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Posts from the ‘Blue Ridge Mountain Resources (BRMR)’ Category

Week 372: Stealth Correction (also updates on Mission Ready, Blue Ridge and Empire Industries)

Portfolio Performance

Thoughts and Review

First off, the portfolio updates in this post are as of August 24th. I’m a little slow getting this out.  So the numbers don’t include what has happened in this last week.

I really got it handed to me in August.  The portfolio was cruising to new highs in July but those were short lived.  Top to bottom I saw a 6% pullback in a little over a month before finally bouncing a couple weeks ago.  Fortunately that bounce has continued this last week so things aren’t as dire any more.

What was funny about the move is that it didn’t feel like things were going that badly.  Usually when I lose 5-6% in a month (this seems to be an annual occurrence for me) I’m tearing my hair out, contemplating throwing the towel in, and generally in a state of disrepair.

Not so this time.  I have been surprisingly unconcerned by the move.

Why have I taken it in stride this time?  Here are a few reasons I can think of.

1. I lost on stocks that I still have conviction in.  Take for example Gran Colombia Gold (which is one of my larger positions).  I’m just not that worried about the move, as painful as it has been.  I’m still up on my position, and it remains cheap with no operating concerns.  I don’t feel like it warrants my worry.  RumbleOn was another (another large position), touching back into the $5’s at various points over that time.  We know what transpired there this last week.

2. I was getting beat up almost entirely by my Canadian stock positions.  Its probably irrational but I don’t worry as much when its my Canadian stocks that are going down.

3. Earnings for most of my positions were pretty good, even if those results weren’t reflected in the stock price.  Vicor was great.  Gran Colombia was stellar.  RumbleOn was fine.  R1 RCM was another stand-out, as was Air Canada.  No complaints.

Anyways it is what it is.  Things have gone better this week.  In the rest of the post I want to talk about 3 stocks in particular and these have turned into rather long excursions.  So I’ll leave any further portfolio comments for another time.

Mission Ready Solutions

Mission Ready has been halted since July 18th.  Nine times out of ten if a stock is on a 6 week halt it wouldn’t be a good thing.  Yet I’m pretty sanguine about the company’s prospects.  The news so far has been pretty good.

The big news happened on July 31st, when Mission Ready signed an LOI to acquire Unifire Inc.  They followed this up with an update on the foreign military agreement on August 2nd.  Then there was another news release August 7th that gave more detail on the foreign military agreement and more detail about the acquisition.  Finally they followed all of this up with a conference call to investors on August 15th.

Having spent some time reviewing Unifire and the deal, I am of the mind that it is a good one.   I am also cautiously optimistic that it will close.  On the conference call the CEO of Unifire was in attendance and spoke at it.  While that doesn’t mean it’s a done deal, his attendance and all the detail provided by Mission Ready points to it being well along.

Here’s the deal.  Mission Ready acquires Unifire for $9 million USD.  The purchase price is comprised of $4 million in cash and 26 million shares (priced at 25c CAD.  They are also taking on at least $6 million of debt (I say at least because Mission Ready didn’t specifically say what Unifire’s total debt was, only that they would be paying back $6 million USD of debt upon close).  With 129 million shares outstanding at $0.25c, $15 million works out to about 50% of the Mission Ready enterprise value.

Unifire is bringing a lot to the table.

As per the first press release Unifire’s “trailing revenue for the 6-month period ending June 30, 2018 was approximately USD$18.3 million”.  Their net income was $750,000 USD.  That’s a lot more than what Mission Ready has (as per the second quarter financials, Mission Ready is running at about $1 million of revenue a quarter).

