Description
I am recommending PGRI as a long. The upcoming vote date for the deal will likely happen before October 28, 2007. I like the long-term prospects of PGRI and I think this first acquisition is a great deal and will form a platform for them to compound intrinsic value at 30% per annum for a long period of time. Long term, the model company to look at will be Chesapeake, which went from 2 to 34 since Dec. 2002. Because of the uncertainty at this time, I think the situation present a "double-dip" opportunity that can reward multi-bagger magnitudes to patient shareholders.
I suggest you open another browser and open the following URL for the presentation :
http://www.platenergy.com/platenergy_files/PlatinumEnergy042507.pdf
I will refer to the pages in the presentation all throughout the write-up.
What I will do in this write-up:
Description of PGRI
Description of Tandem, the target acquisition
Terms of the deal and the capital structure after the deal
Why the acquisition is a good deal for a would-be shareholder in PGRI
Why is the valuation for the acquisition extremely undervalued
Will the deal happen?
Why I think stock price will not come down after the deal
My theories as to why there is such a huge spread on the Tandem shares, as well as the price of the warrants
How to invest if you like the story
DESCRIPTION OF PGRI
PGRI is an investment vehicle to build intrinsic value of the company by:
- using hedge financing to maximize profit and reduce risk resulting from volatile energy markets
- manage operations like an E&P company and manage finances like a bank
- focus on supporting shareholder value (through buybacks, etc) prior to seeking growth
- This is a potential 30% IRR business in an industry with a lot of opportunities. (see page 16 of presentation)
- the CEO is Barry Kostiner, who I thought is impressive
- PGRI went public as a SPAC in late 2005 as a SPAC and raised about $115 million, 95% of gross proceeds of which are currently held in trust pending consummation of acquistion.
In overly simplistic terms, PGRI will acquire and operate E&P companies, arbitraging the differential between the oil prices and the production to produce a more stable cash flow stream. It will use the excess cash flow to buy back stock, and to repeat this process by acquiring other companies. I believe the CEO understands what value investing and capital allocation means.Just to give you a picture, while long-dated oil futures are trading around $70's per barrel, reserves of public companies are valued at maximum of $20 (in Canada) and more like mid-teens in the U.S. Chesapeake is a model example of a company that has smartly arbitraged most of its production, and it has rewarded long-term shareholders very handsomely over the years. (Stock has gone from 2 to 34 since its IPO in Dec 02) What I like about the team at PGRI and specifically, Barry, is that he understands that he must support his stock through share buybacks. As long as he buys back shares, and makes his "income stream" more predictable through arbitrage, he can always raise capital to buy good acquisitions.
After looking at over 50 deals, the team decided to go with Tandem Energy and use it as the platform to grow.
DESCRIPTION OF TANDEM, THE TARGET ACQUISITION
Tandem is a traditional private Midland company, bringing substantial resources to the table, in addition to the management staying on including the COO, two senior engineers and the head of operations, we are also getting a very experienced operating staff of over 40 employees. We have two drilling rigs. We have all the drilling operations.
Tandem Energy has over 22,000 acres of producing E&P assets in Texas and New Mexico. Most of the properties were once owned by Exxon. It has 9 mm Boe proved, with 1,100 Boe per day production. Using assumptions as of March 07 (oil prices have gone up to 80 since then), this is a PV10 Valuation of $188 Million.
There is compelling evidence that the stated 9 mm Boe proved reserves is very conservative. On the next few paragraphs with the help of the presentation, I will show that there are at least 20 mm Boe.
By way of background, Tandem management used a lot of their own wallets to operate the business, so they were severely undercapitalized and will explain why their reserves are understated.
TERMS OF THE PROPOSED ACQUISITION AND CAPITAL STRUCTURE AFTER THE DEAL
About 7.8 million shares of PGRI will be issued to Tandem Corporation, which will then be distributed to the shareholder. Because most of the minority shareholders of Tandem were friends and family of the Tandem management, the management is "generously" giving minority shareholders of Tandem an equivalent of about $4.50 of PGRI shares per Tandem share whereas Tandem's management will get about $2.50 of equivalent PGRI per Tandem share. I will get back to this point later as some investors seem to be so skeptical of a deal that gives minority shareholders a higher valuation that there have been quite a few theories going on in the internet. About $42 million dollars of cash in PGRI will be used to pay off the debt of Tandem. The remaining $60 million in PGRI, plus another $20 million of credit, will be used to buy back PGRI shares after the deal is completed. (This share swap followed by a buyback is similar to the deal between Gillette and P&G. There are tax advantages to this structure) So the enterprise value being paid for Tandem, including all share dilution, is about $140 million.
