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Catching a moonshot with Helios and Matheson

Every once in a while I get one right at just the right time. It doesn’t happen often, but it certainly is nice when it does.  Such has been the case with Helios and Matheson.

I owe this idea to Mark Gomes.  His article led me to the story.

Before I start this post, let me just say I am pained to write about a stock that has gone up so much.  I don’t intend this to be an endorsement of the stock at this level, particularly in the short run, as it could as easily drop as rise 10% or more today (I see the stock is down almost 15% in pre-market on this news, which doesn’t seem all that bearish to me at first glance).  Nevertheless my thought process in this particular case is worth recording and that is what the intent of this blog really is, so here it goes.

I’m not going to step through the story in this post.  There are plenty of other places where that has already been done, both in Mark’s article and this one here.  There is also a good two part series interview with the CEO of MoviePass on the Forbes website (part 1 and part 2).

After learning about the story, I spent all of Monday delving into it.  With some trepidation I bought stock in the $3.50’s and then watched the price rise and then fall back to below where I bought it at the end of the day.

On Monday evening I spent a significant amount of time deliberating about my position.  There were at least a couple of times where I was on the verge of selling my shares first thing Tuesday morning.

Why such anxiety?  Because it is not an easy story to accept at face value.  The business model, essentially selling unlimited monthly passes for movie tickets (the only limit being one purchase a day) is, at least on the surface, a wildly unprofitable proposition.  Every time a customer goes to a second movie, MoviePass loses money on that sub.

This is why, and not without good reason, the company is derided on twitter by most of those with a serious take.  Its very easy to conclude that MoviePass is destined for bankruptcy.  I made a single tweet about the company today (I was afraid if I made more my inbox would see a deluge of nastiness) and the first response I got was ‘it’s called a Ponzi scheme’.

I don’t believe that a Ponzi scheme is quite the right parallel even if things do go awry, but I admit I have no crystal ball to say that all will end well with MoviePass.  Nevertheless I held more than half of my shares today, even as the stock rose some 60% (I admit I did sell some shares, you just have to after that kind of day).

But why did I hold most of what I owned?  Well some of it was momentum, the low float, the past fluctuations in the stock (it rose to $17 last summer, albeit with a much lower share count), but those reasons alone aren’t enough.  There are always circumstantial reasons to stick around.   What gave me the conviction to stick to the stock, to not sell at the open, or when it was up 10% or 20% on the day, was a shift in how I started to think about the stock on Monday night.

Those with harsh criticism of MoviePass are thinking of it as an established business.  It can’t be profitable right now; they are paying full price for tickets and every additional theater goer adds losses to the bottom  line.  The losses are going to accumulate and the company is destined for bankruptcy.  That is the chorus.  That is also how I was thinking about the stock when I was ready to cash out Monday evening.

But what if we start thinking about MoviePass like a start-up.  An early stage start-up doesn’t worry about monetizing.  They worry about disruption, growth and capturing market.  I’m no VC, and maybe this is just me being naive, but it seems like the thesis with many start-ups is that by the time they are ready to monetize, they expect to be big enough that options will present themselves that are not identifiable just yet.  And sometimes that logic is correct.

MoviePass has went from 16,000 subscribers to 400,000 subscribers in a month.  It is undoubtedly going to be much higher in another month.  While I don’t know exactly how they can monetize their subscriber base, I do think that their options (and leverage) increases as their base grows.  Maybe they will be able to leverage their size against the bigger chains.  Maybe the early adopting chains will show such growth that the larger chains will relent.  Maybe ancillary revenues at theaters will increase to a point where it’s a win/win for all.  Maybe they can leverage their data analytics, identifying preferences of card holders and promoting features based on those tastes.

To take a “for instance”, long before I was introduced to Helios and Matheson or MoviePass I read a piece that talked about how important concessions were to the theater business.  The article explained how much money movie theaters made from concessions.  Prices are high and margins are big.  A big part of the business model depends on filling as many seats as possible.  Yet theaters are often far from full.  MoviePass is tailor made to address this problem.  MoviePass is monetizing otherwise empty seats in a way at least somewhat analogous to how the original model for Airbnb monetized empty beds, or how Uber monetized empty cars.