More importantly, in the second press release (the one where they expanded on the details) Mission Ready pointed out that Unifire was the following:

  • A Department of Defense Prime Vendor.
  • A contract holder for the Defense Logistics Agency (“DLA”) Special Operational Equipment (“SOE”) Tailored Logistic Support (“TLS”) and Fire & Emergency Services Equipment (“FESE”) programs.
  • held “multiple General Services Administration (“GSA”) schedules, blanket purchase agreements and contracts with organizations such as the Department of Homeland Security, the U.S. Army Corps of Engineers, West Point United States Military Academy, Idaho National Laboratories, Hanford Nuclear Facilities, United States Air Force, United States Marines, United States National Guard, United States Navy, and many others”

I dug into this a little bit further.  Turns out that Unifire is actually 1 of only 6 participating vendors from the DLA Troop Support program (from this original Customer Guidelines document issued by the TLS).  Here’s a short list of the types of equipment offered by this program:

What does being a vendor of this program mean?  It means that if, as a government organization, you want to order one of the 9,000 items covered by the Troop Support Program, you can (I don’t believe the program has mandatory participation but I’m not sure about that) do it through one of these 6 vendors via this program and get subsidized product.

So who would order through the program?  According to ADS, “authorized Department of Defense, Federal Government and other approved Federally-funded agency customers”.

The overall amounts of product involved are significant.  According to this article:

With both being small-business set-asides, and continuations of prior contracts, the first contract will be used to procure special operations equipment (SOE) worth $1 billion per year, and the second will allow for the purchase of a total $985 million in fire & emergency services equipment (F&ESE).

These are big numbers.  So when Mission Ready stated the following in the August 7th news release with respect to Unifire’s justification for entering into the merger, they weren’t kidding:

Unifire has been limited in its ability to secure the initial capital required to facilitate many of the larger solicitations. Mission Ready has identified sources of capital that will enable Unifire to pursue TLS solicitation opportunities on a much larger scale than they have been able to at any point in their 30-year history, thereby creating immediate and significant growth potential.

Unifire has been getting maybe $30-$40 million a year in total revenue.  But its sitting in the enviable position of being 1 of 6 companies participating in a $2 billion program.  The lost opportunity is significant.

That said, Unifire is a significant vendor for the Department of Defense.  Here is Unifire’s revenue from contracts over the past few years (from Govtribe.com).  It seems to mesh up fairly well with Mission Ready’s stated revenue numbers for Unifire:

In fact Unifire appears to be the 15th biggest Construction and Equipment vendor with the DOD.

What Mission Ready is apparently bringing to the table is availability of capital.  They are going to raise $15 million USD at 25c [note: it was just pointed out to me that the 25c number wasn’t communicated and there was no pricing specified for the PP.  I could swear I read or heard that number somewhere but maybe I’m getting this mixed up with the Unifire shares.  I’ll have to dig into this].  They are also going to enter into a credit facility of a minimum $20 million USD amount.  The idea is that with the capital, Unifire will have a higher “solicitation readiness” and be able to bid on much more than the $2 million per month that they can right now.

Of course the other thing Mission Ready has is a suite of products that will fit nicely with what Unifire offers, and to which Unifire’s manufacturing capacity can be utilized.  And they also have this massive $400 million LOI with a foreign military that we continue to wait on.

On that matter of the foreign military distribution agreement, it appears the wait will continue.  In the August 2nd press release they explained what we already knew.   They had expected to receive orders by now but that this hasn’t happened and while they expect to still receive orders this year, they really don’t know what to expect any more.

They had more comments on the August 7th news release, which was more upbeat, if not cryptic.  With respect to the foreign military purchase order they said the following:

The Company is working diligently to finalize the Licensing Agreement in advance of the initial purchase order(s) (“Purchase Order” or “Purchase Orders”) and expect to complete the agreement for consideration by all parties no later than August 24, 2018.

You could read into it that they expect of some sort of purchase order soon that they need to get this new agreement in place for?  Maybe?  Bueller?  But who really knows.

Here’s what I do know.  I know that if the LOI for Unifire falls through and no PO comes from the foreign military then this thing is going to be a zero (or at least a “5 center, which is effectively the same thing).

But I also know that if the Unifire deal closes, if Mission Ready closes a $15 million financing and a credit facility of $20 million, if Unifire secures the $100 million of business in the next 18 months that is mentioned as a minimum requirement in the terms of the facility, and if the foreign military PO comes through, this stock is going to have a significantly higher capitalization then the current $25 million (CAD).

Honestly, when I review all the details above, I think the odds are on the latter scenario.

