Touchstone Exploration

Is TXP a disaster flick, or a heroic turnaround?

Dear reader,

Touchstone (TXP) and Trinity (TRIN) recently reached on 30th April agreement on the terms of a recommended all share offer where Touchstone will acquire the entire issued share capital of Trinity. Each TRIN shareholder receives 1.5 TXP shares.

Since then apart from the usual several hundred Form 8.3 and 8.5 nonsense notices clogging the RNS feed nothing much has changed. Brokers have withdrawn their forecasts and share prices have moved - TXP down 25%; TRIN up 25% initially but now just 15% up.

Share price changes since the announcement 30/04/24

Trinity Shareholders will, in aggregate, receive approximately 58,341,102 Touchstone Shares. Immediately following completion of the Acquisition, Trinity Shareholders will own approximately 19.9 per cent of the share capital of the Combined Group (based on the existing issued common share capital of Touchstone and the fully diluted ordinary share capital of Trinity as at 30 April 2024 (being the latest practicable date prior to the date of this announcement).

Based upon Touchstone's share price of 41.25 pence as of 30 April 2024 the Acquisition represented an implied value of 61.9 pence per Trinity Share (approximately US$0.77 per Trinity Share), valuing the entire issued share capital of Trinity at approximately £24.1 million (approximately US$30.1 million).

Today with Trin at 45p/47p it is at an implied 32p/33p valuation, which is precisely the share price of TXP. So arbitrage opportunities have disappeared.

There are two questions. Does the lower share price make TXP attractive? What value can be unlocked through the combo?

Well let’s start with what does the combined picture look like. These numbers are as at Q1 and it’s likely both cash and debt will be higher by the merger in Q3. TXP have an extensive capital programme underway.

The combination of TRIN and TXP pre and post merger

TRIN is a 100% oil producer while TXP is a mainly gas (and some oil). Combined these are a 10,540 BOEPD production. Broker forecasts for 2024 put TRIN at 2600-2700 BOEPD while TXP at 9000 BOEPD, so there’s 10% upside to my numbers (which are based on annualising 1Q2024 combined production). 10% upside would be 11,700 BOEPD. On one hand the decline rate at cascadura appears to be fast, on the other, the FY24 work programme is continuing apace too. Measures such as stimulation are being considered by TXP who are reviewing data to determine next steps.

Brokers then put TXP forecast growth at 16,000 BOEPD in 2025, so 18,500-19,000 BOEPD combined with TRIN.

Combining the two we see combining the two market caps and dividing by the shares in issue has a small 0.1p impact on the share price. The combined entity is 1.5x P/NTAV and 1.1X P/NAV. There is a large intangible asset on TRIN balance sheet for exploration & evaluation assets. Whilst this is classed as “intangible” it actually relates to work in progress or to quote the accounts - The amounts of intangible E&E assets represent the costs of active projects the commerciality of which is unevaluated until reserves can be appraised.

Synergy

The rationale for the TXP/TRIN merger is to create a larger player in Trinidad. But also to gain:

1. Shared technical and operational expertise

2. Synergy in running costs & economies of scale especially for corporate overheads.

3. Combined funds flow - both TXP and TRIN are cash generative.

4. Rebalances TXP with a better oil & gas combination and exposure to offshore

5. TRIN’s public listing costs around £0.5m so that is another saving.

6. The business combination takes the business over the £100m mark, so into a larger size bucket - so more attractive to investors.

7. Accrued tax losses of $15.7m in TRIN can be fully used by TXP and

   could provide ~$8m additional post tax profit.

8. The near term TXP assets and the longer term assets in TRIN what Cavendish tell us contain: “Significant Upside but Financing Required: Including the 38.7mmbbls of 2C resources into our valuation highlights Trinity’s upside potential if funding was available, increasing our target price to 347p, a significant c8.4x the current share price.”

TXP Profit Model

I find the broker’s profit models very difficult to follow and they appear to show partial information, and then show a valuation without revealing how they arrive to that.

In this model I’m using the 2025 revenue assumptions for TXP and am working on the basis that TRIN will spend sustaining capex on workovers to repeat its 2024 forecast. The combined column simply combines these. The synergy column then makes a number of assumptions and upsides. I’m assuming an 8% growth to revenue through faster development of assets. I’m then assuming the combined entity will have a 20% royalty (TRIN currently pays 30%).

I then assume a slight improvement to direct costs through asset sharing, improved efficiency and productivity. So despite an 8% growth to revenue, costs slightly fall. I then assume $3m of overhead savings through the combined entity. Listing fees alone account for a third of that.

The result of $37.4m synergy scenario is earnings of 12.8 cents EPS or 10 pence a share, putting TXP on a measly P/E 3.2 and P/FCF of 2.2. In other words for every £1 invested TXP is forecast to generate 45.5p of operating cash flow which it can put towards capex, dividends or debt repayments.

Next Steps:

The merger deal is due to close in Q3 2024 and requires sanction by TRINies, the Trinidanian authorities and the courts.

With TRIN’s management backing the move (1.2% of shares) and various II’s (holding 37.7% more) nearly 40% of votes back the move. So just over half of remaining TRINies need to say yes (36.1% of 61.1% of votes) to be over 75% in favour overall.

Conclusion

When I looked at this before, I was focused on the win/lose or lose/win or win-win. I concluded a win-win. Saving of several million dollars per year should be achievable, if the deal with TRIN closes and TXP is already on a strong trajectory with its work programme for 4-5 new wells. TXP has already grown production, and more drilling is due to come. Translating drills to BOE is the challenge at Cascadura and across the estate.

At a 32p/33p bid ask this appears to offer upside, potentially serious upside. But there are risks and some hefty taxes to consider too.

Regards

The Oak Bloke

Disclaimers:

This is not advice

Micro cap and Nano cap holdings might have a higher risk and higher volatility than companies that are traditionally defined as "blue chip".