I think its worth noting that there was a NY Post article this morning saying that while AMC has expressed hostility towards the MoviePass model (as they are reeling after being just about to launch their own subscription package), “Regal and Cinemark have taken a wait-and-see approach to the $10 plan.”

Helios and Matheson paid $27 million for a 51% ownership in MoviePass back in mid August.  There is a clause in the agreement they signed with MoviePass that preserves their 51% ownership, even in the event of further issuance of shares.  As I mentioned, at the time of the transaction MoviePass had 16,000 subscribers.  So Helios and Matheson paid $2,500 per subscriber.

Is that valuation realistic?  If it is, then you can do the math on 400,000 subscribers.  If its not, and it seems a little steep to me, then what should a subscriber be worth?  I guess if you think the company will do nothing but lose money then its an easy answer and that number is pretty much $0.  But if you think they are going to be able to monetize their base, then it’s a worthwhile question.

After the run up to a little under $6, Helios and Matheson has a market capitalization of about $75 million including the dilution of the convertible notes and warrants they offered as funding for the MoviePass transaction.

At that price, the current subscriber base, which again increased about a bazillion percent in the last month, is being valued at $375 per subscriber.  If (when!) MoviePass doubles that subscriber base, its $185 per subscriber.  The company thinks they can get to 2 million subscribers. If that happens then we are at less than $75.

Those numbers do not seem out of line to me.  Particularly when the options available for monetization are likely increasing as this base grows.

I know I am going to get a lot of feedback on this post.  And I am going to be told how stupid my reasoning is.  So let me remind the reader that one of the tenants that I try to keep is to hold both sides of the argument in my head at all times, and not to commit to either side fully.  This is never more the case then it is here.  I see both sides.  I understand that the optimistic view of MoviePass might be wrong.  And I’m willing to change my perspective.  If I didn’t own the stock already I would be pained to buy it here, but that is mostly a factor of knowing my own psychology and that I would be whipsawed out on a correction.  However already holding the stock, I am willing to give it some rope as I do see a path.  Maybe its blurry but its there, and the market is telling me that path is being cleared.  So I will stick with it for now.


Getting on the EV Bandwagon

I have taken small positions in a number of EV related mining stocks.  As I tweeted on the weekend, the catalyst to these additions were comments out of China about accelerating the move to electric vehicles.



In this post I’m going to briefly go through the positions I’ve taken.  In a later post I will talk in a bit more detail about the one position (well two actually) that I think is the most interesting to talk about (the two companies, which soon will be one, are called Bearing Lithium and Li3 Energy).  Note that I bought many of these positions earlier in the week, and some have run significantly higher since then.  While I’m still holding all of them, they are in some cases less attractive now then they were earlier in the week, at least in the short term.

Albemarle (ALM) – They are the easiest way to play Lithium.  They are a large producer.  They are also expensive, trading at over 15x EBITDA.  But I didn’t think I was going to get them any cheaper given the news from China.

Lithium X (LIX) – They have 20 % ownership in a deposit in Argentina.   The deposit seems to have reasonably good Lithium concentration (500 mg/L).  They are in the process of a feasibility study.  The deposit is right in the middle of a Lithium corridor, with mines from SQM, Albemarle and Oro cobre.  They also have a 20% ownership in Pure Energy Metals, which has a lithium deposit in Nevada.  They have a $200 million market capitalization.  Here is the company presentation.

International Lithium (ILC) – This one is a bit of a flyer.  Well, they are all flyers but this one more than the others.  They have a 20% ownership in a deposit in Australia as well as some early stage properties in Canada and Ireland.  The lithium concentrate grade of the Australian deposit is low but the size is decent.  Ganfeng Lithium, which is a lithium manufacturer in China, owns 17% of the company.  TNR Gold owns 15% and management owns 14%.  They have an $11 million market capitalization.  Here is the company presentation.

Largo Resources (LGO) – They have a Vanadium mine. Vanadium prices have taken off recently, the latest numbers I can get has prices pushing $11/lbs, after averaging under $6/lbs in the second quarter and even less earlier in the year.  The stock has moved a ton, and has moved another 20% since I bought.  But if you run the numbers at $11/lbs Vanadium its still only at about 6x cash flow.  Vanadium prices have spiked even higher in the past.  I saw one chart that briefly put them over $20/lbs.

