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Salamander’s leader fixes his gaze on a region he is passionate about: south-east Asia

by Tom Sieber

As I sit in an office at the top of a modern glass building next to St James’s Park tube station, James Menzies, the chief executive of Salamander Energy, offers me a glass of water. After a quick search I am presented with a mug – he cannot find a glass.

At this point Menzies looks almost as unfamiliar with his surroundings as I am. I get the impression he is itching to be back in south-east Asia, where the company operates. ‘I can’t wait,’ he says, flashing a grin.

Menzies, whose genial nature belies a sharp business acumen, has seen the oil industry from both ends of the spectrum. Having qualified as a geologist from the University of London and later gained an MSc in geophysics and planetary physics from Newcastle University, he began his career at Lasmo, the explorer that sold out to ENI in 2000.

Initially he worked as a geophysicist in the UK North Sea exploration team and later moved on to Vietnam and Indonesia – which is undoubtedly why he puts so much emphasis on Salamander’s status as a pure south-east Asian play.

He returned to the London head office in 1997, when he worked in corporate development and mergers & acquisitions and held down a variety of corporate positions as part of the senior management team. He then spent a couple of years at a corporate finance boutique before helping to found Salamander in 2005.

The group listed on the main market in 2006 and it has since made the transition from small cap to fully fledged FTSE 250 player, with acreage in Thailand, Indonesia, Vietnam, the Philippines and Laos.

Hard-headed realism

In response to a question about what personal qualities he brings to the company as chief executive Menzies points to his blend of corporate and technical experience.

‘Some geologists, who have little experience of the commercial side of things, become romantically attached to an asset and do not know when to give up on it. You cannot afford to do that and that is not the case with me.’

Menzies is keen to emphasise the rest of his team has a similar mix of experience. His lack of romanticism about the industry is reassuring and remains evident throughout the interview. This is particularly the case when he talks about ‘feeding the machine’, by which he means bringing new assets into the company’s portfolio, which can be exploited to create value.

A key part of the company’s growth strategy over the past two years has been a focus on adding such assets through acquisitions. When the company first came to the market its flagship project was the Phu Horm gas field in Thailand. The share price came under pressure after disappointing news on appraisal drilling last year, but its exposure to this asset has since shrunk considerably thanks to the focus on corporate growth.

This emphasis has borne dividends for the company but it does prompt the question as to whether it is still possible to pay a fair price for assets in the region. Asia has become an area of particular focus for the industry over the past few years and, at $128 a barrel, the oil price is still 70% higher than it was a year ago.

Menzies’ admits the environment is more difficult but asserts it is still feasible to pick up attractive projects at a reasonable level. He says: ‘There are certainly a number of competitors and we have increasingly seen interest from places like the Middle East and Japan. It is all about what you can offer the seller.’

He points to the successful £96 million cash and stock acquisition of GFI Oil & Gas, completed in March on relatively attractive terms. ‘If you give the shareholders the opportunity to participate through a place on the share register, that is not something they can necessarily find elsewhere.’

Although Menzies is too diplomatic to say so, GFI was also a very willing seller. Salamander had to agree a conditional loan with the company to allow it to continue to operate while it waited for the deal to close. The value of the GFI deal lay with the short-term production it brought, in the form of the Bualuang oil field in Thailand. This is due to come onstream later this month but that does not mean the pace of activity has slowed. June saw the company buy two assets in Indonesia from Aim-listed Serica Energy for a consideration of $52.8 million. The transaction increased Salamander’s positions in two key Indonesian basins, with which it is already familiar.

Strong position

Salamander’s financial strength means it should be able to swoop for other companies that find themselves in financial difficulties. The £321 million cap ended 2007 with $91.6 million of net cash on its balance sheet. It has since refinanced its debts with a $200 million syndication deal and announced a £100 million share placing, priced at 300p. 3i has already announced its intention to take a maximum £65.5 million of the offer, in return for a potential 14% stake in the firm.

The proposed fundraising, which requires EGM approval on 8 August, was a surprise and, at first glance, contradicts Menzies’ claim at our meeting Salamander is well funded and does not feel capital-constrained.

The placing, dilutive to existing shareholders, has helped knock the stock off its year highs and down to 260p, below the proposed issue price. Yet the deal is fully underwritten and the reaction looks unfair, even allowing for the recent retreat of the oil price. The cash will help with phase two of the Thai Bualuang development, as well as the Indonesian projects in Tutung South Sembakung. All are near-term projects, which should increase production in the next two to three years and beyond.

Another component of the company’s strategy is having a rough 80-20 split, in terms of capital employed, between low-risk appraisal and development work and higher-risk exploration drilling.

I challenge Menzies on whether or not he feels as if the company is offering investors enough bang for their buck in terms of drilling high-impact exploration wells. He is unapologetic: ‘This is what makes sense and if people do not like it, well then I am sorry but...’

He flags up the risks of focusing entirely on high-risk exploration. ‘None of our investments are going to blow the company up,’ he says, ‘but at the same time we have got some pretty exciting prospects in the portfolio.’

He identifies the potentially high-impact drilling taking place on the Bontang block off the coast of Indonesia, with two wells due to be spudded in the fourth quarter. Elsewhere the company recently spudded a well on the under-explored Sandarkan basin offshore Borneo.

‘The key to exploration is exposing yourself to enough wells, with a range of risk profiles, so you give yourself the best chance of making a material discovery,’ he adds.

Ranging widely

The sheer scope of the group’s wider work programme is worth taking into account, with the company likely to drill around 20 wells over the next 18 months to two years.

Menzies points out, not unfairly, this is as an impressive amount of drilling for a company of Salamander’s size.

‘We are still relatively small at the moment but our eventual aim is to become a proper mid-tier independent.’

Although he is a bit backward about coming forward – he is reluctant to define his role at the group, eventually settling on a rather weak analogy with a football manager making sure people are in the right positions – Menzies makes a straightforward, cogent and convincing case for Salamander’s strategy.

The company’s clear focus on south east Asia has at least three obvious advantages. Firstly it makes the investment story easy to understand. Secondly it means the company can focus on where it has the expertise and the knowledge required to achieve real success. Finally the company’s gas exposure means it can benefit from strength in south-east Asian gas prices – a particular feature in Thailand and Indonesia.

The clearest sign of the strategy is Salamander on the cusp of earning meaningful revenues from production. House broker Oriel Securities forecasts pre-tax profits of more than $165 million next year.

CONCLUSIONS: SALAMANDER ENERGY

Risks to earnings forecasts: 4 (5=upside risk, 1=downside risk)

Earnings predictability: 3 (5=very high, 1=very low)

Valuations: 4 (5=cheap, 1=expensive)

Balance sheet strength: 4 (5=cash rich, 1=heavily indebted)

Cashflow: 3 (5=very strong, 1=very weak)

Overlooked? 1 (5=all brokers negative, 1=all positive)

TOTAL 19 / 30