By Gareth Brown in our one-man Vienna office
Whenever a group of shareholders are selling for reasons other than valuation, it’s the value hunter’s obligation to take a look. That explains how I came to spend a day scratching around ASX listed energy group Linc Energy.
Hoping for greater investor support elsewhere, CEO and major shareholder Peter Bond is pushing to delist Linc Energy from the ASX and relist in Singapore. Many Australian shareholders – either unwilling or unable to own foreign stocks – are hitting the exits all at once, the sort of thing Seth Klarman might dream about.
The stock has fallen about 30% since the move was announced, which is almost certainly the effect of price insensitive sellers. Our interest was piqued, and I spent a day to see whether it might be a candidate for inclusion in the International Fund, where we don’t really care what exchange it is listed on.
If the claims are accurate (and I have no reason to doubt otherwise), Linc Energy is the global leader in technology to convert in situ underground coal into synthetic gas, known as underground coal gasification (UCG). It’s also a leader in converting that gas into liquid fuels like diesel and jet fuel.
There’s been market hype around the technology since Linc listed in 2006. No profits yet, nothing but red ink so far. It is, however, interesting technology and the company has recently announced deals that suggest commercialisation might be taking off. But it’s not much for a non-technical value hound to sink their teeth into – especially one with just a day to spare.
The company is also a major holder of coal reserves in Australia, the US and Poland – the UCG process can be undertaken with deep and/or stranded assets, and so appropriate fields can usually be acquired cheaply.
In addition, the company owns a royalty over a coal development in Queensland, a potential shale oil play in the Arckaringa Basin in South Australia, and an eclectic conventional oil portfolio in the US, including some fields in Wyoming bought out of Chapter 11 bankruptcy, significant Gulf Coast assets and a large but unproven prospect in Arctic Alaska. It owns some smaller additional assets.
There is a lot of optionality in this situation – these assets in total are almost certainly worth something and that something could be a great deal more than the current Linc market valuation. Management certainly believes that’s the case. But I have concerns about several matters, chief of which are listed below.
Firstly, I find the hodgepodge of assets disconcerting. I really can’t tie them all together strategically and the company seems to lack focus. If I understand it correctly, the main idea behind buying oil assets in the US (something like $300m invested) seems to have been generating the cash flow to fund further investment in UCG technology and avoid unnecessary equity raisings. This is a questionable strategy. Otherwise, all R&D companies should go out and buy distressed oilfields. Actually, just about everyone should buy distressed oil fields to fund their future desires. The harsh reality, though, is that only experienced technical players can make a success of it. Does Linc fit that bill?
Alaska, Wyoming and the Gulf Coast were acquired from different sellers in a 6-month flurry in 2011. This doesn’t look like a proven strategy developed over years. The Alaskan acquisition in particular strikes me as blue sky dreaming (more on that in a moment), years away from production and cash flow. I fail to understand how Linc is the best placed company in the world to exploit it, other than to guess that they can dream bigger. That may well pay off but they don’t appear to be the best placed technically or operationally.
Secondly, I find the company almost unbearably promotional. I know both mining and technology are generally promotional spaces, but still. Take for example the Umiat prospect in Alaska, which the company acquired an 84.5% interest in for $50m in 2011. On day one, they claimed oil in place of around 1bn barrels and a recoverable 3P reserves of around 200m barrels.
Nobody in the oil industry doubts there’s oil there, the US Navy first drilled the area more than 60 years ago and their drilling formed the basis for those reserves estimate. But the field may well prove unpredictable, and there’s a wide range of guesses as to what’s recoverable from under the ice at Umiat. Obviously, other oil participants aren’t as bullish as Linc on the size or economic recoverability of the field, or the company would never have picked it up for just $50m.
One year after acquiring the field, and it seems before Linc had drilled a single well, they released an independent valuation (that they commissioned) of the field. Ryder Scott valued it in August 2012 on a 2P net present value at US$1.5bn (using a 10% discount rate, which seems too low). A year later and the 2P NPV rose to US$2.5bn based on legislative changes that affect project economics.
