinion, offset the fact that the failure of Ajek-1 to make a commercial discovery continues a disappointing string of unsuccessful exploration wells for Niko (this is now the fifth well Niko has participated in offshore Indonesia, with none having made a commercial discovery).

Indonesia Exploration Drilling:
The Ajek-1 well encountered 23 feet of pay over two target intervals, with additional thin bedded potential still being analyzed. All sands encountered were hydrocarbon filled (C5+ gas composition indicated liquid hydrocarbons). Niko management has assessed the well as having made a sub-commercial oil and gas discovery. The Ajek-1 was the first well drilled in the Kofiau block and the well results should provide valuable information for potential future exploration. Additional prospectivity on the Kofiau block remains in both the Pliocene clastic section as well as a separate (untested) Miocene carbonate play. The Ocean Monarch drilling rig is mobilizing from Ajek-1 to the Nikooperated West Papua IV block (48% operated working interest once a farmout to Statoil is completed) where it will spud the Cikar-1 well in mid- January, with a projected drilling time of 60-70 days. Cikar-1 is targeting a large Miocene carbonate prospect.

India Drilling on the D6 block offshore eastern India (10% non-operated working interest):
The G2 well on the D19 discovery was successfully drilled. The D19 discovery is one of the four satellite gas
discoveries approved for development by the Government of India. The MJ-1 exploration well is currently expected to spud in the next few months. MJ-1 will target the Mesozoic synrift clastic reservoir, similar to the currently producing MA oil and gas field in the block.

Despite the positive indications of potential resource encountered in Ajek-1, we believe that the result is
negative overall for valuation. We have cut our resource assumptions for the Kofiau block by 50%, which has
reduced our Fully-risked NAVPS estimate by 10%. We now value the block on a risked basis at $43 million
(C$0.54/f.d. share) assuming a 20% chance of 200 mmbbl being discovered with future potential drilling. In
total, we continue to see over $1 billion of expected monetary value (risked present value using a 10% discount
post-tax discount rate) in Niko’s Indonesian exploration portfolio.
We continue to assume that Niko will be fully drawn on its $100 million borrowing base by year-end fiscal
2014 (March 31, 2014, see Exhibit 2).

Niko trades at a significant premium on Base NAVPS and 2013E EV/DACF relative to our coverage of
International E&Ps. However, it also trades slightly below the average of other producing International E&Ps
in our coverage on Fully-risked NAVPS

Justification of Target Price
We are reducing our target price to C$12.00 (from C$17.00) based on a combination of 0.85x Base NAVPS
and 0.35x Upside to Base NAVPS (reduced from 0.45x due to another exploration well without immediate
success increasing medium-term financing risk). The 0.35x Upside multiple is significantly below the average
we currently use for other International E&Ps due to financing risk and very long lead times to production and
development associated with deepwater offshore exploration assets. For other International E&Ps, we currently use a range of 0.40x-0.90x in terms of our multiples of Upside to Base NAVPS.

Key Risks to Target Price
Key risks associated with our target price include business risks of the company and industry, including but not limited to: loss of key employees, drilling success, volatile commodity prices, operating costs, capital cost overruns, product supply and demand, financing/access to capital, government regulations, legislation,
unexpected changes in contract/fiscal terms, asset expropriation, royalties, taxes, exchange rates, interest rates, and environmental and weather concerns.

The key near-term risks specific to Niko are:
•Higher-than-average geo-political, fiscal and legal risks: Niko is in dispute over taxation and other
payments with both Indian and Bangladeshi authorities, and has been fined for attempted corruption
under Canadian law. We have generally assumed that any future legal rulings will be in Niko’s favour or
negligible to valuation.
•Financing risk is relatively high.
•Exploration risk is relatively high.

Investment Conclusion
Despite some encouraging indications of operational execution and future resource potential, we view Niko
Resources’ results from the Ajek-1 well offshore Indonesia as negative. Adjusting our modeling has reduced
our Fully-risked NAVPS estimate by 10%. Since we view financing risk as likely to increase slightly with
every well that is drilled without clear success, we are also reducing our target multiple of Upside to Base
NAVPS, and lowering our target to C$12.00 (from C$17.00) as a result. Since a 20% return to target is less
than we’d like to see for a relatively speculative company, and because Niko appears relatively expensive on
conservative metrics such as Base NAVPS, we are reducing our rating to HOLD (from Buy). Niko trades at a
significant premium on Base NAVPS and 2013E EV/DACF and its ability to finance its commitments beyond
2013 is still uncertain, while exploration and political risks are high.
However, on Fully-risked NAVPS, Niko trades at a significant discount. We still believe that Niko has a
world-class exploration portfolio (particularly in Indonesia) and valuable contingent resources in India and
Trinidad. Our valuation of long-term exploration potential implies the company achieving below 15% longterm returns on historical and expected investments, when multiple farm-ins by larger companies imply that those companies see potential for significantly higher returns on a majority of Niko’s Indonesian blocks.
Multiple deals appear to indicate that major oil companies could be interested in Niko or its assets, suggesting management should have options available to avoid another cash crunch.
Potential catalysts include results from Niko’s third deepwater exploration well in Indonesia (Cikar-1)
expected in late March, as well as the MJ-1 well in India. Potential asset sales that help to reduce financial
leverage could also cause a positive market reaction. Possible government approval of higher gas prices in
India remains an unpredictable potential catalyst, in our opinion, but one that likely has significantly more
upside potential than downside risk over the long term. We believe that the government will make a decision to raise gas prices for the D6 block before late (calendar) 2013.