Blue Ridge Mountain

Oh Blue Ridge.  This stock has turned out to be a bit of a disaster.  I bought it at $9 and then at $7 thinking that it could be worth maybe $15 in a relatively short time as they sold the company at a premium.  With the news this week that they are merging with Eclipse Resources that value is likely to be realized over a much longer time period.

I still like the stock and plan to hold my new shares of Eclipse.  But I also recognize that this is a broken thesis.

I think what happened here is two-fold.  First, part of the value in Blue Ridge was in their stake in Eureka midstream, which seemed like it could be valued at $200 million or more itself.  In fact when the company announced the deal to divest their stake in Eureka (back last August), they said that the transaction was valued at between $238 million and $308 million (I’m not going to post the slide that breaks down that value because it has confidential written all over it for some reason).

Well presumably, given that the stock was trading at at $225 million enterprise value before the merger, the market didn’t agree.  The problem was that much of the “value” in the Eureka sale was in the form of fee reductions and the removal of minimum volume commitments (which I don’t believe are going to bring any cash in, though I’m still not sure on this).  So it was different than receiving tangible cash.

The second thing is something I missed originally.  As I wrote about in my original article on Blue Ridge last year, they have a lot of acreage prospective for the Marcellus and Utica.  What I didn’t understand well enough at the time was that much of the acreage in Southern Washington county and northern Pleasant county was outside of what is considered to be the “core” of these plays.  While the step-outs Blue Ridge has had so far have actually been pretty good, there is a lot more work to be done before the acreage gets the sort of value that acres in Monroe, Wetzel or Marshall county get.

I kinda figured this out earlier this year, but by then the stock was in the $6’s, which seemed to more than reflect my new understanding, and honestly even if I wanted to sell it at that level I couldn’t have given the illiquidity.

Well now with the Eclipse merger there is liquidity.  I think what you saw in the subsequent days was a lot of the bond funds that had picked up the stock in bankruptcy and who were now stuck with equity (which could very well be outside of their mandate) selling Eclipse in order to neutralize their Blue Ridge position and effectively get out of the stock.

That this seems to have waned on Friday, in particular given a pretty rough Stifel report on Eclipse, is likely a good sign.

My take is that the combined entity is not expensive.  Here is a little table I put together of what the individual parts and the new Eclipse looks like (my $6.64 for Blue Ridge is based on the conversion of Eclipse at $1.50 per share):

If you look at the comps, the combined Eclipse doesn’t stack up too badly.  5x EBITDA for a company anticipated to grow 20% in 2019 is probably a little cheap compared to peers.

Peer comparisons are hard though because there aren’t a lot of smaller, all natural gas, players in the Marcellus/Utica.  From what I can see its dominated by big companies like Range, Southwestern and EQT.  These companies are 10x the size or more.  They generally trade at higher multiples but that isn’t necessarily instructive.  The smaller “peers” are more oil weighted and in other basins.

So what do I conclude?  I’m going to stick with Blue Ridge/Eclipse because A. it’s not expensive, B. the Blue Ridge management team is leading the combined entity has done a good job operationally with Blue Ridge, C. There is a lot of undeveloped acres between the two companies and if they can prove up even a fraction of them the stock price should reflect that, and D. this is a nice way to play the upside option on natural gas.

But it didn’t turn out the way I expected.

Empire Industries

Empire announced second quarter results on August 27th.  It was another “meh” quarter.  But patiently I wait.

The reality is that Empire has been a perpetual “just wait till next quarter” story since last September when they announced the co-venture partnerships.  They have an incredible backlog of business.  Contract backlog as of June 30, 2018 was $280 million.  The co-ventures have a tonne of promise.  But neither the backlog or the co-ventures have translated into results yet.

They continue to struggle to turn the backlog into profits.  In the second quarter gross margins reversed (again) to 16.7% from 19.6% in the first quarter.  Remember that the magic number the company has said they should be able to achieve is 25%.

The problem has been the continued work through of three first generation rides that are being built at very little margin.  In fact the company said on the conference call that these contracts contributed no margin in the second quarter.  I had hoped that by the second quarter we would see the impact of these essentially unprofitable contracts abate.  But that wasn’t the case.

I talked with investor relations about this and it appears that in the third quarter we should see less of an impact.  But whether this means 22% margins or 18% margins is anyone’s guess.