Capital Structure of PGRI after the deal:
14.4 Million shares that were bought at the IPO
+ 3.6 Million shares to PGRI management
+ 7.8 Million shares issued to TDYH
= 26 Million shares outstanding plus 14.4 Million warrants exercisable at 6
Cash position after the deal:
Out of the 102 million raised, 42 million will be used to pay off the debt of Tandem. There will be a remaining 60 million, BEFORE any exercise of any warrant. So, the enterprise value after the deal will be 201 MM less 60 Million cash = 141 million.
WHY IS THE ACQUISITION A GOOD DEAL FOR THE PGRI SHAREHOLDER
- Merger of 2 skills: E&P skills + Finance Hedging skills
- Tandem management are getting stock instead of cash, so their interests would be aligned with the shareholders of PGRI
- There is a 80 million share buyback to buy back the stock of PGRI after deal is closed
- On paper, the valuation is undervalued and with a little more examination, it appears to be extremely undervalued.
WHY IS THE VALUATION FOR THE ACQUISITION EXTREMELY UNDERVALUED
On paper, the company has a PV10 of 188 Million on assumptions based on 9 mm Boe of proved reserves, prices of oil and gas as of March 2007. The acquisition price is 102 MM. After dilution of shares the purchase price is about 140 Million. But here's the real gravy: Because Tandem was so undercapitalized, the management did not spend a lot to get a "proved reserves" report that is more commensurate to the real number. Fortunately, there are old Exxon maps and several studies done by PGRI's geologists that show the "proved reserves" of 9 million is very conservative.
Before I get there, I have to introduce this oil and gas technical term.
"Waterflood" - A method of secondary recovery in which water is injected into the reservoir formation to displace residual oil. The water from injection wells physically sweeps the displaced oil to adjacent production wells. Potential problems associated with waterflood techniques include inefficient recovery due to variable permeability, or similar conditions affecting fluid transport within the reservoir, and early water breakthrough that may cause production and surface processing problems.
Now, go to pages 6-8 of the presentation link: http://www.platenergy.com/platenergy_files/PlatinumEnergy042507.pdf
- On page 6, you see a map of the properties. (Note that Ira Field and Ballard are close together. more on this later)
- On page 7, the number that should jump at you is that Tandem only booked 207 PUD locations when there are 300 producing wells. Normally there should be 3 to 4 PUDs around a producing well. So, you're talking at least 700 PUD locations not yet booked.
- On page 8, what one gets out of this data is that the Production to date number, which is 20 mmBoe on 105 mmBoe is 20%. A typical recovery in that area is 28%. So the difference, or 8%, alone represents 9 mmBoe. Using the "waterflooding" technique defined above, ti would cost only $2 per Boe to recover that extra 9 mm Boe. Moreover, Ballard which is very close to Ira, has only 1.2 mm Boe, with only a small fraction of the waterflood reserves booked. So Ballard is extremely underbooked. It costs under $2 per Boe to "waterflood".
- Pages 9-10 shows further opportunities to "recomplete". I am not going to elaborate on the "recompletion" opportunities as it would take another longer page and i think just the three aforementioned pages alone should be compelling to show that the "proved" reserves can easily be more than twice as much as the 9 mm Boe reported. In fact, I believe the CEO presented that all in, it is more like 40 mm Boe.
Anyhow, if we just use 18 mm Boe, instead of 9 mm Boe, you are looking at $7.50 per Boe.
The following URL is a transcript of the presentation done in April 2006 by the CEO at IPAA, an oil and gas trade association. I excerpted the part where he describes why he is certain the "proved reserves" of 9 mm are conservative.
http://www.secinfo.com/d12TC3.vNAc.htm
"Now I am going to go into more detail into the assets of Tandem. Here are the locations of the major leases.
For a small cap company you might think that such diverse locations would create a bit of a challenging operating environment. From our perspective, Tandem isn't really a small company. It is just waiting to be liberated by us and turned into a much larger company. What we are excited about is that these assets can be greatly expanded.
So, for instance, our top fields are the Tomball and Choate Fields, which are highly faulted with many multiple objectives there that have not been exploited. That is in the southern, coastal plain region of Texas.
Then we have the Ball Lease in Palo Pinto County in the Barnett Shale area, and also substantial waterflood opportunities in Texas and New Mexico. These areas are profitable and there is a lot we can add to.