This strikes me as strange. Linc clearly made a contrarian bet here, and will ultimately prove or disprove the value of their investment via the drill bit, not before. And yet they’re spending money on independent valuations before drilling a single hole? And they’re getting a valuation that suggests every other oil company operating in the region is a moron for not bidding more aggressively? The company seems to push this valuation regularly. It’s very promotional behaviour around an asset that is yet to prove itself.
My third concern is somewhat related. The timing of various major announcements is either highly coincidental or a worry. Two weeks after the Umiat initial reserve estimate and NPV valuation from the independent valuer in August 2012, the company undertook a secured notes offering of US$265m.
In January 2013 the company released some exciting prospects for shale gas in the Arckaringa Basin (two more independent reports), followed it with some exciting news from Umiat in March 2013, and then immediately proceeded to raise US$200m via a convertible bond issue.
And then there’s the significant $1bn NPV uplift to Umiat in August 2013, 6 days before the company announces the shift to Singapore and a hoped for equity raising from cornerstone investors. It’s certainly not proof of a ‘pump and raise’ fire, but it does smell a little smoky.
There are other issues. Fairly recently (June 2013) Bond said Linc is a seller of coal assets. Since then they’ve acquired the Blair Athol deposit from Rio Tinto. Admittedly, that seems to have cost them peanuts (though site rehabilitation might not be peanuts) and might just be a good opportunistic deal, perhaps even a useful boost to any coal spinoff or divestiture plan.
But the about face might be noteworthy. There are several media rumours that the company is looking at other coal assets in Australia. And let’s not even get into the issue of the unusual related party transactions highlighted on page 103 of the latest annual report, nor the question of ‘why Singapore?’ rather than Australia or the US, where the key assets reside. (Perhaps the bubble in Singaporean small cap mining and oil stocks, which popped in dramatic fashion earlier this week, goes some way to explaining the latter).
All this gets me to wondering about the common thread here, being manager/major shareholder Peter Bond. What sort of character does is take to believe you can master UCG and gas to liquids technology and commercialise it, acquire distressed coal and oil assets all around the place and find the next North Slope giant oil field while you’re at it?
He’s clearly an outsider and I think that could be his most important asset, it takes outsiders to break new ground. But it also means risk. According to this 2012 article, Bond is a university dropout with no official technical training.
I believe that the world chronically undervalues outsiders, so all power to him. But is he really likely to nail it against conventional wisdom in multiple fields all at once? Perhaps more intriguing is that Bond is a big fan of self-help gurus like Brad Sugars and Tony Robbins, and attended a 14 week tour with Robbins on a ‘platinum partnership’ years ago. According to the article, ‘Anything relating to emotional intelligence became a prized learning tool for Bond and he quickly discovered his strengths lay in reading people and understanding what makes them tick.’
So he’s introducing world-changing new technologies, outsmarting old foxes in both the oil and coal industries without a geology degree, and yet his great strength is in ‘reading people’? Bond is not a traditional stock promoter. He owns a truckload of stock in the company and doesn’t appear to have ever sold any shares. Nor does he take a massive salary. He seems genuinely intent on making money with, rather than from, other shareholders. But that doesn’t prove he’s immune to his own hyperbole, which may well be the main risk here.
I haven’t done a detailed sum of the parts analysis of the company, it’s probably beyond my skill set. There may be significant latent value there and today’s buyer might do very well, especially in light of the senseless selling.
Perhaps my concerns about Bond are completely unfounded. And even if well founded, there’s nothing to stop a dreamer turning a large fortune into a massive one. Being sceptical has generally paid off in my career. But I remember expressing discomfort about Twiggy Forrest before Fortescue. Missing just that one opportunity might outweigh by multiples the amount I won’t lose on 100 other dreamers over an investing lifetime. So take my scribblings as you will. But Linc Energy is not the sort of speculation ever likely to find its way into the International Fund’s portfolio.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.