Management also seem to recognize that their cost structure just isn’t low enough right now.  Part of the problem appears to be that they operate much of their manufacturing out of Vancouver.  They hinted that there are going to be changes in this regard in the next few months.

One of the key opportunities was how rapidly the growth — the market was growing, but with this growth came an increasingly apparent need to improve our cost competitiveness to capitalize on this growth. As a result, Empire has undertaken an aggressive action plan to reduce its cost structure, as described in detail on previous calls by Hao Wang, President and Chief Operating Officer of Dynamic Attractions, a wholly owned subsidiary and the primary business unit for Empire…The organization-wide cost-reduction initiative is well underway, reducing our headcount and fixed costs. Furthermore, we’ve identified and implemented design, procurement and production efficiencies that can improve our execution capabilities and our financial results.

They went on to say that “margin expansion is a top priority”.  This is a good thing because it’s crazy to be letting this backlog pass without making any money from it.

The other piece is expansion.  Again they touched on this (“we’re actively looking at innovative ways to increase our production capacity”) in the second quarter call.  It’s clear that right now they are capacity constrained. For instance, the backlog has essentially doubled over the last year and a half and yet the quarterly revenue is pretty much the same.  Its nice to have a backlog that extends out 3 years but it would be nicer if they could grow revenue a bit.

And then there is the co-ventures.  Nothing to announce but still on-track to be announced this year.

Just to recap the co-ventures, last August Empire announced the creation of two co-venture attractions companies.  The intent of these companies were to partner with “tourist-based locations” to co-own and operate Flying Theatre rides.  One of the companies, called Dynamic Entertainment Group (DEGL), would partner with US locations, while the other, called Dynamic Technology Shanghai (DTHK), would partner in Asia (China most likely).

It was a complicated structure with a rights offering (at 50c) and a private placement to their Shanghai partner Excellence Raise Overseas (EROL) also at 50c.

In total Empire invested $12 million in the ventures.  They own 62.5% of DEGL and (I think) 22% of DTHK.  The ownership in DTHK is via DEGL, which is makes things complicated.  The other 28% of DEGL and 78% of DTHK is owned by their partner EROL.  EROL and Empire invested at the same valuation.  Got that?

This somewhat ridiculously complicated ownership structure can be summed up with the following graphic (from the September 2017 presentation):

At the end of the day Empire gets to own 63% of a venture that will build and operate attractions in the United States and about 20% of a venture that will do the same in China.  Empire also gets to build the attractions that these ventures market.  Originally this was going to be at a low margin of 15% but given the recent results that margin is looking to be pretty much right in line <rolls eyes>.

Way back when the venture opportunity was finalized I was able to dig up more information on the economics of the attractions business.  First, I found information on the economics of what appears to be a fairly similar existing ride called FlyOver Canada.  The attraction is part of Canada place in Vancouver.  Flyover Canada is a virtual flight ride experience.  Its also owned by a public company named Viad, so unlike every other attraction I read about, there is actually publicly available information about its performance. Here is a quick summary from the 2016 Viad 10-K:

Flyover Canada showcases some of Canada’s most awe-inspiring scenery from coast to coast. The state-of-the-art, multi-sensory experience combines motion seating, spectacular media, and special effects including wind, scents, and mist, to provide a true flying experience for guests. FlyOver Canada is ideally located in downtown Vancouver, Canada. FlyOver Canada is rated by Trip Advisor as the #1 “Fun & Games in Vancouver” and has been awarded with the Trip Advisor Certificate of Excellence.

Flyover Canada is essentially a flying theater, which is the exact same attraction that Empire is looking to co-venture.  Empire has built numerous flying theaters in the past and references a number of them on their website’s Flying Theatre description.  It doesn’t appear that Empire built Flyover Canada (it was a competitor Brogent) but they did build Flyover Italy, Soaring over California, and Soaring, a Florida attraction.