This page appears a little bit busy. We felt it very important to give a lot of data to investors so they can see everything that is there. Basically, they can do their own analysis and look more deeply into our leases. I'd like to point out a couple of things.If you look at the bottom line, with about 1100 barrels a day, you would think that 290 wells is a lot of wells given the production. But if you look at the distribution of the wells relative to the different leases, you'll see there's really substantial unexploited acreage.
For instance, if you look at our IRA lease and Ballard lease which are the two waterflood opportunities, they have 50 and 140 producers, which are the bulk of the current producing wells. If you look at the Tomball lease about 30 miles north of Houston, that has only18 wells on 7,000 acres. And the sands are basically uniform throughout much of the lease. There seems to be substantial opportunity to further exploit these assets.
Another illustration of upside is if you look at the Ballard and Choate reserves. Look at the PDP and PUD reserves on the gas side -- There are almost no gas reserves allocated to these assets. That is not because a lack of gas, it is because the current contracts are uneconomic. Once the contracts roll off over the next year or so, there will be gas reserves that appear on our reserve report without doing any CapEx, just by virtue of renegotiating the contracts.
A third interesting thing to note is the behind-pipe category, PDNP. Normally with mature fields, mature assets and shallow drilling, there are many multiple zones that have not been exploited. And often when you see assets that come to market through auction, there's enormous effort that goes into doing the reserve analysis. So every last barrel of approved reserve is in there.Because Tandem came to us on a negotiated basis, they were doing it out of their own pockets, so they didn't dress up the reserves. They haven't even begun to explore the upside on the probables and on the behind pipe reserves. That is something we brought in to our geologist, who started to look at the logs and started to look at the history of these wells. There are a lot of assets that just have not been fully exploited and we can get those assets on the reserve report without CapEx, just by reserve engineering.
We clearly believe that Tandem is very high value just given the proved 9.4 million barrels. Existing cash flow easily justifies the acquisition price and builds in a very nice profit. What I'd like to do now is discuss in a little bit more detail some of the potential upside that is beyond the reserve report. "
From a cash flow perspective, I refer to the old presentation filed in Feb 2007. This is somewhat dated and in fact had been removed from the present presentation. Because of the delay of this deal, I assume the numbers for 2008 will really happen in 2009. So, by 2008, you will get EBITDA of about 15 million and by 2009, you will start getting EBITDA of 30 million annual run-rate. This equates to 4.7 times 2009 EBITDA, before implementation of the share buybacks.
IF THIS IS SO GOOD, WHY ARE THE SPREADS SO BIG?
The first question you want to ask is why is spread of the Tandem stock and the acquisition prices so big? I am quite puzzled myself, and here are my theories. First, let me list the timeline of events since January 2006 when the deal was announced.
Jan. 27, 2006 - Tandem/PGRI merger was first announced. Tandem stock went up to $4. Cash deal where minority shareholders get $4.50 a share. Deal expected to close 2nd quarter of 2006.
Aug. 18, 2006 - Deal deadline was postponed to November 30, 2006. Tandem stock starts to drop from $4.
Oct. 5, 2006 - Deal was restructured to an asset purchase and Tandem will receive shares of PGRI instead. The terms of transaction are as defined above. By this time, stock had come down to between $2.50 to $3.00 a share
Dec. 9, 2006 - Deal was extended to Jan. 31, 2007. Deal amended such that PGRI shares to be received by Tandem shareholders will be restricted until dissolution of Tandem. PGRI will use best efforts to register shares within 90 days.
Feb. 16, 2007 - Deal extended to March 31, 2007
April 5, 2007 - Deal extended to May 31, 2007
May 8, 2007 - Optionable shares fall as Bank of Montreal stops being a customer. Optionable's CEO Dave Cassidy turned out to have served some jail time. Optioinable's chairman happens to be Mark Nordlicht who is also PGRI's chairman and PGRI became an innocent victim. Mark Nordlicht has agreed to resign as chairman after the vote date. This news undoubtedly caused some more delays with the SEC.
June 6, 2007 - Deal extended to June 30, 2007
July 24, 2007 - Deal extended to Aug 31, 2007
Sep 11, 2007 - Deal extended to Oct 28, 2007
This deal has been delayed 7 times since Jan. 27, 2006. So, I think investors in Tandem Energy are really tired. They have been spooked plenty of times so far. 18 months is a long wait. So far, the final proxy date is not yet set. But I think the date of the vote will happen before October 28, 2007. If you look at the changes of the latest proxy and the previous proxy statement, you will see minor differences and I notice this is usually a sign before the final proxy date comes out.