Leading Edge Materials (LEM) – I have always enjoyed listening to Jim Dines and he has been on the lithium/rare earth band wagon for some time.  So when I started looking for rare earth stocks I went straight to google and typed in his name.  Leading Edge is his recommendation.  They have a graphite mine and processing facility in Sweden that appears to be nearing production of battery grade graphite.  Graphite makes up 40% of a EV battery by mass.  They have prospects for lithium and cobalt in Sweden/Finland.  They also have a rare earth elements project in Sweden that they released news on today that appears encouraging.  Leading Edge has a $65 million market capitalization.  Their company presentation is here.

Bearing Lithium (BRZ) and Li3 (LEIG) – These two companies will soon be one, as Bearing is in the process of taking over Li3. Li3 has been cash strapped but owns 17.7% interest in a lithium deposit in Chile.  I think of all the positions I’ve taken, I am the most excited about this one, as they appear very cheap compared to other juniors but I haven’t found a good reason for why, other than that Li3 has languished on the OTC and is cash strapped.  I’m going to write this one up in more detail.  If you want a heads-up on that, check out my recent Stockhouse posts on their bullboard.

Why I was willing to add to Mission Ready Services

Yesterday and today have been busy.  I got smacked on Empire Industries and on Blue Ridge Mountain, but also piled into a number of lithium, vanadium and graphite names that has helped claw some of those dollars back.  I will write about those names another time.  Today I was also working on a second post on Mission Ready Services and I wanted to get that out before anything else.

I wrote about Mission Ready Services on Friday.  Over the weekend and yesterday I spent a lot of time researching the company.  The basic question I wanted to answer was whether the company, and its recent news release, are legitimate?

I may yet be proven wrong about this, but so far I do not see anything to make me think it isn’t.

To recap, the news released last week had the following points:

  • Agreement is with a US based contracting party
  • Agreement is for purchases to a large foreign military.
  • Minimum Purchases as per agreement are (USD): Year 1 (2018), $50MM; Year 2 (2019), $50MM; Year 3 (2020), $100MM; Year 4 (2021), $100MM; Year 5 (2022), $100MM.
  • Advance Payments: Distributor agrees to pay Mission Ready (the “Manufacturer”) a down payment equal to forty percent (40%) of the purchase order amount within 10-days of submitting the purchase order.
  • Exclusivity: Manufacturer appoints Distributor, on an exclusive basis, as its sole distributor for the defined territory.

So its huge if it’s the real deal.

As I have dug into Mission Ready, I have actually been quite surprised with the strength of the company’s product.  Here is what I found.

In 2011 a company called Protect the Force (PTF) partnered with the U.S. Army Natick Soldier Research, Development and Engineering Center (NSRDEC) in an attempt to develop a better body armor.  This was in response to soldiers complaining about the bulk and discomfort of existing body armor options.

Together PTF and NSRDEC came up with a new body armor called the Ballistic Combat Shirt.  This article talks is detail about the ballistic combat shirt, describing the creative design that was a departure from existing body armors available, how it benefits soldiers, and some of the awards that it has won.  It references Robert DiLalla, who led the team on the NSRDEC side that partnered with PTF to develop the body armor as well at PTF themselves.

There doesn’t seem to be too much question that the Ballistic Combat Shirt (which Mission Ready has called Flex9Armor for their own product distribution) is better than its predecessors.  DiLalla comments that its “35% lighter, form-fitting and more comfortable”, and reduces the soldier’s thermal burden compared to the Interceptor Body Armor system.  Soldier acceptance has been terrific:

“The Soldiers have spoken loud and clear with more than 90 percent user acceptance in multiple user evaluations,” said DiLalla. “Typically, as we assess new body armor components, we’d consider 60 percent a successful number. So we were quiet surprised…”

There is also a video on Youtube of the armor being tested.

In 2012 Mission Ready merged with PTF, and along with them, acquired their development activities.