Viad purchased Flyover Canada from Fort Capital at the end of 2016.   According to the Fort Capital press release at the time of the sale, the purchase prices was $69 million Canadian (remember if all goes well Empire and its ~$50 million market capitalization is going to own 63% of one of these in the US and 20% of another in China).  Flyover Canada had 600,000 guests and generated $11 million in 2016, so it’s a $20 a pop ride.  In their 2016 10-K Viad gave the following 2017 forecast for FlyOver Canada:

FlyOver Canada is expected to contribute incremental revenue of $9 million to $10 million with Adjusted Segment EBITDA of $5 million to $5.5 million.

The numbers are in US dollars.  Flyover Canada ended up doing $10 million of revenue in 2017, and though there was no EBITDA breakdown I have to assume it was close to expectations.  So it’s margins of 50%+

At the time I talked to IR about the opportunity.  The information I got was that depending on the size of the ride, revenue would be around $8-$14 million USD per year depending on the size.  Margins on the ride would be around 50%. A smaller ride would cost $10 million to $12 million to build, while a larger attraction would cost $18 million.  So these numbers are all pretty much inline with Flyover Canada.

The idea was (and is) that net to Empire’s 60% ownership, and assuming a split with a landowner, they should get somewhere between $3 million to $4 million of recurring EBITDA (CAD) out of the US deal.  I didn’t get any information on the Chinese opportunity.

Empire (via Dynamic Entertainment Group) would partner on the attraction with a landowner in a tourist destination.  The deal would be structured so that Empire got a preferential return until the cost of the ride is paid off.  Empire would make 10-15% margins on the design and construction of the attraction as per their contract with DEGL.  There is also a $3 million subsidy for developing creative content in Canada which would reduce the overall manufacturing cost to $7-$9 million.

The expectation was that the EBITDA should get a multiple of 10x.  Viad bought FlyOver Canada for about that multiple.  Again, if Empire got a 10x multiple on $3 million of EBITDA, that would eat up much of the current capitalization right there.

Overall, it’s always seemed like a decent venture for Empire once it gets off the ground.  The company invested $12.1 million via $8 million in equity and $4 million in debt.  In return they would eventually get the $2-$4 million of recurring EBITDA from the US venture, add two near-term attractions to their construction backlog (one for the US and one for China), and get some additional EBITDA (I don’t know how much) from the Chinese venture.

Of course like everything else with Empire this is a waiting game.  On the call they said “Before the end of the year, we expect to announce our first co-venture location. We expect to have an opening sometime in 2019”.  Hopefully we get an announcement soon.

Portfolio Composition

Click here for the last six weeks of trades.  Note that this is August 24th, so I’m a week behind here.

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Week 324: Underlying Conditions

Portfolio Performance

Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

The late spring and early summer months were a trying time for my investments.

I haven’t written up my portfolio in a while.  Part of that was due to the summer, being away and not having the time to do my usual work.  But I also went through a 3 month period, from mid-May to mid-August, where I lost money and struggled with why. That dampened my spirits for putting pen to paper.

Losing money is hard enough, but it is harder when you have been generally right in your decisions.   I try, like the namesake of this blog, to analyze underlying conditions and let that determine my general bent on sectors and the market.  Where there is a bull market I like to be very long those stocks, and when there is a bear market I like to pull back significantly, retreat into cash, and go short where I can.

Throughout the spring and summer I found myself in a general bull market in US stocks, one that had made me a lot of money throughout the winter.  I was, quite rightly, very long US stocks.  The market kept going up, albeit in fits and starts.  But I began to lose money.  Now I didn’t lose money quickly.  In retrospect that may have been a better route as at least I would have been forced to discover my error.  But instead my losses slowly accumulated over the months of May and June.

What’s more, I did not see noticeably poor performance from any of the stocks I owned.  Sure my names weren’t breaking out to new highs, but my core positions at the time, the likes of Radcom, Silicom, Sientra, Combimatrix, Identiv and Vicor were not by any means breaking down (I leave out Radisys as it is a separate discussion).

It wasn’t until my portfolio was down about 6%, in the middle of June, that I woke up to the fact that something was wrong.  I scoured my list of stocks but found nothing worrisome with the names I held.  I knew that the Canadian dollar had been rising so that must have been having some effect but I had never really quantified my currency exposure.  I had always thought of currency as an afterthought, something that balances itself out in the end.

