NZ Oil & Gas (NZO)

[Snoopy]

On Page 19 Northington discloses discount rate range of 7.5 – 8.5%.

The reference above discloses the discount rate used in the sensitivity analysis.

From page 18.

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5.2.4. Required Rate of Return

We believe that an appropriate required rate of return for NZO’s interest in Kupe ranges between 7.50% and 8.50%, with a mid-point of 8.00%. Our assessment is based on comparable market evidence and considers the operational status of Kupe and NZO’s contractual arrangements with high credit quality counterparties. A summary of the key inputs to our assessment are set out in Appendix 3.5.2.5. Valuation Range and Transaction Price.

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If we then go to Appendix 3.

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Input Parameters for Required Rate of Return

Assumption Discussion

Risk Free Rate

Estimated at 2.5%, based on the current yield to maturity for 5-year NZ Government Bonds.

Market Risk Premium

7% based on a range of market based observations including the Commerce Commission’s market risk premium applied to regulated industries in New Zealand.

Asset Beta

Considering the significant portion of contracted revenue for NZO’s interest in Kupe and the credit quality of the counterparties (Genesis and Vector, who themselves have asset betas significantly below
1), we have adopted an asset beta of 0.9 for Kupe.


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Generally a 'market rate of return' is based on a 'risk free rate' plus a market risk premium.

The Capital Asset Pricing Model calculates the cost of capital as follows:

(Cost of Capital) = (Risk Free Rate) + (Beta)(Equity Market Premium)

= 2.5% + 0.9 x 7% = 8.8%

That figure is above the "7.5% to 8.5%" figure suggested in the report.

Have I done something wrong? Or is the Northington Report not consistent?

SNOOPY

[arjay]

A farmer has a cow that has given lots of milk over the years and looks like its going to produce plenty more milk into the future. A couple more cows are rumoured to be lurking in the bushes behind the barn, but the farmer hasn't yet had time to go see if they're there and bring them into the herd. The farm's doing OK though - milk prices are pretty low just now but they should perk up in time. A marvelous thing happened this morning though: Fonterra offered to buy the cow from the farmer (including that worthless patch of bush behind the barn) for a price higher than what the cow's future milk production is probably worth. So the farmer sold the cow and the worthless piece of bush because it was such a bargain. He didn't really know what he would do with the money, although he'd certianly give some of it back to his family seeing as it was their money that was put up to buy the farm in the first place. With the rest, maybe buy another farm or two if they came up for sale really cheap sometime. In the mean time though he wondered what to do. He was really keen on health and safety and wanted to be remembered for such a passion, so maybe he'd buy a helmet for his quad bike. WHile he was mulling this over milk prices started to recover and Fonterra were quite happy with how their new cow was performing. And, you'll never guess what they found when they were cutting gorse down in that worthless bush they'd bought behind the barn........

[greenglass]

HaHa Arjay, I just love love that. You should try your hand at poetry. Or have you?

[greenglass]

HaHa Arjay, I just love love that. You should try your hand at poetry. Or have you?



Discl:hold

[blackcap]

Thanks Arjay, I have been trying to explain to my partner why her investment in NZOG is not a good one and what they have been doing and done.... made her read your analogy and it all made sense to her

[Queenstfarmer]

Agree to a point with you Arjay...however it will take more than a can of petrol and a scrub cutter to clear that Bush and then there's the risk factor to take into consideration. Finally it may cost as much as $30 mil to reinstate that worthless bush....

[Beagle]

A farmer has a cow that has given lots of milk over the years and looks like its going to produce plenty more milk into the future. A couple more cows are rumoured to be lurking in the bushes behind the barn, but the farmer hasn't yet had time to go see if they're there and bring them into the herd. The farm's doing OK though - milk prices are pretty low just now but they should perk up in time. A marvelous thing happened this morning though: Fonterra offered to buy the cow from the farmer (including that worthless patch of bush behind the barn) for a price higher than what the cow's future milk production is probably worth. So the farmer sold the cow and the worthless piece of bush because it was such a bargain. He didn't really know what he would do with the money, although he'd certianly give some of it back to his family seeing as it was their money that was put up to buy the farm in the first place. With the rest, maybe buy another farm or two if they came up for sale really cheap sometime. In the mean time though he wondered what to do. He was really keen on health and safety and wanted to be remembered for such a passion, so maybe he'd buy a helmet for his quad bike. WHile he was mulling this over milk prices started to recover and Fonterra were quite happy with how their new cow was performing. And, you'll never guess what they found when they were cutting gorse down in that worthless bush they'd bought behind the barn........

Well said...why anyone would back these guys to find a new productive farm is beyond my comprehension. The epilogue to this story will be that the farmer endlessly pontificates about what to do with the proceeds of the cow sale for so long he ends up eating more than half the proceeds up while effectively doing nothing.

[Wiremu]

Arjay, you have it in one. The only point you missed out was the report the farmer had prepared for his family to justify selling the cow, which didn't provide the real valuation because of the costs he was left with which he couldn't offset against the taxable income he had sold in the form of the cow. If we look at his farmyard orchard the report was comparing apples with lemons, not apples with apples.

[JohnPagani]

A farmer has a cow that has given lots of milk over the years and looks like its going to produce plenty more milk into the future. A couple more cows are rumoured to be lurking in the bushes behind the barn, but the farmer hasn't yet had time to go see if they're there and bring them into the herd. The farm's doing OK though - milk prices are pretty low just now but they should perk up in time. A marvelous thing happened this morning though: Fonterra offered to buy the cow from the farmer (including that worthless patch of bush behind the barn) for a price higher than what the cow's future milk production is probably worth. So the farmer sold the cow and the worthless piece of bush because it was such a bargain. He didn't really know what he would do with the money, although he'd certianly give some of it back to his family seeing as it was their money that was put up to buy the farm in the first place. With the rest, maybe buy another farm or two if they came up for sale really cheap sometime. In the mean time though he wondered what to do. He was really keen on health and safety and wanted to be remembered for such a passion, so maybe he'd buy a helmet for his quad bike. WHile he was mulling this over milk prices started to recover and Fonterra were quite happy with how their new cow was performing. And, you'll never guess what they found when they were cutting gorse down in that worthless bush they'd bought behind the barn........

The true logic of the analogy is that it assumes no time value of money, and it assumes highly uncertain outcomes are 100% certainties while simulataneously discounting that premium that is included in the price that crystallises the upside. The logic used would then result in never selling the 'cows' at any price, no matter what the offer was for them, and woulod never fairly value risk and uncertainty. Meanwhile it also ignores the potential loss of value that may occur i the transaction did not proceed. It's also incorrent to state, 'he didn't really know what he would do wit the money' The sum that the Board intends to return exceeds the market valuation of the 'cows' the day before the transaction was announced. It pays to analyse analogies clearly.

[Snoopy]

The true logic of the analogy is that it assumes no time value of money, and it assumes highly uncertain outcomes are 100% certainties while simulataneously discounting that premium that is included in the price that crystallises the upside. The logic used would then result in never selling the 'cows' at any price, no matter what the offer was for them, and would never fairly value risk and uncertainty. Meanwhile it also ignores the potential loss of value that may occur if the transaction did not proceed. It's also incorrent to state, 'he didn't really know what he would do with the money' The sum that the Board intends to return exceeds the market valuation of the 'cows' the day before the transaction was announced. It pays to analyse analogies clearly.

Quite right John. To me, the sale of those Kupe assets to Genesis looks like an excellent deal.

SNOOPY

discl: GNE shareholder