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Is The Merger Between Rockhopper Exploration Plc & Falkland Oil and Gas Limited Fair To Shareholders?

Shares in Falkland Oil and Gas (LSE: FOGL) rose modestly this morning, after the firm announced a recommended all-share merger deal with Rockhopper Exploration (LSE: RKH).

The deal values Falkland at £57m, or 10.7p per share and Falkland shareholders will receive 0.2993 Rockhopper shares for each Falkland share they own. This equates to an 11% premium to Monday’s closing price, although Falkland shares remain down by 50% on one month ago, thanks to disappointing results from the Humpback well.

Isn’t Falkland is worth more?

The proposed deal requires approval from both Falkland and Rockhopper shareholders. In theory this should ensure that it offers balanced benefits to the shareholders of both firms.

However, Falkland shareholders are in a tight spot. At the end of June, Falkland had $40m of cash left from the $95m with which it started the year. That total is now likely to be close to zero, in my opinion. While Falkland had enough cash to fund this year’s drilling campaign, it didn’t have much else.

The wells drilled in Falkland’s licence areas this year have not found any standalone commercial oil and gas deposits. This means that raising more cash to fund further drilling is likely to be difficult and dilutive.

Joining forces and combining licence interests with Rockhopper seems logical and gives Falkland shareholders by far the best chance of eventually making some money from their investment, in my opinion.

Given Falkland’s likely lack of cash, shareholders can’t expect a premium. I’d say that today’s deal is priced quite fairly.

How will Rockhopper benefit?

Combining Rockhopper and Falkland oil assets means that Rockhopper’s proven contingent resources will rise by more than 50% to 250m barrels of oil equivalent. Rockhopper will also become operator of a number of key licences in the North Falkland Basin.

Falkland Oil’s Zebedee discovery earlier this year is very close to Rockhopper’s Sea Lion field. The combined company will now be interested in a much wider selection of acreage in this area. This should strengthen Rockhopper’s negotiating position as operator Premier Oil moves towards making an investment decision for Sea Lion.

Rockhopper will also add Falkland’s portfolio of exploration prospects to its own. Most notable here is the acquisition of Falkland’s stake in the Isobel and Elaine complex. This is thought to contain more than 500m barrels of prospective resources. The original Isobel well did discover oil earlier this year, but failed to reach target depth due to technical issues. This well is currently being re-drilled and is targeting mean, un-risked resources of 400m barrels of oil.

Perhaps the biggest advantage for Falkland shareholders is that Rockhopper has plenty of cash. According to a presentation published by Rockhopper this morning, the combined company will have access to around $130m of cash.

That’s why I believe this is a good deal for Falkland shareholders — their company has effectively been resupplied with cash without serious dilution. That’s a good result in today’s oil market.

However, although I believe today’s deal is a good one for Falkland shareholders, Rockhopper remains a risky play. The company’s revenues from its Italian operations are tiny and the long-term outlook depends on a successful development of Sea Lion.

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Roland Head 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.