As I crunched through the numbers on my currency losses, I realized that while in the very long run my theory that currency balances itself out might be correct, in the short run a currency can make or break you.  The Canadian dollar was in the midst of unwinding 2 years of gains in two months.  Measuring my losses from the portfolio top in mid-May, I was 6% down, of which 5% came from currency.

It is here that I made my first big mistake. I was armed with the information I needed to act decisively.  I knew my problem: stocks were in a bull market, but clearly the US dollar was not, and I was, rather unwittingly, very long the US dollar.

So what did I do?  Something that, in retrospect, was absurd.  I made only a token effort towards the problem, taking only the excess US dollar cash in my portfolio and putting it into a Canadian currency ETF.  This effort, while directionally correct,  impacted about 15% of my US dollar holdings and thus did nothing to alleviate the problem.  I followed this up with an even more inexplicable move, even to me looking back on it now.  I put on index shorts to hedge my long positions.

Here I was with losses proving that I was wrong.  I had determined the source of those losses.  And what did I do?  I did something that was likely only to exacerbate them.

It really goes to show how wrong one’s logic can be when you are trying to cling to what you had. The reality, I think, is I didn’t want to do what was right.  What was right was to sell my US stocks.  Not because my US stocks were going down. They were not.  Not because the theses behind these positions was not sound.  They were.  But because I was losing money on those US stocks.

Unfortunately I could not wrap my head around this.  All I saw were good stocks with strong catalysts.  How could I sell my positions?  It’s a bull market!

I spent most of June compounding my problem with band-aid solutions that only dug me in deeper. I fell back on oil stocks as a Canadian dollar hedge.  This had saved me the last few times; in the past the Canadian dollar had risen because oil had risen, so I had gone long oil stocks and my losses on currency were more than compensated with my gains on E&Ps.  I was saved a lesson and left none the wiser to how impactful currency could be.

But this time around the currency was not rising because of oil.  My appraisal that I should be long oil stocks was based on the flawed logic that what works in the past must work again regardless of conditions.  That is rarely the case.  In June and July I bought and lost money on companies like Resolute Energy, US Silica and Select Sands, all the time continuing to hold onto US dollars and lose on them.

I also went long gold stocks on the similar thesis that if the US dollar is weak then one should be long gold.  In this case I was at least partially correct.  That is the right thing to do given conditions. But my conviction was misplaced. Rather than being long gold stocks because I thought gold stocks would go up, I was long gold stocks to hedge my US dollar positions.  You cannot think clearly about a position when you are in it for the wrong reasons even if a right reason to be in it exists.  Thus it was that in late July I actually sold a number of my gold stock positions. It was only a couple weeks later, finally being of a clear head (for reasons I will get to) that I bought them all back, for the right reasons this time, but unfortunately at somewhat higher prices.

As I say it was at the beginning of August that I finally was struck by what I must do.  I’m not sure what led me to the conclusion but I think an element of deep disgust played a part.  I had just seen my biggest position, Combimatrix, get taken over for a significant premium. My portfolio took a big jump, which took down my losses from my mid-May peak from -10% (over 8% due to currency!) to -7.5%.  But then in the ensuing days I saw those gains begin to disappear.  Part of this happened because Radisys laid an egg in their quarterly results, but part of it was just a continuation of more of the same.  Currency losses, losses on index short hedges, some losses on my remaining oil stocks, and the ups and downs of the rest of my portfolio.

I simply could not handle the thought of my portfolio going back to where it was before Combimatrix had been acquired. I was sick of losing money on currency.  And I was reminded by the notion that you never see conditions clearly when you are staked too far to one side.  So I sold.

When I say I sold, I really mean I sold.  I took my retirement account to 90% cash.  I took my investment account to 75% cash.  There were only a couple of positions I left untouched.  And I took the dollars I received back to Canadian dollars.

I continued to struggle through much of August, but those struggles took on a new bent.  I was no longer dealing with portfolio fluctuations of 1%.  The amounts were measured at a mere fraction of that.   This breathing room afforded me by not losing money began to allow me to look elsewhere for ideas.

I don’t know if there is an old saying that ‘you can’t start making money until you stop losing it’, but if there isn’t there should be. When you are losing money, the first thing you need to do is to stop losing it.  Only then can you take a step back and appraise the situation with some objectivity.  Only then can you recover the mental energy, which until that time you had been expending justifying losses and coping with frustration, and put it towards the productive endeavor of finding a new idea.