In May 2015 the development of the new armor was complete and Mission Ready said the US Army Contracting Command was soliciting bids for the Ballistic combat shirt.  PTF bid on the contract.  The company sounded quite optimistic in the press release.  However it was not to be.   In July 2015 they issued another press release saying that they had not won the contract with the US government.  They met all technical requirements but did not have the lowest price (there is a table below that will show the pricing breakdown).

Being the co-developer of the product, this must have stung.  In response PTF filed a protest.  The outcome of the protest was sustained, as described in a December 2015 news release.

“We recommend that the Army either: (1) reasonably re-evaluate the proposals in accordance with the RFP as written, and make new source selection decisions; or (2) re-examine the RFP’s minimum requirements and evaluation criteria, to determine whether they accurately and unambiguously reflect the agency’s needs, and, if appropriate, amend the RFP, re-open discussions, obtain and evaluate revised proposals, and make new source selection decisions.

The GAO decision on the protest also outlined the original bidders on the BCS.

But nothing much has come of it since.  According to this article, the new armor is being rolled out to the US military in 2019.   PTF isn’t supplying the initial order of the product.  After the December news release articulating that they had won their protest, there was nothing further on the matter.  I think a company called Short Bark Industries (second from the top in the table above) won the bid.  I note this article, which describes the suppliers that Short Bark is using to fulfill its order of BCS, and these government contracts (a government contract for $8.86mm, here for another $15mm, and another for $6mm).  Its worth noting that these contracts are for orders until June 2019 and all orders have been obligated, which means they are filled.  Its also worth noting that, at least from what I can tell, Short Bark is in bankruptcy proceedings right now.

But Mission Ready has kept rights to distribute the armor elsewhere.  The patent on the ballistic combat shirt lists them and the US government as assignees, though I am not sure whether that means Mission Ready actually holds the patent, or whether the patent belongs solely to NSRDEC.  In November 2015 Mission Ready signed an agreement with NSRDEC that gives them exclusive rights to market the Flex9Armor to governments outside of the United States and to other organizations within the United States.

In February of 2016, Mission Ready announced the launch of their version of the Ballistic Combat Shirt, called Flex9Armor.  The armor retails for $500-$600 USD (its worth noting that sometime in the last couple weeks a change was made whereby the retail armor can no longer be ordered on the website).  As described in the news release:

Co-developed with the US Army Natick Soldier Research and Engineering Center and launched by Protect the Force Inc., the Flex9Armor tactical solution is ideal for breaching operations, tight spaces, first-responder protection, and training exercises.  While the Flex9Armor is designed specifically for physically demanding conditions, the low-profile ‘exoskeleton’ design maintains comfort and full functionality for greater articulation in the shoulder and deltoid region.

Since that time not too much has happened in the way of contracts.  Mission Ready has added other products to its portfolio (they acquired a company called ForceOne, announced a small contract for Riot shield covers, and established relationships with the government on a couple of other product developments such as a safety vest for sailors) but revenue from any of the products has been lacking.  Until, of course, the recent news.

The order is so big, it seems most likely that is is from the US government.  The “foreign military” in the news release throws me off that trail, but it is a Canadian listed company, so maybe the US counts as foreign?  Edward Vranic wrote something up last week speculating as much.  As I pointed out, the winner of the previous contract with the US government, Short Bark, appears to be in bankruptcy, which seems coincidental.  But I see nothing about a new tender by the government as of yet, and there is nothing yet in the government contract list.

In some potentially related scuttle that I have to warn you I can’t confirm, there have been some comments on Stockhouse about a 10 year Egyptian contract that they are near finalizing.   Its a bit of hearsay because the presentation that discussed this has been modified.  There was apparently an early version of the August presentation that said they are “finalizing teaming agreement in EagleShield International/Tactical Elite Systems in Egpyt for a 10 year deal that Protect the Force would supply body armor for Egyptian military and later law enforcement”.

In the revised version of the presentation (with the reference to Egypt deleted), on slide 25 it says more generically that “Multiple foreign military and law enforcement opportunities identified since the beginning of 2017– Initial shipments expected to commence in Q4 2017”, which is still a pretty bullish statement.  The same slide also says that Mission Ready is “partnering with ADS Prime Vendor on Air Force Carrier and Armor project” (this one hasn’t been deleted).

