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IGAS Energy PLC Surges 20% Today… But Should You Buy?

IGAS Energy (LSE: IGAS) has announced today that it’s signed a shale gas deal with Ineos. The deal is important, but I don’t think it makes the equity valuation of the shale gas developer incredibly appealing. Here’s why. 

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The shares of IGAS surged more than 20% in early trade. IGAS has secured precious funding, but is that enough to repair its balance sheet? Once the £30m proceeds from the Ineos deal are considered, net cash rises and net leverage goes down to a more sustainable level, but that doesn’t mean IGAS is safe.

If anything, the Ineos deal — which gives the Swiss chemicals behemoth access to certain shale sites — “may open the door to a takeover, although it’s too early to bet on such an outcome,” one senior M&A banker told me today. 

Well, IGAS would be a small bite for Ineos… wishful thinking? 

The Deal 

Commenting on the deal, IGAS said: 

On completion of the transaction, Ineos will acquire an interest in certain licences in the North West and East Midlands and the group’s participating interest in the acreage held under PEDL 133 in Scotland.

The consideration for IGAS’ participating interests comprises £30m cash payable to IGAS on completion and a funded forward work programme of up to £138m gross, of which IGAS’ share to be funded fully by Ineos, is expected to amount to approximately £65m.

The farm-out and purchase agreement is a great opportunity for Ineos to acquire some “first class assets” that clearly have the potential to yield “significant quantities of gas” in future, as Ineos pointed out. The project is rather small for Ineos, but a few millions will be invested, and it doesn’t look like Ineos management is too worried about regulatory hurdles, which have pushed down IGAS stock in recent weeks.

So, Ineos must believe that the government will continue to support the UK’s shale oil and gas industry — which is very likely, I reckon.

Cash

The deal signals a willingness by IGAS to team up with strong partners, but also testifies to the need for liquidity at the shale gas developer, whose equity valuation is still 75% lower than a year ago — and rightly so. The balance sheet of IGAS carries too much debt, and fresh financing — possibly in the form of equity — would likely be needed to fund drilling costs and project development. 

The developer’s cash flows are hard to predict, and its balance sheet is under-capitalised, so £30m of additional cash will only partly help it fix its finances. The problem is that in the next three years very expensive debt has to be repaid, and forward net leverage (as gauged by net debt/adjusted operating cash flow) is in the region of 6x, although it drops to 3x once all the proceeds from the shale gas deal with Ineos are factored in.

It’s not easy to say what’s going to happen next. Commercial banks aren’t really willing support such high-risk borrowers, so high-yield bond investors and larger rivals may be in the driving seat: they can negotiate a hard bargain on existing projects or cut a deal for a large stake in the company at convenient prices. 

IGAS is an opportunistic trade, but if you are on the hunt for long-term value you should opt for one of the stocks included in the latest report produced by our Fool Team. 

Most of these companies have outperformed the FTSE 100 by more than five percentage points so far this year, and will likely continue to do well, regardless of broader market conditions. It's well worth spending time to find out more about the value picks included in our report right now!

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.