In August, as my portfolio fluctuated only to a small degree but still with a slight downward slant, I mentally recuperated. And slowly new ideas started to come to me.  It became clear that I was right about gold, and in particular about very cheap gold stocks like Grand Colombia and Jaguar Mining, so I went long these names and others.  I realized that being short the US market was a fools errand, and closed out each and every one of those positions.  I saw that maybe this is the start of another commodities bull run, and began to look for metals and mining stocks that I could take advantage of.  I found stocks like Aehr Test Systems and Lakeland Industries, and took the time to renew my conviction in existing names like Air Canada, Vicor, Empire Industries and CUI Global.

Since September it has started to come together.  I saw the China news on electric vehicles and piled into related names.  Not all have been winners; while I have won so far with Albemarle, Volvo, Bearing Lithium and Almonty Industries, I have been flat on Leading Edge Materials and lost on my (recently sold) Lithium X and Largo Resources positions.  Overall the basket has led to gains.  I’ve also been investigating some other ways of benefiting from the EV shift.  It looks like rare earth elements and graphite might be two of the best ways to play the idea, and I have added to my position in Leading Edge Materials (which has a hidden asset by way of a REE deposit at the level of feasibility study) to this end.  Likewise nickel, which is not often talked about with electric vehicles and has been pummeled by high stock piles, has much to gain from electric vehicles and could see a resurgence over the next couple of years.  I’m looking closely at Sherritt for nickel exposure and took a small position there so far.

I saw that oil fundamentals were improving and got back into a few oil names, albeit only tentatively at first.  Such is the case that once you are burned on a trade, as I was when I incorrectly got into oil stocks in June and July for the wrong reasons, you are hesitant to return even when the right reasons present themselves.  Thus it has taken me a while, but over the last couple of weeks I have added positions in Canadian service companies Cathedral Energy and Essential Energy, and E&Ps Gear Energy, InPlay Oil and even a small position in my old favorite Bellatrix.  A company called Yangarra Resources has had success in a new lower zone of the Cardium, and I see InPlay and Bellatrix as potential beneficiaries.  These newer names go along with Blue Ridge Mountain Resources, Silverbow, and Zargon, all of which I held through the first half slump in oil.

I even saw the Canadian dollar putting in the top, and converted back some currency to US dollars a couple of weeks ago.

Most importantly, got back to my bread and butter.  Finding under the radar fliers with big risk but even bigger reward.  I have always said it is the 5-bagger that makes my returns.  If I don’t get them, then I am an average investor at best.

I found Mission Ready Services, which hasn’t worked yet but I think is worth waiting for.  I found some other Canadian names that I think have real upside if things play out right (in addition to the above mentioned metals an oil names, I added a position in Imaflex). Most profitably, I was introduced to Helios and Matheson after reading an article from Mark Gomes.

I don’t completely understand the reason why, but good things do not come to you when you are mired in a mess of doing things that are wrong.  It is only when you stop doing what is wrong that other options, some of which may be right, will begin to present themselves.

I also don’t know which of what I am doing now will turn out to be right, and what will turn out to be wrong.  I will monitor all my positions closely and try to keep a tighter leash than I have been.  What I do know is that I will not continue to be wrong in the same way I was through the months of May to August.  And that is a big step in the right direction right there.

Portfolio Composition

Click here for the last eight (!!) weeks of trades.  Note that in the process of writing this update I realized I do not have a position in Gear Energy or Essential Energy in the practice portfolio.  I have owned Gear for over a month and Essential for a few weeks.  This happens from time to time.  I miss adding a stock I talk about and own in my real portfolio.  I added them Monday but they are not reflected below.

Note as well that I can’t convert currency in the practice account.  I know I could use FXC but in the past I haven’t, I have just let the currency effects have their way with the practice portfolio. Thus you won’t see the currency conversions that I talked about making in my actual portfolio.  I may change this strategy the next time the Canadian dollar looks bottomy but as I am inclined to be long US dollars at this point, I’m leaving my allocations where they are for now.

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.