The bottom line for me is that if the distribution agreement is legitimate the stock is significantly undervalued.  A contract that delivers $500 million over 5 years is clearly worth more than a $25 million market capitalization.  While I can’t be positive that the distribution agreement will lead to those kind of revenues, there are plenty of signs that it could.  I was however wrong when I implied on Friday that this was binding, it’s not.  It’s a distribution agreement, so what really matters is the first purchase order from that supplier and the subsequent funds from that order (40% of which are required to be delivered 10 days after the PO).

I added some to my position yesterday.   The product is there without a doubt.  The design team they have at Protect the Force is technically sound, has developed other products for the military, and received awards for their work.  The CEO, Jeff Schwartz, has a background in manufacturing and so that gives me some comfort (there is a Youtube video of both Schwartz and CTO Francisco Martinez talking about the company here).  Nevertheless I still have questions about manufacturing in those quantities (the distribution agreement implies quantities exceeding 100,000 per year), but they were in the running when bidding on the vest manufacturng a few years ago, and their bid was described as technically acceptable, so I would expect there is a plan for manufacturing.  Most important, I still want to see a PO.

I can’t say with 100% certainty that things will go forward as hoped, but there are enough signs that I’m willing to scale up my bet a bit.

Taking a Moonshot on Mission Ready Services

This is a tiny micro-cap on the TSX Ventures.  I just came across the stock this morning.  They have a $35 million market capitalization at current levels.  Just yesterday they announced a huge contract with a foreign military for their Flex9Armor and No-Contact Tactical Shield Covers.  The contract is for $50 million USD in the first two years, followed by $100 million USD for subsequent years.

I might be wrong, but the agreement looks more legitimate than some you see announced from small venture plays.  This isn’t an memorandum of understanding (MOU) or letter of intent (LOI) from what I can tell.  I have found those sort of agreements are often not carried out in the end.

Nevertheless, I can’t be positive if the contract is legitimate.  But it appears to be.  What due diligence I have been able to do in the last few hours suggests the company has legitimate products.  Earlier this year they announced a contract with the US Navy to develop Electrician’s Impact Safety vests.  That the company has had successful bids with the US defense industry gives me at least some comfort in the current contracts legitimacy.

Buying the stock here means I am adding after what has already been a large run.  It may be exhausting itself and I may have caught a short-term top, hard to say.  My thought adding here is that A. you never know where these things exhaust themselves and B. if the contract gets executed then I am still getting shares for well under the $50 million to $100 million revenue run rate of the deal.

As always, I am taking a small position only, as this quite obviously might not pan out.

Adding Gold Names

I decided to add more gold names yesterday as it looks to me like gold is breaking out.  I finally got a move out of some of my existing positions.  Americas Silver has jumped from $3.80 to $5.80, Gran Colombia Gold has moved from $1.40 to $1.60 and Klondex Gold has broken out of its $4 choke hold and is trading at $4.35.

First, I decided to add to both my existing positions in Gran Colombia and Klondex.  Gran Colombia had very good news on Monday, announcing that their mine strike had ended.  The stock, at $1.60, has hardly participated in the gold move, and is one of the cheapest gold stocks out there and less than 4x free cash flow.  The hair remains but the settled mining dispute removes some of it,  and I have to think it goes higher.

Klondex is my largest gold position and I added to it yesterday.  My add here was simply that it appears to have broken out from the $4 level (Canadian).  I’ve written about Klondex in the past.  Its been under pressure for months from an unusual GDXJ rebalancing that caused a lot of forced selling from the fund and follow-ons.  I note that there was a 25,000 share purchase by one of their directors on Thursday.

I added two new positions.  First, I added Wesdome.  Wesdome operates two mines at its Wawa complex in Canada and also has two advanced stage projects in Canada.   They have a $320 million market capitalization and $22 million of cash and no debt.  Guidance for the year is 55,000 oz.  I ran a quick comparison of gold companies looking at their enterprise value per ounce produced.  This is super simplistic of course, it doesn’t account for costs, reserves or development projects that are generally big determiners of value. Nevertheless, when I look at Wesdome it compares favorably (at $5,500/oz) to other miners.  There are cheaper one’s out there (for example Gran Colombia and Jaguar Mining, which I will talk about in a minute), but these generally have a lot of hair.  I don’t see much hair on Wesdome.

