The Value trail...

[petekoch]

Originally Posted by npg

Good stuff, Great!!!

HOV,DHI,BZH and MDC. Any other candidates we can slap on the operating table for an examination?

I felt like resurrecting the Value Trail thread again. Once again, we should prevail upon Justin to create a Value Trail main section.

I mentioned somewhere that I had taken a disliking to the homebuilders, largely because most, if not all, appear to be seriously shareholder unfriendly. I also mentioned that MDC seemed to have the leanest inventories of this troubled sector. Turns out that despite losing @$8/shr, CEO Larry Mizel managed to award himself a $2M bonus in 2007, ostensibly for accomplishing those wonderful numbers.

Mizel is not the exception. Be wary of the homebuilders.

Refining is a fragmented business, but the refiners' margins have gotten cut and the stock prices have been taken down, so I'm watching VLO again. I might look at purchasing it (but at even lower prices), although I get the feeling that some wide-moat businesses will be buy candidates before summer's end.

[nilminih]

Wow Pete,
Where did you find that face?? VLO has a good CFC and we have to check the management and other data. I am also looking at TSO. Any comments?

Originally Posted by petekoch

I felt like resurrecting the Value Trail thread again. Once again, we should prevail upon Justin to create a Value Trail main section.

I mentioned somewhere that I had taken a disliking to the homebuilders, largely because most, if not all, appear to be seriously shareholder unfriendly. I also mentioned that MDC seemed to have the leanest inventories of this troubled sector. Turns out that despite losing @$8/shr, CEO Larry Mizel managed to award himself a $2M bonus in 2007, ostensibly for accomplishing those wonderful numbers.

Mizel is not the exception. Be wary of the homebuilders.

Refining is a fragmented business, but the refiners' margins have gotten cut and the stock prices have been taken down, so I'm watching VLO again. I might look at purchasing it (but at even lower prices), although I get the feeling that some wide-moat businesses will be buy candidates before summer's end.

[joshuat]

MCF update

It doesn't seem like anyone is interested. Anyway, the stock is now at $80. I'm not sure if the scenerio has fully played out or not. $80 could be fair value. Basically, Peak has announced that he will sell the company, and spin off the 'remaining assets' into a new company, Contango Energy. Some people are valuing the sale price right around the $80/share price, but that depends on who buys. A company with a lot of NOLs, or who will find a strategic value in owning this much NG, may very well pay more. Mark Sellers' fund has been buying up the stock in this price range, and filed a 13D indicating his intention of being an activist shareholder in the breakup. This doesn't thrill me - while he is one of my favorite people to track, I don't think Peak needs any help (interference) in the finance department. His wealth is tied up in Contango, and he is going to sell it for a dear price. On the other hand, this indicates that Seller's expects an eventual price well in excess of $80. (also, they are still drilling, and may make additional strikes, upping the proved reserves, thus upping the sale price. Or, not, if they hit a dry one).

The sale will be the dutch and mary rose strikes, which is essentially all of the business. Remember the like kind exchanges I wrote about - basically the company was able to sell a lot of very profitable (like x10 capital) parts and pay no taxes, by buying up more of the dutch and mary rose interests. So, now they will sell it. The upside: Contango will pay no taxes. The downside: the shareholders will. Perhaps this is where Sellers will come in - structuring this to the advantage of the shareholder.


What gets me is all this information was available last summer/fall, and it got no interest.

Anyway, this spinoff sounds very uninteresting, so, of course, I am salivating. Why?

The sale of the dutch and mary rose will be the sale of everything of tangible value. It's everything but the filing cabinets, basically. What on earth are they spinning off?

Recall that I explained that all of MCF's value came from the IP: their ability to search for NG using their supercomputers and geologists where hundreds have already looked, and find the biggest strike in decades. And that is what is being spun off.

The second major value is Peak's financial prowess. That is more murky. He is partially retiring. He will be chairman of the new company, but the CEO and CFO roles will fall to other MCF employees. Sounds uninteresting, yes? Recall that he only has 6 employees, which means that any of them basically will understand the business inside out.

When the sale occurs, shareholders will get a big lump of cash, and some free shares of the spun off company.

What usually happens in spinoffs like this? Historically, people sell, sell, sell. MCF is already small (market cap barely over a billion), the spinoff will be a microcap. Any institution is just going to sell this - it's not worth tracking on the books, and they often have rules that prohibit holding such tiny companies. The 30 major shareholders who hold 75% of the company? That's the wildcard. Most of them are Peak devotees, who got in when it was selling under a dollar. Probably some of them will want to take the ride again, but hopefully others will dump the stock, worried that Peak is not in charge. The big problem is that the stock becomes speculative. the value was obvious with MCF, with proven gas, an LNG port paid for by others, etc. Now, the new company has to start from scratch, and look for a new 'find of the decade.'

I cannot predict what will happen, but I'm hoping for a big sell off. If Peak's wealth is in any way tied into this company, I will probably buy every share I can get my hands on. I find it difficult to believe that he doesn't have new ideas for exploration, new finds ready to purchase, and that he is creating all of this just on a lark.

Greenblatt's book "How to be a Stock Market Genius" explains how to analyze spin offs like these; I'm mostly parroting him. Look for the spinoff that is structured to look very unattractive, but that has the owners of the original company set up to receive a lot of the stock. That's often the mark of a very valuable business being set up to look very unattractive, to push the share prices down so that as many shares as possible can be bought on the open market.

Anyway, no promises. I'm sad that the company is being sold, as these were "for life" shares for me. I take solace in the idea that the spinoff may have a lot of value hidden away. Let's watch.

