Why I Took a Second Look at Cobalt International Energy Inc.

It's tough to find an unprofitable company in the oil and gas sector with a market cap over $7 billion, but Cobalt International Energy  (NYSE: CIE  ) fits the bill. When I first took a look at Cobalt International Energy, I questioned its ability to raise enough cash to fund the development of its numerous offshore projects without hurting shareholder value. In light of Cobalt's recent debt offering, which raised $1.3 billion, and a very promising long-term plan that management laid out at its analyst day presentation, I think this company deserves a second look.

Plugging the cash shortfall
Before the debt offering, Cobalt International Energy had only $1.6 billion cash on hand, which would have been depleted long before its promising long-term story could unfold. 

To put this into perspective, take a look at what Cobalt's cash position would look like had it not raised the additional cash. At the end of 2013, Cobalt International Energy had $1.8 billion in cash and was planning on spending roughly $1 billion in 2014. Cobalt International Energy has yet to generate cash flow from its operations, so it would have run out of cash sometime next year.

With Cobalt's first cash flow generating project starting up in 2016, it would have been forced to issue more shares, divest some of its assets, or issue debt. By effectively raising $1.3 billion through a sale of convertible bonds yielding 3.125%, Cobalt International Energy has removed a major uncertainty facing prospective investors. While holders of Cobalt's convertible bonds could dilute shareholder value if those bondholders converted to stockholders, keep in mind this would only happen if Cobalt was able to start successfully generating cash flow (a bullish catalyst for the stock price).  

2016 is the year of cash flow
Starting in 2016, Cobalt International Energy will start generating a substantial amount of cash flow for the first time. The Heidelberg project, operated by Anadarko Petroleum  (NYSE: APC  ) , is expected to come online in 2016 and is targeting 210 MMBoe-424 MMBoe of gross resources in the Gulf of Mexico. With a 9.4% stake in the Heidelberg, Cobalt should initially net $170 million-$200 million a year once production commences. With a 31.75% stake in the Heidelberg, Anadarko stands to rake in bountiful levels of cash flow as well. 

Cobalt's partnership with Anadarko Petroleum in the Gulf of Mexico has paid off in more ways than one. The Anadarko-operated Shenandoah-2 appraisal well turned up 1,000 net feet of oil pay, making it one of Anadarko's largest discoveries in the Gulf of Mexico. Further exploration in the area could turn up additional resources, with the Shenandoah-3 appraisal well currently being drilled. The Shenandoah project is 30% owned by Anadarko and 20% owned by Cobalt. 

In 2017, the Cobalt-operated Cameia project, which it owns 40% of, is expected to start producing oil by tapping into the Kwanza Basin off the coast of Angola. Cobalt is going to develop 300 MMBoe-500 MMBoe in gross resources through Cameia, which should initially generate $400 million-$600 million in net cash a year for Cobalt. 

Both of the net cash generation forecasts for the Heidelberg and Cameia are based on realized prices being $100 for a barrel of crude and $4 mmBtu for natural gas. Currently WTI, Brent, and Henry Hub prices are all significantly above those levels, which could point to pricing upside once these projects come online.

Future growth
Another prospect off the coast of Angola that Cobalt discovered is the Orca field, which it owns a 40% stake in. With 250 net feet of oil pay in the prospect, Cobalt thinks the Orca could yield 400 MMBoe-700 MMBoe. Next year is when Cobalt plans on drilling an appraisal well targeting those vast reserves. While commercial production is still several years away, data derived from the exploration well paints a promising picture.

The Orca field is just one example of what exploring offshore Angola can yield. There is still tons of exploration upside for Cobalt International Energy in Angola, as the Loengo prospect offers 750 MMBoe-1,300 MMBoe in resource potential. Located in between two previous discoveries, the Loengo prospect is part of Cobalt's decades-long growth story.

As Cobalt keeps digging up additional reserves, it adds substantially to shareholder value at a very low cost. Spending $2.1 billion on exploration costs to uncover 1 BBoe in net resources, Cobalt's cost of $2 to uncover a barrel of recoverable hydrocarbons makes it one of the cheapest deepwater exploration companies in the world. If Cobalt is successful in exploring in the Loengo prospect, then those reserves boost the overall value of Cobalt as an investment. As a company, Cobalt can begin developing those reserves, and if future cash problems arise, it can sell part of its stake in the project to cover some of the costs.

Foolish conclusion
Sometimes it's best to take a second look at a possible investment when new data surfaces, as is the case for Cobalt International Energy. While Cobalt will need to raise additional cash even after its first two projects start producing, it plans on doing so through a reduction in interest or asset swaps that don't dilute shareholder value. Cobalt remains a very speculative stock, but due to its tremendous success in discovering new oilfields, Cobalt has proven that it has the potential to be one of the best offshore plays around. 

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