Jaguar, which I also added, comes out even cheaper, with an enterprise value of less than $1,000 per ounce.  But it has lots of hair.  I actually owned Jaguar years ago.  It has a new management team, a lot more shares, but essentially the same mining complexes.

Jaguar has a market capitalization of $90 million, $20 million of debt and $20 million of cash.

Apart from being really beat down, and very cheap (at least on a superficial basis), Jaguar actually seems like they had gotten their shit together up until the last quarter.  They had consistent production from both their Turmalina, Pilar, and Roca Grande mines.  But production slumped at Turmalina in the first quarter, causing the shares to slide.

The share drop was potentially accelerated by Resolute Funds, which sold 30 million shares over the quarter.  I found this article, which speculates on the impact of the Resolute Funds liquidation.

My bet with Jaguar is that in a rising gold price environment, many past transgressions will be forgotten.  It is also that maybe the second quarter does not portend the future. Jaguar kept guidance in the second quarter, and they had been producing consistently at Turmalina for the past 6 quarters.

Adding a new position in Imaflex, Selling Psychemedics

I added a new position in a company called Imaflex this week. Imaflex trades on the Canadian market.  They produce polyethylene films for packaging, garbage bags and, most recently, agricultural products.  I’ll do a more detailed write-up but for now the thesis is:

  1. this is a small company ($65 million market capitalization)
  2. they just reported strong growth (32% year over year revenue growth in the second quarter)
  3. they are ramping up a new product called Shine N’ Ripe that uses a thin film wrap around plants to increase sunlight and deter insects
  4. that product is gaining traction, having generated $2.1 million of orders in the second quarter on top of $3.3 million in the first quarter, and is driving growth

The company trades at a fairly reasonable valuation of 14x free cash flow based on the trailing twelve month numbers.  Focusing on more recent history, they trade at only 8x free cash flow if you annualize the last quarter results.  This is a small position for me so far, at 0.5%.

Its also in Canada, which means I don’t have to worry about currency, the bane of my existence the last few months.

Selling Psychemedics

A second trade, after much consideration, was to sell Psychemedics.  As the stock rose back to the $21 level I decided I did not have the conviction to wait and see if it would go back into the teens.

Psychemedics didn’t have the best quarter in Q2.  The main culprit was gross margins, which declined from 52% in the first quarter to 48% in the second quarter.  In the last two quarters of 2016, the company had gross margins of 59%.  Historically, margins have been around 50%.

Unfortunately Psychemedics doesn’t give a conference call so we are left with only what they have written to understand the significance of the decline.

What the company said in the second quarter press release was:

In the past quarter, we have made a number of strategic decisions and are implementing a number of strategic initiatives that we believe are in the best long-term interests of the company. Our market share remains strong and we have taken further strategic actions to solidify and strengthen our long-term position in the market. In addition, we now have established a wholly-owned subsidiary in Brazil and have brought on a Country Manager, a Brazilian national to manage our business in Brazil and work with our distributor. We believe in the long-term attractiveness of this market and are willing to make short-term investments and sacrifices.

In the 10-Q they said that “the decrease in margin was attributable to a mix of business, the inclusion of Brazil sales taxes and additional depreciation from equipment placed in service.”

I have been worried that Psychemedics had lost market share in Brazil to a competitor, Omega, that had just started operating in Brazil 3 months ago.  Omega stated on their website that they have achieved 25% market share in Brazil in the first 3 months of operations there.

But after talking to management I got the impression that Omega’s press release may have been optimistic and that while they are now a competitor in Brazil, they have not scaled to the degree they are suggesting.  There was a lawsuit between Omega and (indirectly) Psychemedics earlier this year.  There is clearly no love lost between the two companies.

Still, the rising costs/shrinking margins bother me, particularly given the valuation.  I am uncomfortable that Psychemedics is trading at over 10x EBITDA when they are having trouble maintaining margins and there is some uncertain level of increased competition in the Brazil market.   And I can’t help but look at the long-term stock chart and note that it wasn’t that long ago that the stock traded at $10.  It shouldn’t trade at $10 again, but a motivated seller in a crappy market and I think $15 is not impossible.