[npg]

Interesting how this one is going to play out. TA for update

[joshuat]

I don't think I explained the valuation process. Oil and gas are valued using PV-10, which is the present value of future gross revenue, discounted at 10%. I.e., a basic discounted cash flow. MCF's PV10 as of April was $1.8 billion. Note this is gross revenue - there are little things like taxes to be paid. MCF's current market cap is $1.2 billion, or around 40% less than the PV10 value. When you consider corporate tax rates run at 35-40%, the current stock price sounds rational.

However, recognize that the PV10 pricing assume current prices for oil and gas. It used $9 for gas and $90 for oil. If those prices goes up, the revenue will go up, and ditto if the prices go down. A natural gas bull will value the company at higher than the PV10 price. It also is based on current production rates, and what the production rates should be in the future.

Also, MCF continues to drill new wells, and just acquired a new lease block in the gulf of Mexico, and is drilling another well that is "interesting".

I probably sound like I'm flogging the stock, but it's not clear to many how to value these companies and assets, and as I learn I'm trying to share insight. Right now I'm just waiting for this deal to close, and have my eye on another natural gas company that might be the next MCF.

[joshuat]

Update on the spinoff. Contango is currently drilling Eloise, another wildcat well, and this will form the basis of the spinoff into Contango Energy. He calls it a wildcat. I wonder why he would set up his best people in control of a company if he didn't think there was deep value there. Dutch and Mary Rose was the biggest find in 25 years; he probably did not do it again with Eloise. Regardless, I'm holding, and buying if the spinoff drops after opening.

Most would argue MCF is at fair value now. However, he is shopping for an international buyer who is playing with "monopoly money" - i.e., the low dollar will make MCF cheap. The hope is to get more money from an international player who views the assets as a strategic play. We shall see.

If you want to learn how great management works, look at Ken Peak sometime.

[joshuat]

Bump for MCF.

Full disclosure: I sold all my shares @$92. That was fortuitous, as I was buying a house, and wanted to remove some market exposure.

MCF was trading at 46 today, and I picked up all I could buy at this price. Why? Well, read what Kenneth Peak says himself:

"Our stock, like many others, has dropped dramatically over the past two weeks. Natural gas and oil prices are down significantly, and our production has been shut-in for all of September, so some decline is to be expected. We have run an economic case for our proved reserves, assuming we drill five rate acceleration wells and assuming $7.00 per Mmbtu natural gas and $70.00 per barrel of oil, NYMEX prices flat forever. We then subtracted 35% from pre-tax income for projected federal income taxes. The PV-10 of this case is approximately $1.3 billion or $78.00 per share, assuming 16.9 million shares outstanding. Our reserves have been in place for about 50 million years and aren't going away because of a storm. We have no debt and only six employees and thus our ongoing financial commitments are minimal. Contango has now purchased approximately 100,000 shares. We have approximately $40.0 million in cash and are continuing to purchase shares."

I love the sentence "Our reserves have been in place for about 50 million years and aren't going away because of a storm."

This is a Buffett quality company selling at a greater than 50% discount because of market fear about a storm and oil prices.

Other things to consider: MCF plans to buy back 10% of the outstanding shares - the 100K shares bought so far are a drop in a bucket. Peak was buying shares with his own money in the 75-80 range recently. The estimates above are based solely on proved reserves - it doesn't take into account infrastructure, cash reserves, the 35 leases they own, or Eloise. It assumes that Oil will drop to $70, and never go higher. This $78 value is a deeply conservative valuation.

The sale was called off when oil/gas prices dropped. Do not think that this means the value disappeared - it was merely Peak ensuring that he maximizes shareholder value. The company is wildly valuable at current oil prices, and break even at prices we haven't seen in a very long time.

MCF tripled for me in under a year, and helped put me at something like 80% up for the last year over my entire portfolio. When you find identifiable value like this, you buy big. Unless you think 50 million year old assets will disappear in the next year or so, or a company with no debt and 6 employees will be affected by this credit crisis, which is what Mr. Market is betting. I'll take that bet anyday, anytime.

[joshuat]

Today news was released that MCF received bids for $75-80 for just Dutch and Mary Rose. This was during the NG crash, and the bids that Peak rejected. Putting the rest of the company at, oh, 10 bucks, we have a minimum price of $85. It's trading around 50 right now.

Someone was asking a week or so ago how Buffett determined that Petrochina was so valuable. It's just this simple - value the reserves, compare to the market cap. Here we have several independent sources to verify our math - the math of Kenneth Peak himself, the independent auditors, and the math of the bidders. If you aren't prying the gold fillings out of your children's teeth while they sleep at night to buy some of these shares, I'd love to hear your contrary thesis. :)

[npg]

Sounds like a great coup. Alas, I cannot do the legwork on this one myself, so I pass.

That doesn't mean its a baddy, it just means that it's beyond my circle of competence.

Great find. Happy to hear it worked out so well for you.

[roicommunity]

Originally Posted by joshuat

Today news was released that MCF received bids for $75-80 for just Dutch and Mary Rose. This was during the NG crash, and the bids that Peak rejected. Putting the rest of the company at, oh, 10 bucks, we have a minimum price of $85. It's trading around 50 right now.

Someone was asking a week or so ago how Buffett determined that Petrochina was so valuable. It's just this simple - value the reserves, compare to the market cap. Here we have several independent sources to verify our math - the math of Kenneth Peak himself, the independent auditors, and the math of the bidders. If you aren't prying the gold fillings out of your children's teeth while they sleep at night to buy some of these shares, I'd love to hear your contrary thesis. :)

Joshuat,

Do you know the reasons behind the progressive decline in price for this stock during most of the summer? The reasons you have cited earlier explained why MCF was going up. I would like to understand why the market chose to lower the value of the stock by such an extent during the recent months especially when many companies in the industry were reporting outstanding profit.

Curiour,

JD