Every now and then the most important part of the quarter is not the earnings. That was definitely the case for Contango Oil & Gas (MCF). The company replaced its credit agreement with a new 5-year agreement while management went on a shopping spree. The replacement of the credit agreement was accompanied by some drama.
Source: Seeking Alpha Website January 10, 2020
As shown above, the stock price dropped significantly over fears of the impending maturation of the credit line in place. Once the credit line was replaced, then the stock rallied. The company did need to sell more than 40 million shares of common stock and do a private placement of preferred stock with the largest shareholder of the company. However, shareholders were not wiped out through a reorganization. Therefore, the replacement of the credit line has to be considered a success for common shareholders.
Now management can get on with the business of rebuilding a company that once had a great growth track record but has since fallen on hard times.
Management has a focus to grow “inorganically”. Specifically by looking at bankrupt and other distressed property for “bolt-on” acquisitions. The company has three main areas to emphasize: Oklahoma, the Southern Delaware Basin, and the shallow offshore. Therefore, the key strategy will be to limit operations to consolidation and the minimum necessary drilling requirements to emphasize debt repayment while remaining flexible for more acquisitions. This company intends to be a consolidator while the perceived acquisition and disposal market deteriorates. In short, the immediate strategy will be growth by bargain hunting.
The signs of an industry bottom are beginning to proliferate. Exxon Mobil (XOM) has definitely raised its activity level. Exxon Mobil has long had a counter cyclical strategy as part of its long-term growth. This management has generally “sat out” high pricing activity times and waited for the current spate of bad news (recession around the corner and weak commodity pricing) to begin the next stage of growth. In addition, Comstock (NYSE:CRK) has been scooping up assets in the Haynesville area.
In the meantime, John Goff, with considerable experience in the industry, purchased enough stock to become the largest shareholder and chairman. He has obviously directed this company to begin a bargain shopping spree strategy.
The management purchases have nearly tripled the reserves of the company. This takes some of the “sting” out of the share dilution needed to restore the company to financial health. Common shares outstanding more than tripled to 85 million shares and the preferred stock is convertible to common shares as well. However, this was a far better result than many managements choose.
The preferred convertible stock needed to be issued to properly fund the company pursuant to the new loan agreements. However, the company had run out of authorized common shares to issue. Therefore, management found a way around this until the preferred can be converted by raising the limit of authorized common shares.
This was accomplished by giving the preferred shares the right to vote on an “as converted” basis with the common. Once the major shareholder committed to this plan, not too many more votes were needed to assure any interested parties that a majority would vote in favor of raising the authorized share amounts.
Source: Contango Oil & Gas November 2019 Investor Presentation
More importantly, the reserves stated above appear to be very conservative. More importantly, the White Star acquisition will add about $60 million of cash flow that this company badly needs. The total purchase price was a bargain at slightly more than two times that cash flow. The Will Energy acquisition will add about $5 million of cash flow over the next year.
The debt had been paid down to about $28 million at the end of the third quarter. The bank line was raised to about $145 million upon the close of the White Star acquisition to accommodate the purchase.
The cash flow generated by the original company operations appear to be around $12 million annually. Taken all together, the company now has cash flow from operating activities of about $77 million for a maximum credit line of $145 million. The proposed operating ratios are a tremendous debt improvement over the mess left by the previous management.
In addition to this cash flow noted above, management drilled several oil wells in the Southern Delaware area of Texas. Two of those have begun cleaning up and initial production. One of those production rates exceeded 1,600 BOED for a new company record. Once all four wells are producing, there will be a significant addition to both reserves and to cash flow.
Reunion With Brad Juneau
This management is also putting the original operating plan back together. On December 20, 2019, the company announced the signing of a joint development agreement with Juneau Oil & Gas. Those with some long-term memories of the history of the company may remember that Mr. Juneau co-founded this company. His company thereafter brought proposals to Kenneth Peak, who ran Contango in those days. That led to many decent discoveries and a good track record for Contango.
If current management can make this arrangement work as well as it has in the past, then shareholders have a lot of very good days to look forward to in the future. This arrangement attracted the attention of T. Rowe Price & Associates enough that funds managed by them invested approximately $50 million. When combined with the sale of another 2.34 million of preferred shares, the company netted about $53 million for general corporate purposes that included the drilling of a well on the latest offshore prospect.
Contango is now in growth mode. Rapid growth does have its own risks. But the presence of John Goff, who is known to have considerable industry experience, will mitigate the risk of rapid growth. In the meantime, the emphasis on the repayment of debt should enable the company to take advantage of more deals as they become available.
The current market outlook for the industry would appear favorable to the consolidator strategy announced by this management. In addition, there are several non-core properties that management wants to sell to raise cash.
Investors should therefore expect at least another acquisition or two in the coming fiscal year.
One of the areas, primarily the Oklahoma leases, can be subject to regulation to mitigate earthquakes. Management appears to have done its homework in this area. Still, there is a risk of a shutdown of some or all of the operations until the source of future earthquakes can be determined.
Management does have to properly run these properties once they are acquired. There is always the risk that the properties do not meet expectations.
There is no assurance that management will succeed in finding enough “bolt-on” opportunities to realize the advantages of size that are envisioned.
Management may overpay for an acquisition.
The new venture with Juneau Oil & Gas may not yield the results expected.
This management is unusually experienced for the size of the company. This is one of the few times that past financial history probably will not apply to the future. This management intends to build its own oil and gas company from scratch using many of the current assets and operations as a cash register. Therefore, investors would need a lot of faith in the current management to invest in the company. That faith appears very well justified. But not all investors are comfortable making an investment in a company that essentially does not have a track record. As this management proves itself, more investors will notice the company and the stock price should appreciate considerably from current levels.
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Disclosure: I am/we are long MCF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may buy more MCF at any time.
Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.