On the other hand its entirely possible that the market looks past the second quarter, the stock continues to trade at this level for a while, and then we get an upside surprise in the third quarter and its back to the mid-$20’s.  I’ll accept the risk I miss out on that.  If I had a bit more confidence, ie. if I hadn’t just been smacked down by an incessantly strong Canadian dollar, I might be more willing to take the risk.  But given the strength in the Canadian dollar, and my suspicion that the US dollar weakness is not a temporary event, if I am going to own a US stock, it needs to be a lopsided bet. Psychemedics doesn’t feel like that right now, so I’m out.

Love the Illiquidity: Blue Ridge Mountain Resources

Back in June I got an old stink bid filled on Blue Ridge Mountain Resources.  It took a while to fill.  The stock trades on the grey markets, meaning there is no active bid and ask (at least none that I can see), the security is extremely illiquid and can go for days without trading.   You can’t even access the website with their financials and presentations without getting a password from the company, which is why I haven’t written about my position until now.  Recently the company uploaded a recent presentation onto their public site, which gives me the opportunity to talk about my position and refer to that.

Blue Ridge Mountain is the post-bankruptcy resurrection of Magnum Hunter Resources.  I have had pretty good luck with these sort of post-bankruptcy, grey market situations. Here’s the pattern: I wait patiently to get an order filled at  a good price, I wait patiently for the stock to get listed on an exchange where it can get some volume, and then I wait patientlu for it to be revalued accordingly.  It doesn’t happen overnight, but more often then not it happens.  Most recently, this was a successful strategy with R1 RCM (formerly Accretive Health).

Blue Ridge owns significant assets in the Marcellus/Utica basins in Ohio and West Virginia.  They own 77,000 acres in the Marcellus and 109,000 acres in the Utica.  Much of this acreage is in the dry gas and gas-condensate sweet spots. Below are maps of their acreage in each basin (Marcellus on the left and Utica on the right):

The company also has a 44.5% ownership in the Eureka pipeline, which is a gas gathering pipeline in Ohio and West Virginia that snakes through the Blue Ridge Mountain acreage.

Blue Ridge has a market capitalization of $450 million at $9/share.  At the end of second quarter, as they continue to sell off non-core assets (Magnum Hunter was a bit of a serial acquirer, so Blue Ridge Mountain has a range of assets outside on the Marcellus/Utica that are considered non-core, including some Bakken acreage, some Kentucky acreage, and other real estate holdings), they had almost $100 million in cash.  They have no debt.

The Marcellus/Utica Acreage

Forgetting for a second about Eureka, lets just take the Blue Ridge gas assets on their own.  Assuming a value on acreage alone, and assuming that about half of that has overlap between the Utica and Marcellus (I have not found any public information that delineates just how much of the Utica and Marcellus acres overlie each other) the stock is trading at around $2,500/acre.  Recent transactions in the Marcellus/Utica have taken place anywhere between $5,000/acre and $9,000/acre.  Here is a list of recent Marcellus/Utica transactions that I compiled:

The most recent transaction was when EQT Corp acquired Rice Energy for $8 billion.  Here are comments on the acreage valuation of the deal and in the area:

Analysts with The Williams Capital Group LP estimated an average price per undeveloped acre for the transaction of $9,900, “which is roughly in line with core acreage valuations over the past year.” Analysts with Bernstein similarly calculated a per-acre price of around $9,000.

Now I don’t think that all of the acreage is worth $9,000/acre.  I think that some of the acreage might be worth that though, or at least close to it.  The Tyler, Wetzel and Monroe county acreage is all in the same counties as prior transactions, so I would expect it to go in the $4,000 to $8,000 per acre range and some of the Northern most acres might be worth $9,000 or more.  Blue Ridge Mountain announced on their first quarter call that they divested a small number of acres (350) in West Virginia for about $4,500/acre.