The other theory I have is that some investors felt very uncomfortable with the "minority shareholders get more" structure. There are some strange precedents in the past. My conclusion is that those theories are just "guilt by association" and largely noise.
WILL THE DEAL HAPPEN?
28 out of 33 SPAC deals have been approved so far. Like I said in my previous write-up on CRB, there is a lot of motivation for the SPAC deals to go through. I had previously examined 4 out of the 5 deals that did not make it, and the target acquisitions for each of those 4 failed deals were either of dubious business models, had no revenues, or horrible financials. This is not the case with PGRI.
Furthermore, CEO has spent $1 million dollars buying warrants. Realize that the warrants go to zero if they don't happen. This is the same CEO who is buying a house out of foreclosure in Houston and yet would spend $1 million dollars to buy warrants. To me, it shows a lot of conviction. Furthermore, if you look at the Form 4 filings, you see a well-known family name. - Ghermezians. This is the billionaire family that is behind the Mall of America. I believe this family will be a source of support to buy in warrants and shares to support shareholder approval of this deal. If you analyze the whole situation there are only about 8.65 million shares that are needed for deal to happen. This equates to about $67 million, which is not a terribly huge amount by most standards.
I believe that when the CEO goes on the roadshow, many fundamental investors will see the value of PGRI's long-term business model. Once PGRI gets past this acquisition, then you have a company run by a CEO who understands value investing and capital allocation. If he continues to generate IRR in this $80 oil price environment either by buying back shares or finding other acquisitions (he told me there is a lot now in his pipeline), the stock can hit 11 to 12 easily in 2 years. The CEO actually wants to tell his story to the more fundamental investors who can understand his business model. In case you want to meet with the CEO, you can call Barry Kostiner at: (212) 581-2401 .
WILL THE STOCK DROP AFTER THE DEAL (assuming it closes)?
Lately, the stock price of many SPACs after deals are closed have come down. With PGRI, I think the share buyback support will prevent the stock from falling by a lot. PGRI is setting aside up to $80 million dollars to buy back shares. In truth because of 105b1 regulations (which prevent a company from buying back more than 25% of daily trading volume), this $80 million will not be all used up anytime soon. However, this buyback support, in my opinion, will prevent the stock from dropping as much as the other SPAC deals.
SO IF YOU LIKE THE SITUATION, HOW WOULD YOU INVEST?
You can buy the stock PGRI, or you can buy the target company, Tandem Energy, and if you want to add some spice, you
can add to your purchase by buying the the warrants. There is not much risk in PGRI the stock. If you like the deal, you buy the stock and vote for the deal. If deal does not happen, you still get the cash in trust back. The warrants are struck at 6 and the cash in trust is around $7.71 . At present the warrants trade as a proxy of whether the deal will happen or not. You can run some scenarios and you will see that the stock must go down to at below $6.40, for the current warrants priced at $0.80 to be under the water. You have until Oct 23, 2009 to exercise the warrant. By then, assuming 30 mm capex, company will have about 90 million cash before share buybacks. If the stock can trade at 6 times cash flow before any share buybacks, you are looking at $10 stock price per share or warrants valued at $4. Now, if all warrants are exercised at $6, then you are looking at $8.90 stock price so the warrants are still valued at $2.90. You are looking at a 3.6 to 5 bagger in two years time. The warrants, incidentally, are callable at $11. If you get called, then you are looking at a 6.25 bagger. What about PGRI the stock? If the stock is worth $11 before buyback 2 years from now, that is a 45% return 2 years from now. And for TDYH, the stock is worth about 200% higher(before share buybacks) in 2 years time (2.20 becomes 4.50 and that 4.50 is 45% higher 2 years from now). Personally, I have higher valuations for PGRI 2-3 years from now assuming share buybacks, smart acquisitions and multiple expansion along the lines of Chesapeake Energy.
In conclusion, I like PGRI because it is an investment in a long-term story where you can compound at %30 IRR run by an able team with a capital allocator who understands value. In the short term, because of a combination of confusion, neglect and weariness, there is an opportunity to buy the stock, the warrant or the target acquisition with very good risk-reward scenarios, at potential 2 year returns of 45%(conservative), 500% (a bit risky), and 200% returns(middle risk) respectively.
Catalysts
- Pending deal vote
- Upcoming road show
Catalyst
- Pending deal vote
- Upcoming road show