I’m less sure about the acreage in Washington county, because I haven’t seen any transactions in that area of late.  Of course this could be simply because Blue Ridge Mountain owns most of the prospective acres in Washington county (if you study their map you will note their leases cover most of the NE quadrant of the state).  They said on the first quarter call that they planned to market the sale of 23,000 non-core acres in the southern part of Washington county in the second quarter.  So it will be interesting to get more details on what they can sell that acreage for.  They also said they would be drilling a well in Washington county in the third quarter of 2017 and the way they worded it gave the impression this is the first well they’ve drilled there in some time.  All of this acreage is within the Marcellus and/or Utica windows, so I doubt that very much of it is going to be worth less than $2,500 per acre.  Some of it is clearly worth much more.

Production for the Marcellus/Utica assets was 74MMscfepd in the first quarter. In the second quarter, because of asset sales, natural declines, and the fact that Blue Ridge hasn’t drilled any wells in a year, production had declined to 65 MMscfd.

The company expects to drill 4 Utica wells in the second half of 2017.  With production from those wells, exit guidance is to get production back to 100 MMscfd.  They described their base rate at between 51-59MMscfepd at year end, meaning that these four wells will add between 30-40MMscfepd.  Their base decline is between 12-15%, which is quite low (this is the one benefit you get when you don’t drill any wells for a while).  Given the low decline of the base production and the high impact of new wells, its not hard to see how Blue Ridge Mountain can grow production once they start drilling.

On a flowing boe basis, the current market capitalization (ignoring Eureka completely) values them at $32,000 per flowing boe net of cash.  That number is much lower if you use exit production guidance.  It is also not reflecting what is really valuable; the sizable undrilled land position with no wells on it throughout West Virginia and Ohio.

Eureka Midstream

While a case can be made that the natural gas acreage exceeds the current value of Blue Ridge on its own, there is also the Eureka pipeline to consider.  Eureka has been underutilized for the last number of years because of limited takeaway capacity from West Virginia and Ohio.  It currently operates at about 30% capacity.  Nevertheless, the midstream operation is expected to generate $66 million of EBITDA in 2017.  This guidance was reiterated in the second quarter.

Pipeline assets can go for up to 20x EBITDA.  At 15x EBITDA Eureka would be worth about $300 million to Blue Ridge.

But there’s a catch.  Morgan Stanley has a majority ownership (54%) in the pipeline.  But Morgan Stanley also has a preferential return clause for their ownership: the return on their original capital investment is guaranteed a minimum of a 10% IRR in the event of sale.  This works out to a preferential return of $672 million if a sale was completed this year.  Below I clipped the relevant clause from the bankruptcy documents:

The preferential return clause makes me a little uncomfortable valuing Eureka.  Its not clear to me what incentive Morgan Stanley has, as majority owner of the pipeline, to initiate a sale if they can watch their investment grow at 10% annually.

Nevertheless, the pipeline ownership is worth something.  In its 2016 year end financials, Blue Ridge Mountain recorded their equity interest at $185 million.  This is after a write-down of $180 million that the company took in November 2015.

Obviously, Eureka’s value could increase substantially as new takeaway capacity is brought on to take gas out of the Marcellus/Utica basins, which will allow midstream assets like Eureka to operate closer to full capacity.  Blue Ridge Mountain said in the first quarter that they expected Eureka to exit the year with 1.1bcfpd of gas flowing through Eureka, up from 850mmscfpd currently.  This 30% increase in throughput should help Eureka get closer to the 10% IRR that is consistent with the Morgan Stanley clause.  Assuming a corresponding bump to EBITDA, Eureka would generate $85 million of EBITDA in 2018, which at a 15 multiple would value Eureka at $573 million for Blue Ridge Mountain.

The company has said that they are exploring options with Eureka.

Summing it up

So what’s it all worth?  Well there is a lot of uncertainty with the numbers.  With Eureka I can get anywhere from $150 million to $600 million.  With the Marcellus and Utica assets it could be between $400 million and a billion depending on what you value the acreage at.  So its a pretty big range.

But what I feel pretty comfortable saying is that together these assets should be worth more than the current stock price.  Maybe significantly more.  The hard thing is accumulating the stock.  I think you have to just put in a reasonable bid with a long date and wait for it to come to you.